Gas price cap: Should you dump RIL, other oil stocks?

The finance ministry also said it should be examined whether it is possible to ensure that RIL delivers its current supply shortfall at the old price of $4.2 per mBtu and does not get undue benefit of an increased price

Oil & gas stocks came under heavy selling pressure in trade on Wednesday after reports suggested that the finance ministry has shot off a letter to the petroleum ministry, asking it to consider putting a cap on the increase in domestic gas price when the pricing formula suggested by the Rangarajan panel is implemented from April 2014.

After a three-year hiatus and stiff opposition from most political parties, the Cabinet Committee for Economic Affairs (CCEA) had recently given its nod to the proposal of hiking the prices of natural gas to $8.4 per mmbtu (metric million British thermal units) from April 1, 2014 for a period of five years.

The hike comes three years when in May 2010, the government has hiked the price of administered gas from $1.8 per mBtu to $4.2 per mBtu.

Besides, the finance ministry also said it should be examined whether it is possible to ensure that Reliance Industries (RIL) delivers its current supply shortfall at the old price of $4.2 per mBtu and does not get undue benefit of an increased price.

While the S&P BSE Sensex lost 0.75%, the S&P BSE Oil & gas index ended down 1.83%. Among individual stocks, RIL, ONGC and Cairn India slipped 2–3%. Stocks of oil marketing companies, on the other hand, lost between 1 and 3%.

So, should you be worried and dump these stocks fearing the worst?

Points out Nitin Tiwari of Religare Institutional Research: “In our view, a move by GoI to make RIL sell KG-D6 gas at the old rate of US$ 4.2/mmbtu beyond April’14 would be met by stiff resistance from the company and pave way for arbitration. RIL and GoI are already entangled in arbitration proceedings over cost recovery and penalties for not meeting contracted production levels.”

“Our estimates suggest that at the current rate of production (~15mmscmd), RIL would take seven years to complete the shortfall of outstanding gas (~37500mmscm), implying no revisions in KG-D6 gas price from April’14 onwards. However the definition of ‘outstanding’ gas and the basis of calculation is not clear, i.e. whether the shortfall in supply would be as per (a) firm gas allocation (~63mmscmd) (b) firm and fall-back gas allocation (~93.3mmscmd) or (c) MC/AIDP approved production levels for the number of years the field has been in production,” he adds.

Adds A K Prabhakar, senior vice president - equity research at Anand Rathi: “I don’t expect a massive scale back in prices. The important aspect of recent government policy on oil & gas has been a gradual hike in market prices, which we have seen in the case of petrol and diesel price.  Besides, the as per the policy, gas prices will be revised every three months and it would become market linked. So, this is major positive.”

Tiwari of Religare, on the other hand, says that ONGC and OIL are already factoring in the likelihood of a higher subsidy burden due to an increase in natural gas prices. Therefore, an attempt to cap natural gas prices would have negligible impact on both companies.

RIL is the best buy from the pack for a target of Rs 1,000 in next one year, Prabhakar says. He also likes Cairn India and OIL India as compared to ONGC, and points out that PSU companies have risk of OFS and higher subsidy outgo.