Energise your trades

Till the Budget, there will be many trading opportunities in the energy sector.

The Kirit Parikh Panel's recommendations on petroleum pricing are radical: move closer to retail price decontrol on various petro-products. According to the Panel's recommendations and estimates, this would mean a rise of around Rs 4.7 a litre (petrol), Rs 2.3 (diesel), Rs 6 (kerosene) and Rs 100 per cylinder of LPG.

The recommendations imply continued subsidies on kerosene and LPG. According to the chairman, if the report is implemented in toto, the Government's subsidy burden will be capped at around Rs 20,000 crore a year, assuming crude prices stay within the range of $70 a barrel to $150 a barrel.

The case for moving towards market prices is clear. In FY 2008-09, the PSU oil-marketing companies suffered over Rs 100,000 crore in the form of subsidy burdens as crude spiked above $140. In FY 2009-10, that burden will fall to a still-onerous Rs 40,000 crore because crude prices have eased (currently around $73).

The Government of India (GoI) absorbs those losses as the majority shareholder of the PSUs in question, and thereby, it risks making the entire sector sick. This is also unfair to minority shareholders and it has been a massive disincentive for private investments in retailing. If instead, the GoI fully compensated the PSUs while maintaining the subsidy (rather than the very unfavourable oil-bond formula of partial compensation that is used at present), it would add a big item to the fiscal deficit.

The other side of the equation is as clear. The subsidy helps keep transport costs for the entire economy under control. If transport costs rose, so would inflation across the board and that is already a problem area.

A further point is that kerosene and LPG subsidies supposedly help the poor. This is actually dubious because the subsidy disproportionately benefits upper-income groups, causing a distortion where diesel has become the fuel of choice for expensive vehicles.

Incidentally, diesel is also a massive, growing head in the operating expenses for power-starved industries. In particular, rural telecom networks depend on diesel gen-sets to keep base stations running and so do many other service industries.

About kerosene, the NSS data cited by the Panel suggests that the bottom 40 per cent of rural households spends less than 2 per cent of their total aggregate expenditure on kerosene. This is down from around 3 per cent in 2002, when kerosene prices were last raised. The proposed hike would push estimated proportion of expenditure on kerosene up to around 3 per cent again for this population segment. The LPG hike would similarly push the expenses on LPG for urban households back to around the 2002 levels.

The big question is, how much of the recommendations will be accepted? Obviously, this is a politically sensitive issue. It also has big implications for both upstream and downstream players in the petro-chain.

Producers like ONGC, OIL, and even Reliance and Cairn could stand to gain since their realisations would come closer to international prices and importantly, they would also have a stable predictable policy environment. GAIL, which stays out of the subsidy net as a pure distribution-marketing agent, is also likely to be a gainer if the Panel's views are accepted.

Retailers would gain the most. The initial impact would be like pumping steroids into the weakened balance sheets of BPCL, HPCL and Indian Oil Corporation as they stopped losing money on every litre sold. The second stage would see Reliance, ONGC, Shell, Essar, and so on, reviving their retail plans and rolling out the chains of pumps for which they have already obtained licenses.

It would also change the scenario for refining. Instead of the current thrust on exports, private players would seek to exploit local markets. India already has substantial surplus refining capacity at very competitive margins so, exports would continue anyhow. But, the domestic returns would be better for most private players as well.

However, will the Panel recommendations be adopted? Your guess is as good as mine. One good thing is, if they are accepted, it's likely to happen before the Budget so that there isn't a double blow.

The only guarantee is that there will be a lot of trading opportunities in the energy space over the next three or four weeks. These are all big listed companies with a lot of derivative liquidity. The fundamental outlook for them will depend on the policy decisions. But the trader who can swing both ways with the rumours would have opportunities to make money within this settlement, whatever the government does.