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Energy: Dismantling, not so hot

Mar 22, 2002

The oil & gas sector, among the stodgiest of old economy industries, till recently, did not arouse excitement within the investment community. In fact, the scrips always featured in a value investors' list. However, that seems to have changed with the Government going ahead with deregulation and disinvestments in the sector. The Government plans to stick with the original administered pricing (APM) dismantling schedule, linking prices of transportation fuels to international markets from start of the new fiscal (FY03). Private sector participation has also been permitted in the petroleum marketing segment. Heating up excitement further, the Government has successfully divested stake in the pure marketing company, Indo-Burmah Petroleum (IBP). Whetting investor apitite for refining & marketing (R&M) companies, the Department of Disinvestment (DoD) has hinted at even bigger ticket sales. As per statements made earlier, within three months of industry deregulation, the Government will start disinvestment process for the two oil companies, Bharat Petroleum (BPCL) and Hindustan Petroleum (HPCL). In fact, DoD has already invited proposals for adivisors to the process from the invesment banking community. Consequently, activity in these scrips remain buoyant. Going by the IBP sale, the entire process is likely to take more than six months.

Having said that, a lot of investor excitement for these scrips namely, HPCL, BPCL and Indian Oil (IOC) is due to perceived benefits accruing from dismantling of APM. However, not many have been able to put any number on the benefits to accrue from price deregulation. Dismantling of the mechanism is not entirely complete. As per the original schedule, subsidy on kerosene and LPG was to be reduced to 33% and 15% respectively of international parity prices. The subsidy element, anticipated in the region of Rs 90 bn, was to be transferred to the general budget and the oil pool account would become redundant. During the budget, the FM indicated that prices of these products are likely to be deregulated over three to five years. Also, recently the FM rolled back Rs 20 on LPG cylinder price hike.

APM Dismantling: Windfall gains?
BPCL HPCL IOC
Petrol 10.7% 9.0% 4.9%
Diesel 47.7% 42.4% 37.1%
SKO 9.3% 11.1% 13.1%
LPG 8.3% 8.8% 6.9%
Total sales 76.0% 71.3% 62.0%
volume sale share

Gauging the upshot from dismantling in the oil sector, benefits are likely to accrue only over the longer term, as SKO and LPG prices are brought in line with international markets. At the same time, petrol prices could correct much faster to prevailing international prices, which could adversely impact sales. Currently, domestic prices are estimated to be 26% above the landed cost of petrol. In value terms, the share of SKO is likely to be lower, as compared to volume share and vice-verca for LPG. Assuming, aggregate contribution to sales being similar to volume share, the benefit could be in the region of 7%-8% on complete decontrol. That said, benefits will also depend on LPG and SKO price movements in international markets. Softer prices, as seen during 1998 could wash out much of the gains. Also, it is more likely that the Government will announce 100% linkage with international markets when prices are ruling low, which will prevent a sharp spurt in domestic prices. Although the windshield is frosty, topline gains from APM dismantling do not seem to warrant much excitement.

Price comparatives
Domestic Landed Cost % diff.
Petrol Rs/litre 28.0 20.5 26.6%
Domestic Commercial % diff.
LPG Rs/Kg 19.0 28.7 51.5%

A positive impact from the dismantling process though, is likely to reflect on interest expenses of these companies. As subsidies are reduced, lesser amount of funds are likely to be blocked with the Government. This could tighten the working capital cycle resulting in lower short-term borrowings. Although the oil account (OPA) will become redundant, the risk of delayed payments has not been entirely mitigated, as the Government will still need to re-imburse the companies for LPG and SKO sales. Prompt re-imbursement could further lower interest expense.

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