Over the past 6 months, ever since the diesel prices were raised, albeit stepwise, there was hope among investors that finally the upstream and oil marketing companies (OMCs) will be treated like companies and not a part of the exchequer, however, there are some who beg to differ saying the past hasn't proved that the grip of populism will go out.
CNBC-TV18 on Wednesday reported that the Finance Ministry wants oil marketing companies to absorb a much higher share of under-recoveries this fiscal. It is learnt that state-run OMC's IOC , HPCL and BPCL have been asked to absorb as much as Rs 5,000 crore as against Rs 900 crore in FY13. The overall under-recoveries are anyway higher.
Even though oil minister Veerappa Moily is busy campaigning in Karnataka ahead of the general elections, OMCs are hopeful that he will intervene and negotiate their share down to almost Rs 3,500-3,700 crore.
Vasudeva, who retired last month, said that upstream companies are under tremendous pressure due to high subsidy burden.
"ONGC and Oil India have to pay USD 56 per barrel of oil production. Today, the cost of production for both ONGC and Oil India is around USD 41. So if they get about USD 44 then the margins available to them from the oil business is only 3-4 dollars," he said.
Moreover, OMCs are also making tremendous losses. If these subsidies or under-recoveries are not compensated, they borrow it from the market. "The borrowing is at about Rs 1,30,000 crore. Last year, their interest burden itself was about Rs 5500 crore, which is about 50 percent of their profit before taxes," Vasudeva said.
"Thus, it is killing both the upstream companies because of the heavy burden and OMCs because they are not getting the subsidies in time. They are borrowing on behalf of the government and are incurring these interest charges. Thus, this needs to be corrected," he added.
CLSA in its note said that it expects oil ministry to put up some resistance on behalf of OMCs. "The recent upmove was based on assumption of nil subsidies for OMCs allowing them to benefit from elimination of diesel subsidies. The newsflow may shatter that (rally) premise," the note said, adding that the adhoc subsidy formula may limit the potential of Rs 2,600 crore interest benefit from elimination of diesel subsidies flowing to the bottomline of IOC, BP and HP.
CLSA said that it prefers upstream companies in the state-owned space. "We prefer upstream names ONGC, OIL, within state-owned space as these stocks are not building the gas price hike which will be implemented from April 2014. Any reduction in subsidies should also lead to a re-rating for these stocks," the note said.
In the OMC space, it has reiterated 'sell' on IOC, HPCL and outperformer for BPCL, and thinks OMCs may also reverse recent gains.
JP Morgan views a higher downstream subsidy share as a near-term negative for OMCs as it will add to earnings pressure. It feels the recent rally could take a pause.
"The three state refiners have rallied 35-40 percent since early January. We could see a pause in this rally, with an increase in the subsidy burden. BPCL, which in contrast to peers has reported a smaller 9MFY14 loss (Rs 7.5 crore), continues to remain our key pick in the space," the JP Morgan note said.
Below is the transcript of Sudhir Vasudeva's interview to CNBC-TV18's Latha Venkatesh and Sonia Shenoy
Latha: In the last six months or so ever since the diesel prices were raised step-by-step 50 paise there has been a hope trade among the investment community that finally the oil marketing companies (OMCs) and the upstream companies will be treated like that as companies and not as part of the exchequer. What is your guess, now that you have relinquished office do you think that India will conquer its populism enough?
A: I think the time has now come whether we like it or not this populism will have to be shunned off now and the government has taken this very wise decision of increasing the diesel prices from January and 13 times the diesel prices have been increased. Unfortunately in the middle the oil prices went up and the rupee depreciated and all that whatever was done was undone.
Today with this 50 paise being increased still that under recoveries of the order of about Rs 7.35. So another 15 months if everything remains constant this problem should be over and I think no government whichever government comes to power, can ignore this. Reforms is the only way forward so I believe that the reforms will go forward and hopefully we will be working in market determined price mechanism very soon.
Sonia: The disappointment in the market stems from the ad hock procedure, earlier there was an expectation that there would be nil subsidy burden for these OMCs and now we understand that the finance ministry wants the OMCs to absorb the remaining Rs 5500 crore of under recoveries. Do you think the government is right in telling the OMCs that since upstream part is making money so they should perhaps go ahead and absorb some of the under recoveries since ONGC and Oil India compensate them being upstream companies?
A: It would be wrong for me to say whether the government is right or wrong but upstream companies are tremendously under pressure with the present mechanism of subsidy sharing. ONGC and Oil India have to pay USD 56/ barrel of oil production and today the cost of production for both ONGC and Oil India is in the order of about USD 41. So if they get only about USD 44, the margin which is available to them from oil business is only about USD 3-4.
But if you see on the other hand, the OMCs they are also making tremendous losses and if these under recoveries are not being compensated by the government that are being rolled over, so they are borrowing from the market and their borrowing today is of the order of Rs 130,000 crore. Last year the interest burden itself was about Rs 5500 crore which is about 50 percent of their profit before taxes. So it is killing both, the upstream companies because of the heavy burden and the OMCs because they are not getting the subsidies or under recoveries in time. So they are borrowing on behalf of the government and they are incurring these interest charges so this needs to be corrected.
Latha: But will they ever be allowed to become really profit making companies? At the most they will perhaps be allowed to price it to perfection. Do you think even an NDA government even assuming that they will be a little more market oriented will allow oil companies to make profits, at the most meet their costs?
A: If you see last year the under recoveries were of the order of Rs 161,000 crore, government paid Rs 100,000 crore, upstream companies paid Rs 60,000 crore and OMCs had to bear the burden of only Rs 1029 crore. So if this year they have to pay Rs 5500 crore, this can seriously affect their profitability. I don't know whether they will be in the black or they will be in the red. Government probably would see they should not be making losses otherwise the market cap would also be affected but it is a burden which is becoming gradually unbearable.
Sonia: Will the strength of the rupee solve any of the problems of the sector at all in the near term?
A: Definitely. Every rupee variation against dollar affects by Rs 4,700 crore. So the under recoveries will come down if rupee appreciates. But for the upstream companies if prices are denominated in dollar they will be making losses. So if one had losses another hand gains.
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