Rising crude prices: What it means for India's oil, telecom sectors

Public sector oil refining-marketing companies (OMCs) have taken a hammering in the past year. The downtrend is likely to continue. Bharat Petroleum Corporation (BPCL), Hindustan Petroleum Corporation (HPCL) and Indian Oil (IOC) are down 8.5 per cent, 10.8 per cent and 4 per cent, respectively in the last 30 days, and down by 19 per cent, 19.9 per cent and 62 per cent in the last year. GAIL, which is a gas marketer, is also down 23 per cent in the last 30 days. 

The equation is simple. If crude oil prices rise and gas prices rise alongside, OMCs suffer due to falling refining margins. The impact of the entire price hike cannot be passed on at retail level. The PSU OMCs are further hamstrung because they cannot export either. 

The government will have to cope with further problems if crude continues rising. The retail price is politically sensitive and higher prices are inflationary. If prices remain decontrolled, and continue to rise, there will be public discomfort. 

One option is to cut back on the considerable quantum of taxes imposed, amounting to over 50 per cent of retail prices for most fuels. That means lower tax collections. Alternatively, not raising retail prices would lead to losses for OMCs. Subsidising such losses, alongside higher subsidies for cooking gas and kerosene, would place a higher burden on public finances. 

Traders can short futures of OMCs and take long positions in the crude commodity market. The pressure on the rupee caused by rising crude prices creates another target. Investors looking at export businesses can take heart from rupee weakness as well. 

These are all well-understood themes. However, there has been less focus on the impact of a price rise on primary oil and gas producers. There has also been less attention paid to private sector refiners. There are two major PSUs involved in exploration and production (E&P), that's ONGC and Oil India. ONGC also has a key subsidiary, ONGC Videsh Limited (OVL), which operates overseas.

Private sector players in E&P include Cairn India (a subsidiary of Vedanta Group), Hind Oil Exploration, Essar Oil (now part of Rosneft Group), etc. ONGC is in the process of taking over HPCL to create an integrated entity. 

The PSU producers price oil and gas according to set formulae. Hence, E&P firms gain if international prices rise, since the formulae are linked to international prices. Investors can look at positions in the E&P segment. 

But there's a history of forcing PSU E&P players and GAIL to share in the subsidy burden, if international prices rise above a certain level. At sustained prices of above $75/ barrel, this enforced subsidisation is likely, given policy history. That's one reason why investors have not been enthusiastic about ONGC and OIL. However, ONGC could develop higher valuations if it manages end-to-end integration with HPCL. 

Private sector refiners export. That protects margins to some extent. Reliance Industries (RIL) has very cost-effective production with margins well in excess of benchmark Singapore Gross Refining Margin. However, the refining margin inevitably reduces if the cost of crude/gas rises. So, rising crude could reduce profits for RIL, going forward. If this does happen, it may lead to a change in trend for the RIL share, which is up over 37 per cent in the past year and 8 per cent in the last month.

Rising crude prices may also alter the dynamics of the entire telecom sector. RIL's subsidiary, Reliance Jio Infocomm requires massive ongoing investment, which will come easier if RIL is making bumper profits. It's hard to extrapolate. But rising crude could trigger an accelerated IPO for Jio, and also enable stiffer competition from other telecom entities if investment in Jio slows down.