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● Falling oil prices have led to OMCs’ outperformance. In this note
we highlight how the recent government action has increased
leverage to crude prices, and how oil at US$90/bbl could
materially alter the outlook.
● Recent price increases or tax cuts mean losses on retail diesel are
eliminated at US$90/bbl (Brent). Diesel has historically incurred
the bulk of losses, and has also driven growth in losses.
● Structurally, the consumption of LPG/SKO (the other controlled
products) is less than oil produced by ONGC/OILI. If a cap on
upstream realisations is introduced (as is expected), incremental
losses on LPG/SKO can be funded by ONGC/OILI – government
will not be on the hook for growing outflows from the budget, and
may have to pay a modest Rs97 bn (US$2.2 bn) for FY13.
● This can allow for a better funding of IOC/BPCL/HPCL, increasing
EPS. A US$60/bbl cap can help ONGC’s EPS increase Rs3.7
(over FY11); OILI may see less upside.
● A lot of things fall in place if oil heads to US$90/bbl.
OMC/upstream may trade well in a weak market. Yet, we think full
valuations can only be realised once the policy adjustments are
made, and when these stick through some oil volatility.
Larger sensitivity to crude
Declining crude prices mean Indian oil marketing companies (OMCs)
were up 8-10% over the last week, in a falling market. In this note, we
highlight how creeping government action has increased leverage to
crude prices, and how oil (Brent) at US$90/bbl could solve a lot of the
government’s oil subsidy/funding problems.
● Recent price increases or duty cuts mean the break-even price for
retail diesel sales is now a relatively high US$90/bbl (16% below
current Brent prices). Diesel sales have historically led to a bulk of
total industry losses (44% in FY11).
● Diesel consumption also tends to grow rapidly (a 9% CAGR
during FY2007-11E). LPG/SKO (the other two controlled products)
grow slower (a 3% CAGR during the same period). The
elimination of losses on diesel (if oil stays at US$90/bbl) can keep
total industry losses range-bound.
● Oil/product sales volumes at ONGC+OILI+GAIL are more than
LPG/SKO consumption. If government is able to avoid losses on
diesel sales (through retail price increases if crude moves only
marginally around US$90/bbl), ALL incremental losses on
LPG/SKO can be funded through incremental revenues at
ONGC/OILI/GAIL (if the proposed cap on realisations is
implemented). Government will not have to worry about increasing
subsidy each year – which can allow it to better fund OMC.
Win–win situation
At US$90/bbl and with a US$60/bbl cap on ONGC/OILI realisations,
each of the stake holders can see upside:
● Government of India – Assuming no diesel losses, government
would have to pay c.Rs97 bn (US$2.2 bn) to fund residual FY13
LPG/SKO losses, lower than amounts paid historically. Though
government may try to recover lost taxes, incremental payouts will
not be demanding.
● ONGC’s FY11 net realisation was c.US$53.8/bbl (OILI at
US$58.5/bbl). At US$60/bbl, ONGC could see Rs3.7 rise in EPS.
● If government chooses to pay for all residual LPG/SKO losses,
OMCs could finally realise 100% funding, allowing them to report
strong EPS. While debt may still have them appear expensive on
EBITDA, a P/E expansion could still lead to upside.
Oil price volatility a risk
While a US$90/bbl crude print can allow material policy head room,
the recent government behaviour suggests policy can change with oil
price volatility – sustained zero losses on diesel may not hold if crude
went back up. Full valuations may only be realised if government
sticks to any new subsidy policy, yet further declines in crude prices
can continue to be a positive for OMCs, which can continue to
outperform a falling market.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
● Falling oil prices have led to OMCs’ outperformance. In this note
we highlight how the recent government action has increased
leverage to crude prices, and how oil at US$90/bbl could
materially alter the outlook.
● Recent price increases or tax cuts mean losses on retail diesel are
eliminated at US$90/bbl (Brent). Diesel has historically incurred
the bulk of losses, and has also driven growth in losses.
● Structurally, the consumption of LPG/SKO (the other controlled
products) is less than oil produced by ONGC/OILI. If a cap on
upstream realisations is introduced (as is expected), incremental
losses on LPG/SKO can be funded by ONGC/OILI – government
will not be on the hook for growing outflows from the budget, and
may have to pay a modest Rs97 bn (US$2.2 bn) for FY13.
● This can allow for a better funding of IOC/BPCL/HPCL, increasing
EPS. A US$60/bbl cap can help ONGC’s EPS increase Rs3.7
(over FY11); OILI may see less upside.
● A lot of things fall in place if oil heads to US$90/bbl.
OMC/upstream may trade well in a weak market. Yet, we think full
valuations can only be realised once the policy adjustments are
made, and when these stick through some oil volatility.
Larger sensitivity to crude
Declining crude prices mean Indian oil marketing companies (OMCs)
were up 8-10% over the last week, in a falling market. In this note, we
highlight how creeping government action has increased leverage to
crude prices, and how oil (Brent) at US$90/bbl could solve a lot of the
government’s oil subsidy/funding problems.
● Recent price increases or duty cuts mean the break-even price for
retail diesel sales is now a relatively high US$90/bbl (16% below
current Brent prices). Diesel sales have historically led to a bulk of
total industry losses (44% in FY11).
● Diesel consumption also tends to grow rapidly (a 9% CAGR
during FY2007-11E). LPG/SKO (the other two controlled products)
grow slower (a 3% CAGR during the same period). The
elimination of losses on diesel (if oil stays at US$90/bbl) can keep
total industry losses range-bound.
● Oil/product sales volumes at ONGC+OILI+GAIL are more than
LPG/SKO consumption. If government is able to avoid losses on
diesel sales (through retail price increases if crude moves only
marginally around US$90/bbl), ALL incremental losses on
LPG/SKO can be funded through incremental revenues at
ONGC/OILI/GAIL (if the proposed cap on realisations is
implemented). Government will not have to worry about increasing
subsidy each year – which can allow it to better fund OMC.
Win–win situation
At US$90/bbl and with a US$60/bbl cap on ONGC/OILI realisations,
each of the stake holders can see upside:
● Government of India – Assuming no diesel losses, government
would have to pay c.Rs97 bn (US$2.2 bn) to fund residual FY13
LPG/SKO losses, lower than amounts paid historically. Though
government may try to recover lost taxes, incremental payouts will
not be demanding.
● ONGC’s FY11 net realisation was c.US$53.8/bbl (OILI at
US$58.5/bbl). At US$60/bbl, ONGC could see Rs3.7 rise in EPS.
● If government chooses to pay for all residual LPG/SKO losses,
OMCs could finally realise 100% funding, allowing them to report
strong EPS. While debt may still have them appear expensive on
EBITDA, a P/E expansion could still lead to upside.
Oil price volatility a risk
While a US$90/bbl crude print can allow material policy head room,
the recent government behaviour suggests policy can change with oil
price volatility – sustained zero losses on diesel may not hold if crude
went back up. Full valuations may only be realised if government
sticks to any new subsidy policy, yet further declines in crude prices
can continue to be a positive for OMCs, which can continue to
outperform a falling market.
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