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Yet another effort to curtail subsidies
The recently released interim report of a government panel renews the debate on
effective targeting of LPG/Kero subsidies through direct cash transfers. A pilot will
be implemented by end-2011 but effective implementation is still years away and
will be predicated on the Ministry of Finance agreeing to directly fund subsidies.
We are more enthused by the near term hope of capping subsidized LPG
availability to 4-6 cylinders per connection that could cut u-r by US$1-2bn and lift
SOE EPS by 3-17%. We prefer upstream (ONGC, OIL, Gail) over downstream.
Another shot at effective targeting of subsidies
q The government has long being cognizant of the leakages in various subsidies that
it has administered; overall subsidies in India now approach ~2.5% of GDP.
q It renewed this debate earlier this year by constituting a panel to recommend ways
to implement direct cash transfer of LPG, kerosene and fertiliser subsidies.
q The Nandan Nilekani headed panel recently released its interim report proposing a
general solution framework while also making some specific recommendations.
Rollout of CSMS, UID and financial inclusion; a pilot by end 2011
q The panel recommends the implementation of a core subsidy management system
(CSMS) integrated with the UID enabled bank accounts of customers.
q This will allow LPG and kerosene to be sold at market prices while also
automatically transferring cash to customers in lieu of the subsidy. Over time, the
government will also restrict the allowances to those who really need it.
q The panel recognises the need for a gradual transition and recommends that pilot
studies be undertaken by end-2011 to understand these issues.
q Indeed, the creation of CSMS, rollout of UID and financial inclusion will take time.
Implementation will take time
q The proposal to target subsidies to those that need it is not new and piecemeal
proposal in LPG and kerosene have been attempted before.
q These have faced headwinds from state governments, dealers and vested interests
thriving in the dual price regime. Systems of OMCs also need to gear up.
q While the government does seem more focussed now than before, effective
implementation will take time as our interactions with industry participants suggest.
Will subsidies be funded by MOF; will MOPNG give up control
q In particular, direct cash transfers require the Ministry of Finance (MoF) to
administer subsidies via the budget instead of ad-hoc mechanisms in place today.
q With LPG and kerosene subsidies at US$14bn (0.7% of GDP, US$10 = US$2.3bn)
at current Brent of US$118/bbl, the decision will not be easy to take.
q It may also require the MoF and Ministry of Petroleum (MoPNG) to agree on a way
to formalise the upstream subsidy burden. This will have to take the form of a
special oil tax that will be collected by the MoF. The MoPNG has always opposed
this, instead favouring an adhoc formula which allows it to dictate SOE cashflows.
More hopeful of volume cap on subsidised LPG but not without headwinds
q We are more enthused by the near term proposal to cap the availability of
subsidized LPG cylinders to 4-7 per connection; current averages are at ~7.3.
q Given the distribution of LPG consumed, even a cap at the current average will take
down LPG consumption by 15-20% cutting annualised u-r by ~Rs35bn.
q A cap at six cylinders will cut u-r by US$1.2bn; at four will cut this by US$2bn.
Continue to prefer upstream over downstream
q There are headwinds here too (political opposition, pushback from states, need to
hike dealer commissions, OMC systems, validation of rationing, false or duplicate
connections) but if implemented, it is akin to 14-24% price hikes that will lift EPS.
q Under our framework (one-third upstream, 50% govt, 17% OMCs), a cap at four
cylinders will lift IOC’s EPS by 4-5%, BPCL by 8-9% (higher sales per connection),
and HPCL by 14-15% (max relative share of LPG subsidies as share of core PBT).
q ONGC, Oil India EPS will rise by 4-5%. Gail, which shares only LPG-kero subsidies,
will see EPS rise by 6%. We continue to prefer upstream over downstream to play
policy interventions where ONGC and Oil India (~3.5x EV/Ebitda) are our top picks.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Yet another effort to curtail subsidies
The recently released interim report of a government panel renews the debate on
effective targeting of LPG/Kero subsidies through direct cash transfers. A pilot will
be implemented by end-2011 but effective implementation is still years away and
will be predicated on the Ministry of Finance agreeing to directly fund subsidies.
We are more enthused by the near term hope of capping subsidized LPG
availability to 4-6 cylinders per connection that could cut u-r by US$1-2bn and lift
SOE EPS by 3-17%. We prefer upstream (ONGC, OIL, Gail) over downstream.
Another shot at effective targeting of subsidies
q The government has long being cognizant of the leakages in various subsidies that
it has administered; overall subsidies in India now approach ~2.5% of GDP.
q It renewed this debate earlier this year by constituting a panel to recommend ways
to implement direct cash transfer of LPG, kerosene and fertiliser subsidies.
q The Nandan Nilekani headed panel recently released its interim report proposing a
general solution framework while also making some specific recommendations.
Rollout of CSMS, UID and financial inclusion; a pilot by end 2011
q The panel recommends the implementation of a core subsidy management system
(CSMS) integrated with the UID enabled bank accounts of customers.
q This will allow LPG and kerosene to be sold at market prices while also
automatically transferring cash to customers in lieu of the subsidy. Over time, the
government will also restrict the allowances to those who really need it.
q The panel recognises the need for a gradual transition and recommends that pilot
studies be undertaken by end-2011 to understand these issues.
q Indeed, the creation of CSMS, rollout of UID and financial inclusion will take time.
Implementation will take time
q The proposal to target subsidies to those that need it is not new and piecemeal
proposal in LPG and kerosene have been attempted before.
q These have faced headwinds from state governments, dealers and vested interests
thriving in the dual price regime. Systems of OMCs also need to gear up.
q While the government does seem more focussed now than before, effective
implementation will take time as our interactions with industry participants suggest.
Will subsidies be funded by MOF; will MOPNG give up control
q In particular, direct cash transfers require the Ministry of Finance (MoF) to
administer subsidies via the budget instead of ad-hoc mechanisms in place today.
q With LPG and kerosene subsidies at US$14bn (0.7% of GDP, US$10 = US$2.3bn)
at current Brent of US$118/bbl, the decision will not be easy to take.
q It may also require the MoF and Ministry of Petroleum (MoPNG) to agree on a way
to formalise the upstream subsidy burden. This will have to take the form of a
special oil tax that will be collected by the MoF. The MoPNG has always opposed
this, instead favouring an adhoc formula which allows it to dictate SOE cashflows.
More hopeful of volume cap on subsidised LPG but not without headwinds
q We are more enthused by the near term proposal to cap the availability of
subsidized LPG cylinders to 4-7 per connection; current averages are at ~7.3.
q Given the distribution of LPG consumed, even a cap at the current average will take
down LPG consumption by 15-20% cutting annualised u-r by ~Rs35bn.
q A cap at six cylinders will cut u-r by US$1.2bn; at four will cut this by US$2bn.
Continue to prefer upstream over downstream
q There are headwinds here too (political opposition, pushback from states, need to
hike dealer commissions, OMC systems, validation of rationing, false or duplicate
connections) but if implemented, it is akin to 14-24% price hikes that will lift EPS.
q Under our framework (one-third upstream, 50% govt, 17% OMCs), a cap at four
cylinders will lift IOC’s EPS by 4-5%, BPCL by 8-9% (higher sales per connection),
and HPCL by 14-15% (max relative share of LPG subsidies as share of core PBT).
q ONGC, Oil India EPS will rise by 4-5%. Gail, which shares only LPG-kero subsidies,
will see EPS rise by 6%. We continue to prefer upstream over downstream to play
policy interventions where ONGC and Oil India (~3.5x EV/Ebitda) are our top picks.
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