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Energy
India
Subsidy Sudoku remains unresolved. We see the lack of clarity on the subsidysharing
mechanism as affecting the sentiment for the sector and may result in lower
valuations for companies slated for divestment––ONGC, OIL and IOCL. We believe a
stable pricing and subsidy-sharing mechanism will provide certainty to earnings for the
sector and will help the government achieve its disinvestment target from the sale of
shares of these oil companies.
Subsidy-sharing mechanism still clouded in mystery
The lack of clarity on the subsidy-sharing mechanism for FY2012E continues to impact investor
sentiment for the sector. The situation has been exacerbated by recent media reports on higher
subsidy will be borne by the upstream companies. As per media reports, upstream companies may
be asked to bear `567 bn as subsidy burden for FY2012E (one-third of notional gross underrecovery
of `1.7 tn estimated before price hikes and duty cuts). The management of ONGC has
confirmed that it has not received any communication from the government to the effect.
Hopefully, the government will protect earnings of downstream companies
We continue to work on the philosophy that the government will provide sufficient compensation
to the downstream companies to ensure a certain level of profitability for these companies. We
assume that downstream companies will bear `74 bn as net under-recoveries for FY2012E versus
`69 bn for FY2011. We would highlight that the government had given full compensation to the
downstream companies in FY2009 when the companies had a weak operational year. We note
that downstream companies had a tough 1QFY12 given weak refining margins, which were partly
mitigated by adventitious gains. Exhibit 1 gives the key details of 1QFY12 results of downstream
companies.
We maintain our assumption of upstream share at 39% of the gross under-recoveries
We maintain our assumption that the upstream companies will bear 39% of the gross underrecoveries
for FY2012E. We compute gross under-recoveries at `1.1 tn and upstream share at
`417 bn for FY2012E. Even if we assume that the government keeps the net crude oil price
realization at FY2011 levels, we compute the share of upstream companies at ~45% of the gross
under-recoveries. We compute FY2012E EPS for ONGC and OIL at `34 and `129 in this scenario.
Media reports suggest that the upstream companies will bear `567 bn, which puts the share of
upstream companies at ~50% of our base-case estimate. However, we see a low likelihood of
such a scenario as it would translate into a crude oil price realization of US$41/bbl for ONGC
which is significantly lower versus the realization in FY2008-11. Exhibits 2 and 3 gives the net
crude price realization for ONGC and OIL and Exhibit 4 gives the earnings and net crude price
realization for ONGC and OIL under various scenarios of subsidy sharing.
Weakening of rupee will result in higher gross under-recoveries
We see the recent weakening of the Indian Rupee versus the US Dollar as resulting in higher gross
under-recoveries for the sector. A weakening of the Rupee against US dollar would result in higher
gross under-recoveries as the domestic prices of diesel, LPG and kerosene are regulated. A `1/US$
depreciation will result in additional gross under-recovery of ~`70 bn for the industry on an
annualized basis (at US$110/bbl). The impact on the upstream and downstream companies will
depend on the eventual subsidy-sharing mechanism worked out by the government (see our note
‘A weakening rupee is largely positive’ released on September 14, 2011 for a detailed discussion
on the impact of weakening rupee on upstream and downstream companies.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Energy
India
Subsidy Sudoku remains unresolved. We see the lack of clarity on the subsidysharing
mechanism as affecting the sentiment for the sector and may result in lower
valuations for companies slated for divestment––ONGC, OIL and IOCL. We believe a
stable pricing and subsidy-sharing mechanism will provide certainty to earnings for the
sector and will help the government achieve its disinvestment target from the sale of
shares of these oil companies.
Subsidy-sharing mechanism still clouded in mystery
The lack of clarity on the subsidy-sharing mechanism for FY2012E continues to impact investor
sentiment for the sector. The situation has been exacerbated by recent media reports on higher
subsidy will be borne by the upstream companies. As per media reports, upstream companies may
be asked to bear `567 bn as subsidy burden for FY2012E (one-third of notional gross underrecovery
of `1.7 tn estimated before price hikes and duty cuts). The management of ONGC has
confirmed that it has not received any communication from the government to the effect.
Hopefully, the government will protect earnings of downstream companies
We continue to work on the philosophy that the government will provide sufficient compensation
to the downstream companies to ensure a certain level of profitability for these companies. We
assume that downstream companies will bear `74 bn as net under-recoveries for FY2012E versus
`69 bn for FY2011. We would highlight that the government had given full compensation to the
downstream companies in FY2009 when the companies had a weak operational year. We note
that downstream companies had a tough 1QFY12 given weak refining margins, which were partly
mitigated by adventitious gains. Exhibit 1 gives the key details of 1QFY12 results of downstream
companies.
We maintain our assumption of upstream share at 39% of the gross under-recoveries
We maintain our assumption that the upstream companies will bear 39% of the gross underrecoveries
for FY2012E. We compute gross under-recoveries at `1.1 tn and upstream share at
`417 bn for FY2012E. Even if we assume that the government keeps the net crude oil price
realization at FY2011 levels, we compute the share of upstream companies at ~45% of the gross
under-recoveries. We compute FY2012E EPS for ONGC and OIL at `34 and `129 in this scenario.
Media reports suggest that the upstream companies will bear `567 bn, which puts the share of
upstream companies at ~50% of our base-case estimate. However, we see a low likelihood of
such a scenario as it would translate into a crude oil price realization of US$41/bbl for ONGC
which is significantly lower versus the realization in FY2008-11. Exhibits 2 and 3 gives the net
crude price realization for ONGC and OIL and Exhibit 4 gives the earnings and net crude price
realization for ONGC and OIL under various scenarios of subsidy sharing.
Weakening of rupee will result in higher gross under-recoveries
We see the recent weakening of the Indian Rupee versus the US Dollar as resulting in higher gross
under-recoveries for the sector. A weakening of the Rupee against US dollar would result in higher
gross under-recoveries as the domestic prices of diesel, LPG and kerosene are regulated. A `1/US$
depreciation will result in additional gross under-recovery of ~`70 bn for the industry on an
annualized basis (at US$110/bbl). The impact on the upstream and downstream companies will
depend on the eventual subsidy-sharing mechanism worked out by the government (see our note
‘A weakening rupee is largely positive’ released on September 14, 2011 for a detailed discussion
on the impact of weakening rupee on upstream and downstream companies.
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