As international crude oil prices ballooned over the course of the last decade, increasing from about USD 25 per barrel in the early 2000s to over USD 100 per barrel towards the end of it, India – major importer of oil – was one of the worst-hit countries.
In a bid to "insulate consumers from the full impact of high prices", as explained in the Union Budget document, the Indian government has historically maintained a subsidy regime, mandating oil marketing companies (OMCs) to sell domestic (kerosene, LPG) and automotive (diesel and petrol, the latter was deregulated in 2010) to sell fuels below cost.
The resulting loss incurred by the oil retailers – also termed under-recoveries – would then be reimbursed using funds mainly jointly provided by the government (as subsidy) and upstream oil companies (explorers such as ONGC).
However, as crude prices jumped, the amount of under-recoveries has seen a sharp rise over the past 10 years or so.
Here we capture the financial impact of the subsidy regime on the operations and financials of both upstream as well as downstream companies over the past 10 years.
ONGC
Oil explorer ONGC has contributed most of the non-government-funded part of under-recoveries over the past 10 years.
As a result, "while the gross realization for ONGC stood at USD107 per barrel in FY14, its net realization was only at USD 41 per barrel led by subsidy sharing of USD66 per barrel".
Comparatively, in FY05, ONGC's gross realizations stood at USD 52 per barrel while net realizations were at USD 39 per barrel.
This has resulted in muted earnings-per-share growth for the company. In FY05, EPS stood at Rs 16.8 while it came in at Rs 31 nine years later, a compounded growth of a mere 7.04 percent.
OMCs
On the other hand, oil marketing companies too bore the brunt of the subsidy burden as they had to resort to taking on more working capital and long-term debt, thanks to delayed payments from the government.
A classic case in point is HPCL , which has seen consolidated sales grow from Rs 63,428 crore in FY05 to Rs 2.36 lakh crore in FY14.
Even as profit growth remained choppy. It stood at Rs 1,415 crore in FY05 and Rs 1,079 crore in FY14.
This was in part due to the burgeoning debt burden, which increased about 16 times in 10 years.
As a result, return on capital employed dipped from mid teens to mid single digits.
Recently, under-recoveries reduced to near zero, thanks to the January 2013 decision to hike prices by 50 paise a month till they reached market levels.
Analysts expect the government to deregulate diesel prices soon. The reduced under-recoveries would help both upstream and downstream oil companies.
In a note, Motilal Oswal wrote that ongoing diesel reforms have the potential to reverse the upstream (ONGC) subsidy trend from 70-40 (subsidy-net realization) to 40-70 i.e. subsidy will reduce from USD70 per barrel to USD 40 per barrel while net realization would increase from USD40 per barrel to USD70 per barrel.
This could result in earnings to grow a compounded 20 percent over the next three years.
While for OMCs, interest cost as a percentage of sales had increased from lows of 0.1 percent in FY04 to about 1.2 percent led by funding for diesel under-recoveries, analysts at the brokerage firm wrote.
"During the last 12 months, diesel under-recoveries have come down significantly leading to meaningful reduction in the OMC's working capital requirement. We estimate OMCs debt to reduce by 15-25 percent, leading to 8-16 percent EPS benefit," the report said.
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