Energy: A weakening rupee is largely positive::Kotak Sec,

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Energy
India
A weakening rupee is largely positive. We see the recent weakening of the Indian
Rupee versus the US Dollar resulting in (1) higher gross under-recoveries for the oil
sector, (2) positive impact on ONGC’s EPS as higher realizations offset higher subsidy
loss, (3) positive impact on the earnings of Cairn India and Reliance Industries and
(4) negative for the earnings of Castrol India. The rupee has depreciated sharply by 8%
since August 1, 2011 led by large FII outflows of US$1.6 bn.


Increase in gross under-recoveries due to weakening rupee
A weakening of the rupee against the US dollar would result in higher gross under-recoveries as
the domestic prices of diesel, LPG and kerosene are regulated. A `1/US$ depreciation will result in
additional gross under-recovery of ~`70 bn for the industry on an annualized basis (at US$110/bbl).
Exhibit 1 shows that gross under-recoveries will increase to `1.15 tn from `1.04 tn, if we were to
assume average exchange rate of `47.5/US$ for the remaining period in FY2012E.
Higher crude price realizations to offset higher subsidy losses for ONGC
The upstream oil companies (Cairn India and ONGC) will benefit from a weakening of the rupee
due to higher crude price realizations. However, the positive impact on ONGC will be offset to
some extent by a higher subsidy burden due to the increase in gross under-recoveries. A `1/US$
increase would increase ONGC’s FY2012E EPS by 1% after considering the negative impact of
higher subsidy burden. Cairn India will benefit from a weakening rupee due to higher realizations;
our FY2012E and FY2013E EPS for Cairn India will increase by ~3% to `47 and `51.2 for a `1/US$
increase in exchange rate.
Impact on downstream companies is a bit more complicated
We highlight that the impact of a weakening rupee on downstream oil companies (BPCL, HPCL
and IOCL) is slightly convoluted given that the prices of some of its products are regulated by the
government. We note that a weakening of the rupee would lead to higher refining margins for
the refining segment of downstream companies. Thus, the companies would stand to gain on the
unregulated products. However, the losses on regulated products will increase, which would result
in higher gross under-recoveries. The net impact from rupee depreciation will depend on the
quantum of increase in net under-recoveries to be borne by downstream companies.
RIL will benefit from higher chemical and refining margins, E&P will also benefit
We expect RIL to benefit from a weakening of the Rupee across all its segments. We highlight that
the prices of its products and raw materials are linked to the landed cost of imports; it gets export
prices in case of exports of products (refined products primarily). We note that the net impact on
margins would be positive as a weaker Rupee would result in higher prices in Rupee terms for
both products and raw materials. We also expect RIL’s E&P segment to benefit from a weakening
rupee given higher realization. A `1/US$ increase would increase RIL’s FY2012E and FY2013E EPS
to `70 and `77.4, respectively, from our base-case EPS estimates of `67.4 and `74.9.
Castrol will be negatively impacted due to higher raw material costs
A depreciation in the value of the Rupee versus the US dollar would be negative for Castrol as it
will increase the cost of raw materials (LOBS and additives), which comprise a significant portion of
its overall costs. Castrol imports its entire requirement of LOBS and additives, the prices of which
are linked to dollar prices. A `1/US$ increase would reduce Castrol’s CY2011E and CY2012E EPS
to `21.3 and `21.7, respectively, from our base case estimate of `21.9 and `22.3.