Freeing diesel : Profound effect across many industries

The decontrol of diesel over the weekend will have a profound effect on the oil industry value chain. It could significantly reduce the fiscal deficit and inflation. A decontrol of diesel also positively affects the transport and telecom sectors at this instant.

The oil subsidy mechanism worked as follows. The central government set a retail price for various fuels. State and central governments charged taxes on top of that retail price. The central government would partially compensate refiners (which it owned) for the losses (called underrecoveries) at the given retail price, via oil bonds. Upstream government-controlled business such as Oil and Natural Gas Corporation (ONGC) would be forced to share the burden of the oil subsidy. As a result, downstream public sector undertakings (PSUs) in oil marketing would struggle, and upstream ones would see profits reduced and the fiscal deficit would balloon if the price of crude oil rose.

Gas and kerosene meant for household use still remain price-controlled, though there's been a rise in the gas price. However, retailers can review the price of diesel, petrol and aviation turbine fuel with price revisions tracking global crude prices. The government will not provide subsidies for losses on these fuels. But there should not be serious losses barring sudden sharp spikes since crude oil prices have fallen.

Being allowed to sell diesel at a profit should help repair the balance sheets of Bharat Petroleum Corporation Limited, Hindustan Petroleum Corporation Limited, Indian Oil Corporation, etc. It should also boost the profits of Oil India Limited (OIL) and ONGC since these must contribute less to the underrecovery subsidy.

Let us suppose crude prices stay close to current levels for a while. Refiners would get a chance to book serious profits and ONGC would also benefit because of the lower underrecovery burden. It may provide a boost to the vehicle manufacturing industry. The railways will reap some benefits since costs would reduce for the single-largest consumer of diesel. Telecom operators would also gain. Collectively, telcos use more diesel in their power backup-gensets than the railways. If crude prices drop rather than staying stable, the same effects will be accentuated.

If crude prices rise, the government would still gain since it is not subsidising diesel. Refiner-marketers would gain since these can charge remunerative market prices. However, rising prices could hurt the government in political terms. Successive governments have avoided decontrol since it was first proposed in 2002.

There are strong reasons to believe crude prices will not rise much for the next year. Prices have fallen because the global demand is low and because the US has managed to ramp up production of tight oil and shale gas. The supply is liable to exceed demand and also likely to grow quicker than it for a while.

These are ideal circumstances for a decontrol. The refiners can make some money until the cycle turns round. Cynically speaking, if the government feels it cannot take the political heat as and when crude prices rise significantly, it could always "recontrol" under such circumstances.

The decontrol throws up prospects in the PSU refining and marketing space. It should also benefit ONGC and OIL. Over the next two quarters, we could also see cost-savings across telecom companies and in the transport -logistics sector.

The author is a technical and equity analyst