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Clarity on subsidy-sharing mechanism to offer comfort in earnings estimates
Media articles suggest the government is reworking the subsidy-sharing mechanism to allow
higher profitability for upstream companies (OIL and ONGC). We see sufficient scope for the
government to allow ‘higher’ net crude realizations to upstream companies on a ‘sustainable’
basis while restricting its own burden to a manageable level, after deregulation of diesel, which
has led to near-equivalence between consumption of subsidized fuels and production of
subsidized crude oil from nominated fields (see Exhibit 1). The equivalence of subsidized
consumption and subsidized production will help the government to mitigate any impact from
an adverse movement in global crude prices and exchange rates by adjusting the subsidy
discount on upstream companies, while ensuring a consistent level of net crude realizations. A
consistent subsidy-sharing formula will make earnings more predictable and be construed
positively by investors.
We expect reforms to curtail cooking fuels subsidy in the near term
We expect the government to implement measures to restrict the subsidy burden on cooking
fuels in the near term, taking the benefit from a benign crude price environment. (1) Increase in
retail prices by a nominal amount on a monthly basis and (2) reduction in the cap of subsidized
LPG cylinders to 6-9 per household a year (versus 12 currently) and cutback in quota of
subsidized kerosene for the PDS may curtail cooking fuel subsidies meaningfully. Exhibits 2 and
3 show our computation of potential savings on LPG subsidies from the aforesaid measures. We
also see benefits from implementation of modified direct benefit transfer for LPG subsidies
across India from January 2015, which will reduce leakages in the near term and provide a
good platform to further restrict subsidies to only the deserving section of population in the
medium term. We expect kerosene to also come under the ambit of DBT in the next 1-2 years.
We fine tune estimates to factor revised crude price and exchange rate assumptions
We assume US$60-62/bbl of net crude realizations for OIL and ONGC and 20% savings on LPG
subsidies from FY2016, which will restrict the government burden to a manageable level of
`300-330 bn (see Exhibit 4). We revise our FY2015-17 EPS estimates of OIL to `55.5 (-1.5%),
`70 (-2.5%) and `74.9 (+3.8%) and of ONGC to `32.8 (-3.6%), `41 (-2.6%) and `45.4
(+6.8%), factoring (1) lower crude price assumptions, (2) weaker rupee-dollar exchange rate
and (3) other minor changes. We have assumed Dated Brent crude price of US$92/bbl for
FY2015, US$80/bbl for FY2016 and US$85/bbl for FY2017. Our economics team forecasts the
rupee-dollar exchange rate at `61/US$ in FY2015, `63/US$ in FY2016 and `65/US$ in FY2017.

Clarity on subsidy-sharing mechanism to offer comfort in earnings estimates
Media articles suggest the government is reworking the subsidy-sharing mechanism to allow
higher profitability for upstream companies (OIL and ONGC). We see sufficient scope for the
government to allow ‘higher’ net crude realizations to upstream companies on a ‘sustainable’
basis while restricting its own burden to a manageable level, after deregulation of diesel, which
has led to near-equivalence between consumption of subsidized fuels and production of
subsidized crude oil from nominated fields (see Exhibit 1). The equivalence of subsidized
consumption and subsidized production will help the government to mitigate any impact from
an adverse movement in global crude prices and exchange rates by adjusting the subsidy
discount on upstream companies, while ensuring a consistent level of net crude realizations. A
consistent subsidy-sharing formula will make earnings more predictable and be construed
positively by investors.
We expect reforms to curtail cooking fuels subsidy in the near term
We expect the government to implement measures to restrict the subsidy burden on cooking
fuels in the near term, taking the benefit from a benign crude price environment. (1) Increase in
retail prices by a nominal amount on a monthly basis and (2) reduction in the cap of subsidized
LPG cylinders to 6-9 per household a year (versus 12 currently) and cutback in quota of
subsidized kerosene for the PDS may curtail cooking fuel subsidies meaningfully. Exhibits 2 and
3 show our computation of potential savings on LPG subsidies from the aforesaid measures. We
also see benefits from implementation of modified direct benefit transfer for LPG subsidies
across India from January 2015, which will reduce leakages in the near term and provide a
good platform to further restrict subsidies to only the deserving section of population in the
medium term. We expect kerosene to also come under the ambit of DBT in the next 1-2 years.
We fine tune estimates to factor revised crude price and exchange rate assumptions
We assume US$60-62/bbl of net crude realizations for OIL and ONGC and 20% savings on LPG
subsidies from FY2016, which will restrict the government burden to a manageable level of
`300-330 bn (see Exhibit 4). We revise our FY2015-17 EPS estimates of OIL to `55.5 (-1.5%),
`70 (-2.5%) and `74.9 (+3.8%) and of ONGC to `32.8 (-3.6%), `41 (-2.6%) and `45.4
(+6.8%), factoring (1) lower crude price assumptions, (2) weaker rupee-dollar exchange rate
and (3) other minor changes. We have assumed Dated Brent crude price of US$92/bbl for
FY2015, US$80/bbl for FY2016 and US$85/bbl for FY2017. Our economics team forecasts the
rupee-dollar exchange rate at `61/US$ in FY2015, `63/US$ in FY2016 and `65/US$ in FY2017.

Clarity on subsidy-sharing mechanism to offer comfort in earnings estimates
Media articles suggest the government is reworking the subsidy-sharing mechanism to allow
higher profitability for upstream companies (OIL and ONGC). We see sufficient scope for the
government to allow ‘higher’ net crude realizations to upstream companies on a ‘sustainable’
basis while restricting its own burden to a manageable level, after deregulation of diesel, which
has led to near-equivalence between consumption of subsidized fuels and production of
subsidized crude oil from nominated fields (see Exhibit 1). The equivalence of subsidized
consumption and subsidized production will help the government to mitigate any impact from
an adverse movement in global crude prices and exchange rates by adjusting the subsidy
discount on upstream companies, while ensuring a consistent level of net crude realizations. A
consistent subsidy-sharing formula will make earnings more predictable and be construed
positively by investors.
We expect reforms to curtail cooking fuels subsidy in the near term
We expect the government to implement measures to restrict the subsidy burden on cooking
fuels in the near term, taking the benefit from a benign crude price environment. (1) Increase in
retail prices by a nominal amount on a monthly basis and (2) reduction in the cap of subsidized
LPG cylinders to 6-9 per household a year (versus 12 currently) and cutback in quota of
subsidized kerosene for the PDS may curtail cooking fuel subsidies meaningfully. Exhibits 2 and
3 show our computation of potential savings on LPG subsidies from the aforesaid measures. We
also see benefits from implementation of modified direct benefit transfer for LPG subsidies
across India from January 2015, which will reduce leakages in the near term and provide a
good platform to further restrict subsidies to only the deserving section of population in the
medium term. We expect kerosene to also come under the ambit of DBT in the next 1-2 years.
We fine tune estimates to factor revised crude price and exchange rate assumptions
We assume US$60-62/bbl of net crude realizations for OIL and ONGC and 20% savings on LPG
subsidies from FY2016, which will restrict the government burden to a manageable level of
`300-330 bn (see Exhibit 4). We revise our FY2015-17 EPS estimates of OIL to `55.5 (-1.5%),
`70 (-2.5%) and `74.9 (+3.8%) and of ONGC to `32.8 (-3.6%), `41 (-2.6%) and `45.4
(+6.8%), factoring (1) lower crude price assumptions, (2) weaker rupee-dollar exchange rate
and (3) other minor changes. We have assumed Dated Brent crude price of US$92/bbl for
FY2015, US$80/bbl for FY2016 and US$85/bbl for FY2017. Our economics team forecasts the
rupee-dollar exchange rate at `61/US$ in FY2015, `63/US$ in FY2016 and `65/US$ in FY2017.


LINK
http://www.kotaksecurities.com/pdf/dmb/MorningInsight05122014da.pdf