Decade old uncertainties on OMC under recoveries to continue

With the Diesel price hike in March being differed, question mark on pace of fuel price reforms continue to exert pressure on Oil marketing companies

The euphoria surrounding fuel price reforms in line with Kelkar committee recommendations had subsided in January’13 itself. Stocks of HPCL, IOC and BPCL after touching their 52-week highs and started correcting after January 18. The government’s decision to hike diesel prices had gradually taken sheen away from the Kelkar committee recommendations of immediate price hike in th diesel, kerosene and LPG prices and complete decontrol of diesel by early FY15.

Stocks of HPCL, IOC and BPCL are currently trading 23%, 18% and 15% lower than their 52-week highs respectively. HDIL suffered the maximum damage, as it is is most leveraged to price reforms. BPCL is also trading lower, however, it has a play in exploration and production activities, which can provide triggers.

The prospects of HPCL and IOC performing better, thereby, will depend mostly on faster oil pricing reforms that remain jeopardized by the government’s current political compulsions. Thus, most analysts do not see much traction in the stocks despite them trading at attractive valuations.

Slow pace of reform - An overhang

Government allowing oil marketing companies (OMCs) to raise diesel price in small steps had led to an initial 1%  price hike only on January 18, against 20% that was needed.

Further, after just two price hikes (one each in January and February), the third one scheduled for the month of March hike has been defered looking at the budget session in progress. Political compulsions of the government and the approaching general elections In FY14 again raise doubts over continuity of price hikes at the desired pace.

Reacting to the current deferment of diesel price hikes, analysts at HSBC observe that “just after two increases, OMCs have taken a pause in the month of March. This, in our view, indicates that full deregulation of the diesel price is unlikely in near term”.

It is due to this that they maintain an 'underweight' on oil marketing companies.

Even analysts at IIFL say: “We are currently factoring in only Rs 4 a litre increase in diesel prices in the next year as against Rs 6 a litre if price hikes continue at current pace. (One would have expected 12 price hikes of Rs 0.50 each in the financial year).

LPG cap increase further negative

Even if one was to consider a full Rs 6 price hike in FY14, this would have led under recoveries for oil companies going down by Rs 36,000 crore as for every rupee increase in diesel prices the under recoveries are reduced by around Rs 6,000 crore.

However, the government's move to raise cap on subsidized LPG cylinder from 6 to 9 has taken away some sheen as this would increase the susbidy burden by Rs 9,700.

Crude price downside limited

However, oil companies have received some relief looking at the decline in crude prices. Breant crude oil was trading at $118 a barrel in the state of February, which has now come down to $110 levels. However, analysts don’t see much decline from here on.

Analysts at Morgan Stanley see brent prices of $110 a barrel and rupee at 54.5 to a dollar. 

Sujit Lodha at Asian Market Securities does not see much downside in crude prices and assuming Brent at $110 and rupee at 53.5 to a dollar sees total under recoveries for FY14 at Rs 1,10,000-1,20,000 crore.

Although, generally, oil marketing companies do not bear major portion of the subsidy and government does not allow OMC’s to end the year in the red; however, the delay in reimbursement of subsidies by the government leads to increased working capital requirement and hence higher interest outgo.

Thus, with subsidies on kerosene continuing and those on diesel not brought down at a fast pace, analysts do not have a strong outlook for HPCL and IOC.