Street factoring in Ukraine war-driven sustained spike in energy prices

Post hike in retail fuel prices and hopes of higher profitability have led to gains in stocks of oil and gas producers, and distribution companies

The energy shock is filtering into retail. Gas and crude prices started rising in December and spiked on the Ukraine war. Due to electoral considerations, the retail prices were not hiked until the five key Assembly elections concluded. As a result, there were under-recoveries through the last four months, offset to some extent by inventory gains.

In the last two weeks however, there have been a sequence of price hikes in petrol, diesel, aviation turbine fuel (ATF) and in compressed natural gas (CNG) and liquefied petroleum gas (LPG). The price of domestic natural gas is reset every six months (April-Sep and Oct-March) according to a formula which takes overseas natural gas (NG) contracts into account. The reset in April raised domestic NG prices by 110 per cent for APM (administered pricing mechanism) gas, and by 62 per cent for HPHT (High Pressure High Temperature) gas.  

India is heavily import-dependent and Centre and state governments also raise huge revenues from various imposts on fuels. The earlier formula of asking retailers to offer subsidised prices, and compensating them via oil-bonds was cumbersome and negatively impacted government finances and the balance sheets of fuel retailers.

Fuel is a necessary good – if it has to be bought at higher costs, households as well as corporates will compensate by spending less elsewhere. High retail fuel prices also feeds into inflation and may result in lower consumption demand in other sectors.

Petrol, ATF and diesel demand is guaranteed to rise, given increase in economic activity. Crisil estimates that gas demand will grow by over 10 per cent in 2022-23 despite the rising prices. When it comes to natural gas, it is cheaper than petrol and diesel as transport fuel so the transport market should not be impacted. When it comes to cooking gas, there are no alternatives, so the market is captive. Industries such as ceramics, paints, speciality chemicals, fertilisers, insecticides, plastics, film, etc., use these fuels as feedstock and they will see profit margins eroded, due to the rise in raw material costs. The Fertiliser subsidy will have to be hiked after the gas price hike.

For ONGC, OIL, and to some extent Reliance Industries and Vedanta, the price hikes will lead to a rise in profitability, since they are all gas and crude producers. The gains could be extraordinary for ONGC while RIL has large downstream exposures as well as its digital and retail segments and Vedanta has many other divisions (mostly concerned with metals).

Public sector oil marketing companies (OMCs) BPCL, IOC and HPCL will suffer under-recoveries even at the current retail prices for petrol and diesel. However, the market is expecting further staggered hikes of another Rs 6-7 per litre of petrol/diesel, which should restore positive margins. (ONGC has a majority stake in HPCL which could mean lower profits at the consolidated level.) The OMCs had a difficult Q4, sustained only by inventory gains, while suffering big under-recoveries. The Q1, 2022-23 should be better.

The city gas distribution (CGD) companies will need to hike tariffs by an estimated Rs 14 per kg to retain profitability, given prevailing prices. GAIL will need to raise prices for its LPG. The CGD players have pricing power because natural gas remains considerably cheaper than alternatives in transport and there is no alternative in household consumption. Indraprastha Gas (IGL) has already hiked tariffs. Some industrial gas consumers (and gas-based power generators) may shut down/reduce consumption.

The stock market reaction to the hike has been positive. BPCL, GAIL, IOC and HPCL have rallied sharply in the last session while ONGC, Reliance have also done well. Adani Total has shot up, while IGL has also risen almost 2 per cent.