Energy: FY2012 looks fine, FY2013 uncertain : Kotak Securities PDF link

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http://www.kotaksecurities.com/pdf/indiadaily/indiadaily02042012.pdf

FY2012 looks fine, FY2013 uncertain. We believe `400 bn in additional
compensation from the Government for FY2012, as sought by the Oil Ministry and
perhaps already provided for by the Government in the FY2013 Union Budget, will
result in a lower subsidy burden and robust profits for upstream companies. However, a
pragmatic pricing policy for regulated fuels and crude price correction are critical for
FY2013E earnings. We reiterate our BUY ratings on ONGC and OIL.
Upstream companies likely to report robust earnings for FY2012
According to media articles, the Ministry of Petroleum and Natural Gas has sought additional
compensation of `400 bn from the Government for FY2012, assuming a subsidy amount of `530
bn for ONGC, OIL and GAIL. In our view, the Government has provided for `400 bn of additional
compensation for FY2012 in the FY2013 Union Budget, implying total compensation of `880 bn
(`450 bn paid in 9MFY12 and `30 bn of regular payment) out of gross under-recoveries of `1.4 tn.
However, there is much uncertainty about the `400 bn figure: a section of the Street believes that
only a part of it pertains to FY2012. If our understanding is correct, then the share of underrecoveries of upstream companies for FY2012E will be a maximum of 39%, modestly higher than
our estimate of 38% (`520 bn absolute amount) and in line with FY2011’s 38.7%. Thus,
upstream companies will likely post robust profits for FY2012. Exhibit 1 shows our estimates of the
subsidy burden and net income for upstream companies and Exhibit 2 shows our expectations of
subsidy sharing mechanism for various participants.
Likely increase in retail prices to cut FY2013E gross under-recoveries
We expect upstream oil companies to benefit from likely increases in retail prices of regulated fuels
(diesel, kerosene and LPG), which will reduce under-recoveries for FY2013E. We estimate FY2013E
gross under-recoveries at `1.1 tn based on crude price of US$110/bbl and a moderate increase in
retail prices; `1.4 tn assuming unchanged retail selling prices (see Exhibit 3). We note that
downstream companies have indicated an increase in gasoline prices by `3-5/liter over the next
few days. Although gasoline is a deregulated product, oil companies did not raise retail prices
despite an increase in global prices; we expect price increases on regulated fuels over the next few
weeks.  
Uncertainty remains for FY2013E at current crude prices  
We compute gross under-recoveries at `1.6 tn, based on an average crude price of US$125/bbl
and a moderate increase in retail selling prices through FY2013E. However, this amount could
increase sharply to about `2 tn if retail prices of diesel, kerosene and LPG are left unchanged
(Exhibit 4 shows under-recoveries at various levels of crude prices under two scenarios of moderate
price increase and stable retail selling prices). We believe (1) a pragmatic pricing policy by the
Government for regulated petroleum products and (2) correction in global crude prices from
current high levels will be critical for more confidence in the companies’ FY2013E earnings.
Increase in net realizations to drive profitability; reiterate BUY on ONGC/OIL
A formula, adopted by the Government, to fix the subsidy amount at US$56/bbl on crude sales
from nominated fields of ONGC and OIL for FY2012E offers us some assurance that upstream oil
companies will be able to earn reasonable net crude realizations in future. Exhibits 5 and 6 give
the historical net crude realizations of ONGC and OIL and our estimates over the next few years.
We reiterate our BUY rating on ONGC and OIL with 12-month target prices of `325 and `680,
respectively, given (1) large potential upside from current levels and
(2) inexpensive valuations at 7-8X FY2013E EPS.