BofA-ML cuts oil price forecast to $55-70 per barrel

Calls for delinking upstream burden from subsidies

With concerns on China’s growth, expectation of rising Iranian oil production, and persistent dollar strength, Bank of America-Merrill Lynch has announced a cut in its Brent oil price forecast from $60-80 per barrel to $55-70 per barrel.

“But, we expect prices to rebound into the year-end, driven by an accelerating decline in non-Organization of the Petroleum Exporting Countries (OPEC) production led by the US, a temporary pickup in Chinese demand on monetary stimulus and seasonally strong global demand,” the body said. It added the OPEC could keep prices above $50 per barrel to fund their budgets.

The report said Indian upstream firms stand to gain significantly from lower subsidy burden on the back of the current downturn in oil prices.

The oil subsidy is likely to fall 60 per cent to Rs 30,000 crore, and at $80 per barrel, the subsidy is unlikely to rise beyond Rs 70,000 crore, eight per cent lower than the last financial year’s subsidy, the report said.

BofA-ML lauded the government for a transparent subsidy formula for the current financial year, which would mean a 95 per cent cut to Oil and Natural Gas Corporation Limited (ONGC) and Oil India Limited’s (OIL) subsidy burden driving oil price realisations higher ($52-57 per barrel from $45-47 in FY15) on their nomination field production despite lower Brent price forecasts.

“The share of upstream in funding subsidies will drop to below 10 per cent as compared to the historical average of 35-55 per cent over the last decade,” it said.

The government had announced it would bear oil marketing companies (OMCs) losses to subsidised sales to the extent of Rs 12 per litre for kerosene and Rs 14 per kilo on cooking gas. BofA-ML said the pre-announcement of the current financial year’s formula was positive, but called for adoption of a stable formula, “which is ideally delinked from subsidies and assumes the form of an oil tax, linked with oil prices”.

A break from an ad-hoc, subsidy-linked formula would improve earnings predictability and refocus emphasis on efficiency and returns. “This is also crucial for the long term outlook for ONGC and OIL, handicapped as they are from lack of production growth amidst high decline ratios from their mature assets,” the report said.

The research firm said like most upstream companies, ONGC and OIL are not immune to lower oil prices but their near-term earnings will be supported by ongoing domestic subsidy reform. Moreover, both companies trade at trough valuations on almost all parameters, making them compelling buys, BofA-ML said.