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Oil boils over - Views on News from Equitymaster

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Oil boils over
Mar 13, 2008

Crude prices have been rising steadily over the past four years to reach their all time highs of US$ 110/bbl this year. Infact, even the Indian basket of crude has crossed the US$ 100/bbl mark. Incremental demand from the China and India; supply constraints from the OPEC; geopolitical tensions in Iran, Nigeria and Venezuela; a declining dollar; and speculative activity have all contributed towards the record prices.

(Source: EIA, US Dept. of Energy)

Downstream companies face under recoveries
Although they are supposed to be de-regulated, the government of India still meddles in the prices of petroleum products due to concerns over inflation and popular disapproval. As a result, the public sector oil marketing companies (PSU OMCs), i.e., IOC, HPCL and BPCL cannot fully recover costs in the retail sales prices and face revenue under recoveries of around Rs 10 per litre of petrol, Rs 12 per litre of diesel, Rs 21 per litre of Kerosene and Rs 304 per cylinder of LPG.

Upstream companies’ share
The upstream public sector upstream companies, i.e., ONGC, OIL and GAIL have to share 33% of the under recoveries of the downstream companies going forward, by supplying them discount on sales.

 

The government’s share: oil bonds
The government issues oil bonds to the downstream companies to absorb a portion of the under recoveries. It plans to share 52% of the under recoveries of the downstream companies going forward.

What to expect?
Artificially low prices of petroleum products fail to provide the price signals that reduce demand. As a result, the Indian consumer continues to gorge petroleum products and mount the under-recoveries for downstream companies, subsidy bills for upstream companies and issue of oil bonds for the government.

The effects are there for all to see. Under-recoveries for the downstream companies have begun to jeopardize their “navratna” status. Subsidies by the upstream companies will disincentive them to incur incremental capex in exploration and production at a time when the government is promoting the NELP VII rounds. Oil bonds are only a method to postpone the present budgetary support into the future even though the same government levies excise on petroleum products in the present.

With crude prices showing no signs of letting down and price hikes unlikely in India in an election year; we expect the energy sector to experience more pain going forward.

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