Modi lights up oil and gas ahead of Diwali - Livemint

In doing away with controlled diesel prices and raising gas rates, the government gifted itself a lower fiscal deficit as well. Photo: Reuters

There couldn’t have been a better opportunity for the government to reform the oil and gas sector. Crude prices have fallen sharply and pesky political considerations such as state elections are out of the way. In doing away with controlled diesel prices and raising gas rates, the government gifted itself a lower fiscal deficit as well.

For investors in this industry, it is the realization of a long wait. They had gotten tired: the S&P BSE Oil and Gas index fell 5.5% in the past month compared with a 3.7% decline in the S&P BSE Sensex. Now, finally, reforms have come to pass.

Falling crude prices had anyway meant that losses on selling fuel below cost were coming down, but diesel price deregulation now makes things clearer for the long run as well.

Eventually, the biggest benefit for oil marketers will come in the form of increased marketing margins. That much is clear from the example of petrol which was freed earlier. Margins for that fuel increased to Rs.1.7 per litre from 70 paise per litre once prices were removed from state control.

Diesel volume is 3.5 times that of petrol, giving an additional boost. Brokerage firm Jefferies expects that earnings of oil marketers could increase by as much as 46% from a year ago because of higher marketing margins. Another potential 30% could come from the subsidy reduction, the firm said in a 25 September note.

To be sure, this would have to be weighed against decreases in market share as private firms such as Reliance Industries Ltd (RIL) and Essar Oil Ltd push for a bigger play in oil retailing.

However, investors don’t seem to be concerned about a possible loss in market share. “With non-PSU players accounting for around 7% of retail outlets, we believe PSU OMCs could lose about 8-10% of the market share once diesel is fully deregulated,” pointed out a note from Emkay Research in September.

A lower-than-expected gas price hike

The other big announcement—gas price hike—was also expected. While the government has announced that the new price is $5.6 per million British thermal units (mmBtu), that is on gross calorific value. That, according to analysts, translates to $6.17 per mmBtu on a net basis, which is comparable with the existing $4.2 rate—lower than what was expected, yet up by almost half.

Oil and Natural Gas Corp. Ltd (ONGC) is expected to be the biggest beneficiary as it is also the largest seller of domestic gas. However, with the consensus brokerage assumption on gas price at $6.5-7.5 a unit, there could be a marginal 4-6% cut in gas producers’ earnings per share estimates for the next two financial years. The gas business contribution to profits is much higher for ONGC than RIL. For RIL, the contribution from the oil and gas business is very small at 6.4% of pre-tax earnings for this fiscal year (stand-alone).

One positive for RIL though is that the company could get higher prices for output from its D1 and D3 fields depending on the outcome of a pending arbitration.

Another point about the gas price increase is a premium that the government has promised for discoveries in difficult terrain such as ultra-deep water areas and so on. Investors would do well to keep a tab on this.

User industries: urea prices have to go up

The lower-than-expected hike in gas price will come as a relief for fertilizer companies. A $1 rise in gas prices will raise urea industry’s input costs by Rs.2,200-2,400 crore, according to analyst estimates. With a rise close to $2 per mmBtu, the additional cost will be close to Rs.4,000 crore. That is manageable considering that the government will make an estimated Rs.3,800 crore from the gas price hike.

Theoretically, the price hike should not worry the fertilizer industry as the price gap between selling price and actual costs are borne by the government through subsidies. But delayed payments are a familiar story here.

Urea manufacturers fear that the gas price hike will further stretch their working capital and impact profitability because of higher interest payments. To take Chambal Fertilisers and Chemicals Ltd ’s example, per-tonne interest costs have almost increased fivefold over the past decade.

These concerns have receded a bit now as the gas price hike is lower than expected. With the government also approving a special banking arrangement of Rs.14,500 crore for pending dues, there is additional relief.

Apart from Chambal Fertilisers , Rashtriya Chemicals and Fertilizers Ltd and Tata Chemicals Ltd also use domestic gas for urea production. That said, timely payments and rationalization of urea prices will address the problem of urea makers. A steady hike in urea prices will be far more cost-effective than receiving the subsidy from the government.

Power tariffs to rise, but will SEBs bite?

The hike in gas prices could possibly bump up fuel costs of gas-based plants by up to 50%, say analysts. Thus, tariffs will rise. But the ability of power plants to pass on this increase is limited. Many private sector power plants do not have power purchase agreements. Even those units that have sewn up supply contracts might find it difficult to sell power because state electricity boards can’t be forced to buy expensive electricity. At a 30% or so capacity utilization levels, power from gas-fired plants can cost as high as Rs.6 per unit.

It remains to be seen how state electricity boards will juggle between higher tariffs and a power shortage. In any case, only 9% of India’s electricity generation capacity is fuelled by gas. Because of the lack of availability of the fuel, these units ran at 21.9% capacity utilization levels from April to September this fiscal year and contributed to 4% of electricity output this year. Of course, if the Centre subsidises states to the extent of the tariff increase, things will remain at status quo. But it has been silent on this matter.