Hope of diesel price hike stokes oil stocks

In what is being seen as a step towards partial deregulation of diesel prices, the government has permitted state-owned oil marketing companies (OMCs) to revise diesel prices periodically. It has also hiked the cap on subsidised LPG cylinders in a year to nine starting April 1, 2013, as against the current cap of six that are available in a fiscal.

The steps are in-line with the Kelkar Committee report, which had suggested complete deregulation of diesel prices by the start of fiscal 2014-15 as well as raising kerosene and LPG rates.

Post the announcement, the stocks of OMCs like Hindustan Petroleum Corporation Ltd (HPCL), Bharat Petroleum Corporation Ltd (BPCL) and Indian Oil Corporation (IOC) flared up nearly eight per cent intra-day. The stocks though, gave up some of the gains later -- they closed the day with gains ranging three to seven per cent -- possibly due to some apprehensions over follow-up action. The BSE oil and gas index was the top sectoral gainer – up 3.4 per cent, as compared to around 0.8 per cent rise in the benchmark indices.

“The government today raised the cap on subsidised LPG gas cylinders from six to nine in a year. However, there is no change in LPG prices at the moment. This is contrary to the expectation that a hike in subsdised cylinder cap would come with an increase in LPG price considering the high gross under recovery (GUR) on petroleum products. Concrete measures to reduce GUR are required to keep the subsidy bill under check,” said Abhinav Goel, senior director, India Ratings and Research.

Market’s interpretation
So, how are analysts interpreting the moves by the government and is it a good time to buy stocks from the oil and gas space?

“The statement seems ambiguous since there is no clarity on the frequency with which the OMCs can hike prices. Given the political compulsions, I don’t think the companies will be able to significantly raise prices. However, the statement is positive only for the short-term,” said A K Prabhakar, senior vice-president (equity research), Anand Rathi. “Given a chance, I feel OMCs will definitely hike diesel prices, at least by Rs 1 (per litre). I am positive on BPCL, Oil India, ONGC and Gail. I believe these stocks can outperform the market going ahead,” he adds.

Dayanand Mittal, an analyst at Ambit Capital, however, is not excited. He believes the OMCs will still need government approval for hiking the prices. And, while he believes that the step is in the right direction, he isn't reading much into these statements right now. Mittal adds, “The OMCs are losing close to Rs 9.5 per litre on diesel, and if permitted, the hike can be to the tune of Rs 2–3 a litre right now. This amounts to around Rs 80,000-90,000 crore annual loss on subsidised diesel. A Rs 2 hike in prices can bring down the under-recoveries by Rs 15,000 crore.”

Inflation impact
The recent economic data – the index of industrial production for November and wholesale price index (WPI), the main inflation indicator, came in at 7.18 per cent for December 2012 – lower than the 7.4 per cent rise estimated by analysts, had given rise to hope of a cut in the interest rate by the Reserve Bank of India (RBI) in its Monetary Policy review scheduled for January 29.

However, the central bank chief, D Subbarao, raised concerns about the high inflation yet again on Wednesday, denting hopes of a rate cut this month. But, given the possible rise in diesel prices now, which will help the government lower its fiscal deficit, economists are still hopeful that the central bank could oblige.

“Though the decision is positive, we actually need to see a follow through on the announcements. If there is a follow through and diesel prices are hiked, it will definitely have a bearing on inflation. Rs 2 hike in the diesel prices will have a 20-30 basis points impact on inflation. We are still hopeful of a 25 basis points rate cut in the January policy review,” said Sonal Varma, economist, Nomura.