The removal of the export parity pricing threat may help the OMC stocks near term :: Credit Suisse

● Media articles over the last few days have carried reports on the
likely recommendations of the Dr. Kirit Parikh committee on fuel
pricing in India. These suggest the committee may recommend
trade parity pricing of fuels be continued, contrary to expectations.
● In addition these also suggest the monthly increment in diesel retail
prices may be increased to Rs.1–1.5/ltr, and that upstream
companies pay 85% of profits made on crude as subsidy. There is a
risk that these media reports are incorrect, or that recommendations
are changed before publication, and around report acceptance.
● We estimated (here) that the IOC/BPCL/HPCL stocks are pricing in
the impact of export parity pricing by trading at 0.2–0.3x core book.
If this is taken off the table, there may be a near-term stock relief
even though FY14 RoE remains dependent on govt. payments.
● Any impact on upstream will depend on adoption of the new payment
formula, and the calculation of crude production costs. Back of
envelope calculations suggest net realisations for ONGC should not
change much. Clarity on payments can help multiples expand. In this
space, we have OUTPERFORM ratings on ONGC, BPCL and GAIL.

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Export parity surprise?
Various media (e.g. Economic Times, Financial Express) have carried
articles over the last few days about the likely recommendations of the
Dr. Kirit Parikh committee on fuel pricing. These generally suggest:
● The draft report favours the retention of the trade parity pricing for
controlled fuels (diesel in particular), at least until diesel prices
remain controlled,
● Retail diesel prices be increased by Rs.1–1.5/ltr each month, up
from the c.Rs0.5/ltr currently being effected,
● The price of PDS kerosene be increased by Rs.2/ltr now, another
Rs.2/ltr in April 2014 with subsequent increments being in line with
growth in agricultural GDP,
● LPG prices be increased by Rs.100/cylinder by March 2014, with
annual increments of Rs.100/cylinder thereafter until the pricing is
decontrolled, and
● The limit on subsidised cylinders be reduced back to six per
household, and subsidy be targeted using the Aadhar-based
direct transfer scheme.
In addition, TV reports (eg: CNBC) suggest the Dr. Parikh committee
may also recommend a new upstream subsidy sharing formula—
where ONGC/OILI may have to pay 85% of profits on domestic oil in
subsidy; with GAIL potentially exempt.
Several unknowns still
There is risk that the media reports may be incorrect, or that the
current reported draft proposals are changed before the report is
finalised. There is also uncertainty about whether the government will
adopt these recommendations (in part or in full). We understand the
terms of reference of the committee required recommendations on the
implementation of Export Parity (upon the insistence of the finance
ministry). That the report seemingly goes against that may also create
some uncertainty.
Impact on OMCs difficult to determine with precision
We estimated (here), that implementation of export parity pricing
would hurt OMCs' GRM by $2.2–2.3/bbl; post which IOC/BPCL/HPCL
may deliver 3–9% RoE. Non-implementation does not take this risk off
the table completely. There is risk (at least near term) that the finance
ministry does not pay adequate subsidy in FY14. Yet, with the OMC
stock pricing in EPP, a benign report can provide some upside.

Upstream impact depends on implementation
The impact of this report on ONGC/OILI/GAIL depends on the
acceptance of any new upstream sharing formula. This must come
from the finance ministry—which is in a tight fiscal corner already. In
addition, it will depend on how 'profit' on oil production is calculated.
We understand ONGC suggests costs of crude production are about
$40/bbl. If ONGC then retained 15% of profits (at $110/bbl Brent), its
net realisations would be about $51/bbl—similar to levels it currently
makes. Implementation of the new mechanism should not then lead to
material earnings changes for ONGC. Any clarity in subsidy sharing
policy though can allow for multiple expansion and for the market to
focus on near-term volume growth. Within the space, we have
outperform ratings on ONGC, BPCL and GAIL