Energy: Rupee at historical low may result in subsidy at historical high ::Kotak Securities

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Energy
India
Rupee at historical low may result in subsidy at historical high. We see weakness
in the Rupee as hurting the investment thesis (if there is one) for downstream oil
companies given (1) burgeoning gross under-recoveries and (2) tough operating
conditions. However, we expect a repeat of the scenario in FY2009 when the
Government had to fully compensate the downstream companies to ensure profitability
for these companies. We maintain our RS ratings on the downstream stocks (BPCL,
HPCL and IOCL) given an uncertain macro-environment.
Stumped by the Rupee; all players in a fix
The recent weakening of the Rupee (17% since September 2011) will likely result in very high
gross under-recoveries for FY2012E which, in turn, will put pressure on the financials of all the
participants (downstream companies, upstream companies and the Government). We compute
gross under-recoveries at `1.3 tn for FY2012E assuming exchange rate of `52/US$ for the
remainder of FY2012E. This does not auger well for the earnings of downstream companies which
are already languishing under tough operating conditions. Exhibit 1 gives our estimate of gross
under-recoveries and likely subsidy-sharing arrangement. We do highlight that the negative impact
of the weakening of the Rupee would be mitigated to some extent given positive impact on the
refining and petrochemical businesses of the downstream companies.
1HFY12 was harsh, 2HFY12E may be worse
We highlight that the downstream companies have reported a total EBITDA loss of `175 bn in
1HFY12 which was the result of (1) high net under-recoveries of `283 bn, (2) forex-related losses
due to weakening of Rupee and (3) high inventory/adventitious losses. The situation has been
exacerbated in 3QFY12 led by (1) further weakening of Rupee (`50.9/US$ versus `45.3/US$ in
1HFY12), (2) decline in refining margins (see Exhibit 2), (3) no respite from high crude oil prices
and (4) low likelihood of change in prices of regulated products given political compulsions.
A repeat of FY2009 imminent—downstream not in a position to bear any under-recoveries
We do not rule out a repeat of FY2009 in terms of the subsidy support provided by the
Government to the downstream companies. We expect operating earnings of downstream
companies to be severely impacted by (1) recent weakness in refining margins, (2) under-recoveries
on sale of petrol which is deregulated and (3) high forex losses given the weakening of the Rupee.
We believe that the Government may have to fully compensate the downstream companies in
FY2012E for under-recoveries on regulated products (LPG, diesel and kerosene).
Gross under-recoveries will likely be high in FY2013E
We estimate gross under-recoveries for FY2013E at `1.2 tn (see Exhibit 3) assuming (1) crude oil
(Dated Brent) price at US$100/bbl, (2) exchange rate of `52.5/US$ and (3) no change in retail
prices of regulated products. However, we find it difficult to forecast net under-recoveries (and
hence earnings of downstream companies) given (1) limited clarity on subsidy-sharing policy to be
adopted by the Government, (2) no pragmatic pricing policy on regulated products and (3) highly
volatile crude oil prices.
Revised earnings to reflect (1) weaker Rupee and (2) nil net under-recoveries
We have revised our earnings estimates for BPCL, HPCL and IOCL (see Exhibit 4) to reflect (1)
weaker exchange rate assumptions, (2) nil under-recoveries for FY2012E and (3) other minor
changes. We have revised our exchange rate assumptions for FY2012-14E to `48.7/US$,
`52.5/US$ and `51/US$ from `47.3/US$, `49.75/US$ and `48.5/US$ previously.