Oil and gas: Changing paradigm

If implemented fully, the Kirit Parikh committee report translates into gains for all

The Kirit Parikh Committee report has outlined recommendations on aligning petroleum product prices with international prices and suggested a formula for sharing the subsidy burden with upstream oil companies, given that fiscal prudence is the need of the hour.

The committee hopes to cap the government’s share of the subsidy burden by reducing total subsidy and consequently under-recoveries. It has fixed a crude price-linked formula for the share of burden to be shouldered by upstream companies.

Key measures include eliminating all petrol and diesel subsidies by deregulating prices at the refinery and retail level. Secondly, reducing public distribution system (PDS) kerosene allocation across India by 20 per cent at least and raising PDS kerosene prices by Rs 6 per litre. Finally, the committee recommends increasing LPG prices by Rs 100 per cylinder.

The committee recognised the government’s obligation to fully compensate the under-recoveries of downstream companies marketing domestic LPG and PDS kerosene. It recommends that this be done by mopping-up a percentage of incremental revenues accruing to upstream companies from blocks allocated to them by the government by nomination. The percentage is linked to international crude prices and ranges from 20 per cent, when the crude price is at $60-70 per bbl, to 80 per cent, when over $90 per bbl levels.

The residual gap is to be financed through the Budget and if all recommendations are implemented, it should reduce the subsidy burden between 50-70 per cent, with crude at $70-140 per bbl. The government’s burden will be in the range of Rs 20,000-Rs 23,000 crore. This includes a fixed rate of PDS kerosene and LPG subsidy through the Budget.

The recommendations are positive for OMCs (oil marketing companies) like HPCL and BPCL which have borne the brunt of under-recoveries, with the government approving a Rs 12,000-crore support for OMCs for FY10 (markets expected Rs 30,000 crore) and sharing only about a third of the burden. Upstream companies (ONGC and OIL) will take on the subsidy burden through price discounts to OMCs that are a share of incremental revenue from the allocated blocks. The mechanism is linked to crude prices and is definitely more transparent than the current ad hoc decision making.

OMC valuations are set to improve if these recommendations are approved.  Analysts expect FY11 EPS to grow 50, 90 and 70 per cent for IOC, BPCL and HPCL, respectively, should the government take on the net subsidy. GAIL also turns out to be a big winner, as it is not bunched with the upstream companies, since it was not allocated blocks with ONGC and OIL. Analysts estimate FY11 EPS upsides of about Rs 6-8 for GAIL.

Upstream companies will benefit as the report doesn’t outline any cap on realisations, which range within $55-60 per bbl currently and will benefit from a free pricing environment, as under-recoveries reduce with a removal of auto fuel subsidies.

However, any upsides will come through only when the recommendations are approved. The universal feel on the Street is that the government is unlikely to take these major steps suddenly but will implement them in a phased manner.

The BSE Oil and Gas index dipped after the report was released, down 0.8 per cent on February 4, over the previous day’s close. GAIL surged over 3 per cent in that period, while the Sensex shed 1.64 per cent. On Thursday, however, the story was different, with the oil and gas index falling 3.4 per cent in line with a dip in broader indices.