Oil & Gas Upsides contingent on staying the course:: Prabhudas Lilladher

Government action to curtail rising under-recoveries and prevent ‘dieselization’ of
the economy, and its intent to cap subsidies by raising prices for the second time this
year, could act a significant game changer for the sector. We view the Government’s
decisions to (1) revise diesel prices by small amounts periodically and (2) fully
deregulate prices of bulk diesel as a big positive for all the oil PSU stocks. We believe,
while the stocks have reacted positive to the development, further rerating will be
contingent on implementation of the gradual continuous price increase of diesel.
‘Implicit assumption ‘of Rs0.45/litre hike in diesel prices for the non-bulk user
segment over period of 6-7 months could save Rs 200-240bn (22%-25% of pre
announcement diesel subsidy), including elimination of bulk user subsidy (~17% of
diesel consumption).
! Impact on FY14 under‐recovery estimates: Originally, we expected FY14 fuel
under-recoveries at Rs1.24tn assuming a Brent crude price of US$105/bbl,
INR/USD exchange rate of Rs53 and no further fuel price increases. Hence
assuming (a) Rise in LPG cap to 9, (b) Diesel sold to Bulk buyers at market rate
and (c) Diesel price for other consumers is increased by Rs0.45/litre every month
for next 6 months, FY14 fuel under-recoveries would be reduced by 21% to
Rs982bn.
! HPCL room for more upside, BPCL largely priced in: We believe the OMCs offer
further re-rating prospects if the gradual price hikes were to be continued for a
longer period. Amongst the OMCs; HPCL would be prime beneficiary of the
move given its significant leverage to the policy action. We Recommend
Accumulate on the stock with Target price of Rs404/share (12% upside). Though,
in terms of quality of earnings, we like BPCL as it offers E&P portfolio play.
However, upside from the current levels seems capped in case of BPCL.
! Upstream valuations pricing in ~US$60/bbl net realizations: Although, a decline
in the subsidy would also be significantly positive for upstream PSUs (such as
ONGC and Oil India), as it would increase their net realization, we would be
cautious on the subsidy sharing ratio and quantum of benefits flowing to
upstream companies. We see benefits to upstream PSUs resulting in net
realisation increasing to ~US$60/bbl. However, current upstream valuations
seem to be factoring in most of the positives, we downgrade OIL to Accumulate
with a Revised Target price of Rs609/share, while maintain accumulate on ONGC
with a Revised Target price of Rs361/share.

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Outlook
We believe the OMCs offers great prospects of re-rating if the gradual price hike
were to be continued for a longer period. Amongst the OMCs; HPCL would be prime
beneficiary of the move given its significant leverage to the policy action. We
Recommend Accumulate on the stock with Target price of Rs404/share (12%
upside).
A decline in the subsidy would also be significantly positive for upstream PSUs (such
as ONGC and Oil India), because it would lower their subsidy burden and provide
required minimum break-even crude oil prices to carry forward their exploration and
development plans. However, we believe that the subsidy sharing mechanism is the
key event to watch going ahead. With fuel subsidy reducing to manageable levels,
upstream is likely to see positive leverage to oil prices resulting in net realisation of
~US$60/bbl. We recommend Accumulate on OINL from BUY earlier with Revised
Target price of Rs609/share, while maintain accumulate on ONGC with a Revised
Target price of Rs361/share.