Foreign institutional investors (FIIs) are changing their outlook towards India’s oil and gas sector. Even before the government announced a partial diesel decontrol in mid-January, FIIs had raised their stake marginally in oil marketing and upstream companies. Market players say public sector oil and gas companies are now on the radar of FIIs, which is important given the fact that they had shunned Oil and Natural Gas Corp’s (ONGC) offer for sale in March 2012.
The top funds that have stepped up buying in oil marketing companies (OMCs) include Vanguard Group Inc, Brandes Investment Partners, Bank of New York Mellon and DNB Asset Management. The names of these funds figure in the latest shareholding pattern filed by the companies.
“FII interest was waning in the domestic oil and gas sector for the past five-six years. That does not seem to be the case any more. Over the past month or so, we have seen some quality portfolio investment in the country’s oil and gas sector stocks. Also, companies like IndianOil Corp, where government stake is above 75 per cent, are divestment candidates,” said Saurabh Mukherjea, head of equities at Mumbai-based Ambit Holdings.
OMCs such as Indian Oil, Hindustan Petroleum Corp Ltd (HPCL) and Bharat Petroleum Corp Ltd (BPCL) never attract FIIs due to their huge under-recoveries. Even ONGC, which is among the top three companies in India in terms of market capitalisation, was not favoured by investors due to its subsidy-sharing agreement with the government. The subsidy on diesel alone is worth Rs 94,000 crore per year. All three government-owned OMCs share the risk associated with a largely ad-hoc mechanism for subsidy reimbursement. The subsidy was also raising the government’s fiscal deficit.
According to the ministry of petroleum and natural gas, the under-recoveries by the three OMCs have been rising over the past three years. For the nine months ended December 31, diesel accounted for 59 per cent of the companies’ total under-recoveries of Rs 125 crore.
“Some of these FIIs buying into oil and gas stocks are deep-pocket investors. So, a re-rating of these stocks is certain. It only remains to be seen if OMCs are freely allowed to hike the price of diesel, which will add more substance to the story,” said Sanjeev Prasad, senior executive director, Kotak Institutional Equities.
Estimates by analysts suggest diesel deregulation per se would translate into a 30-60 per cent reduction in under-recoveries for the financial year 2014-15 (versus FY12-13). Further, analysts with foreign brokerages also said government oil companies might put out a road map to capitalise on the large network of petrol pumps they had across the country and develop them to take advantage of retail play. Indian Oil, HPCL and BPCL put together own 30,000-40,000 petrol pumps across the country.
While experts believe the next quarter shareholding filing will give a broad picture of FII buying in oil and gas companies, their stake in HPCL rose from 6.24 per cent to 7.31 per cent in December itself. The FII stake in BPCL rose from 9.4 per cent to 10.04 per cent during the month, while in Indian Oil, it rose from 1.04 per cent to 1.38 per cent. After staying away from the ONGC offer for sale last year, FIIs raised their stake from 5.55 to 5.79 per cent in the company.
State-run oil companies are currently factoring in only Rs 2-3/litre increase in diesel price. Hence, a complete deregulation of diesel price would lead to a second round of re-rating for OMCs (HPCL and BPCL) to closer to their peak P/B (price to book) multiple of 1.3x-1.5x (from the current level of 0.8-1.1x). A lower subsidy burden will result in ONGC’s and Oil India Ltd’s net crude realisation rising to $60-65 per barrel from the current level of $50-55, said a note from Ambit Capital.
Following the government announcement that OMCs can raise diesel price by 50 paise every month, shares of all the three oil and gas companies surged over 10-15 per cent in January. This year, BPCL surged over 20 per cent, HPCL 28 per cent and Indian Oil 27 per cent to their new 52-week highs, compared to a three per cent rise in the benchmark index in the same period.
The government also said that in around two years, diesel would sell at market rates, meaning OMCs will no longer make under-recoveries on the fuel. The government has already allowed OMCs to sell diesel to bulk buyers such as railways and industries, who account for 17 per cent of diesel sales, at market prices.