The year 2004 provided investors with enough reasons to cheer with the benchmark BSE-Sensex gaining over 14% during the year, despite the infamous 'Black Monday' in May following a change in the government at the Centre. The sector that was affected the most during the year was the energy sector with elections and other political repercussions playing a major role in product pricing and therefore, the company performance. However, the major moves during the later half by the government on the policies front have resulted in the energy sector witnessing gains of 5.5%, thereby proving to be an under-performer.
In this article we take a look at the various factors that led to such a performance despite the fact that the sector witnessed volumes growth of nearly 6% YoY during the first six months of FY05.
The energy sector could be segmented into the following three segments in order to have a proper reflection of the impact on each - Upstream (exploration and production), Marketing and Refining.
Standalone refineries: The largest beneficiaries of the international events in the energy sector were standalone refineries as product prices reached record highs. To put things in perspective, petrol prices touched a high of over US$ 53 per barrel while diesel prices crossed US$ 55 per barrel mark. Also, the fast growing LPG witnessed prices in the range of US$ 480 per tonne as against the long-term average of nearly US$ 300 per tonne. Since refineries realize import parity prices at the refinery gate, gross refining margins averaged around US$ 7 per barrel in 2004 (US$ 4 per barrel in 2003). But for the duty cuts announced by the government in the latter half of the year, the refining margins could have been higher.
Downstream companies: The oil marketing and refining PSUs witnessed a mixed performance during 2004 due to various political ramifications despite robust growth in sales volumes. Diesel sales (which account for over 40% of total petroleum products basket) witnessed double-digit growth as against negative growth during the earlier years. However, a freeze on prices on the back of firm international product prices resulted in the marketing companies selling products at a loss in certain states. IOC, despite the marketing losses, witnessed gains on the refining front while IBP, the only PSU marketing company without a refinery backup, witnessed losses due to high costs. Further, the change in the government led to significant drop in HPCL and BPCL share prices as a result of the scrapping of disinvestment plans. Also, policy environment did not help matters.
Upstream companies: High crude oil prices in the international markets helped the upstream major ONGC reap rich benefits during 2004. To put things in perspective, ONGC realized nearly US$ 42 per barrel during 2QFY05 as against average realizations of US$ 28 per barrel in FY04. This resulted in a jump of 50% in realizations, as a result of which, the scrip witnessed gains of 15% YoY. However, the company had to contribute a large sum towards the subsidy-sharing scheme on account of sale of LPG and kerosene through the PSUs, as a result of which, profits declined. We believe that the government policies regarding gas prices are likely to help ONGC gain further ground.
What to expect?
We continue to remain positive towards the oil marketing companies in 2005 on the back of expected robust growth in volumes. Further, industry-friendly decisions of the government regarding duties and product prices are likely to help the downstream oil marketing companies witness gains. Also, falling crude oil prices could help cut costs, thereby improving profitability.
Although the standalone refineries witnessed a record year in 2004, 2005 is likely to result in relatively lower refining margins, although sustainable over US$ 5 per barrel over the next few years. Further, expansion of refining capacity by the integrated downstream players (HPCL, BPCL and IOC) is likely to add pressure on the domestic front, as India is petroleum products surplus, therefore, resulting in exports, which is relatively less rewarding.
Upstream major, ONGC is likely to gain as international crude oil prices hover around US$ 35 per barrel in 2005. Further, its investments in overseas ventures through its wholly owned subsidiary, OVL is likely to bear fruit with Sakhalin fields going into production in 2005. To add to the company's profitability is the much talked about gas pricing policy being discussed, whereby the government could increase gas prices, resulting in gains for ONGC. At the current juncture, we would advise investors to remain cautious, as many of the above factors have already been factored into the prices.