Oil prices rising; policy uncertainties continue:: Motilal Oswal

Visit http://indiaer.blogspot.com/ for complete details �� ��

Wall of Worry – the whistleblower series

Oil prices rising; policy uncertainties continue

-     Post the partial deregulation in June 2010, the government has been silent on the next phase of deregulation. While the markets have been expecting diesel deregulation and subsidy rationalization before FPO/divestment of IOC and ONGC, we believe the government is unlikely to deregulate in the near term due to (1) higher oil prices, (2) impact on inflation and (3) forthcoming state elections.

-     Though just four months remain for the end of the current fiscal year and five months have elapsed since partial deregulation, the government is yet to announce any formula for subsidy sharing for the current year.

Burgeoning 2HFY11 under-recoveries

Crude oil prices have increased 12% since partial deregulation in June 2010. 3QFY11 average price till date is ~US$85/bbl v/s US$77/bbl in 1HFY11. If the 3QFY11 average price were to be maintained for 2HFY11,

then the full-year under-recoveries will be Rs655b (as against Rs319b in 1HFY11 and Rs461b in FY10).

Government seems to be in no hurry to deregulate diesel

Post the partial deregulation in June 2010, the government has been silent on the next phase of deregulation. While the markets have been expecting diesel deregulation and subsidy rationalization before FPO/divestment of IOC and ONGC, we believe the government is unlikely to deregulate in the near term due to (1) higher oil prices, (2) impact on inflation and (3) forthcoming state elections.

FY11 subsidy sharing undecided till date

Though just four months remain for the end of the current fiscal year and five months have elapsed since partial deregulation, the government is yet to announce any formula for subsidy sharing for the current year. Our interaction with MoPNG suggests that for the short-term, the government is likely to continue with the formula of 1/3rd sharing by upstream - the OMCs' share would be decided based on their ability to bear the subsidy burden, thus ruling out the scenario of 'nil sharing' by OMCs. 

No respite for OMCs on the refining front

We remain cautious on the refining sector outlook and believe that margins are unlikely to improve meaningfully from current levels. The earnings of all the three OMCs are highly sensitive to GRMs - every US$1/bbl in GRM results in a 13-28% change in EPS. We model GRM of US$4/bbl for FY11 and US$4.5/bbl for FY12 (v/s US$4/bbl in 1HFY11 and last 5-year average of US$5.5/bbl) .

Upstream a relatively safe bet under policy uncertainties

Uncertainties over de-regulation and subsidy sharing can lead to under performance of the PSU Oil companies. We believe upstream companies are better placed than OMCs in this environment. At our base case subsidy sharing assumption of 33% for upstream and 11% for downstream, a US$10/bbl increase in oil prices (from US$75/bbl to US$85/bbl) impacts OMCs' earnings by 15-45% while the earnings of ONGC remain largely protected.