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Fuel price hike: Impact on OMCs

Jun 5, 2008

The government's relief package to the PSU oil marketing companies (OMCs)- IOCL, BPCL and HPCL-announced on June 4, 2008 impacts many segments of the Indian economy. There are macro level implications on inflation and fiscal deficit along with micro level implications on companies in the banking, logistics, aviation, auto and FMCG sectors among others. In this article, we shall look at how the package affects the OMCs. Before the hike
With the Indian basket of crude touching US$ 125 per barrel, the estimated gross under-recoveries (excess of input cost over final product price) for FY09 had reached Rs 2,453 bn.

Gross underrecoveries incurred
Rs bnFY05FY06FY07FY08FY09E
Petrol2 27 20 73 NA
Diesel22 126 188 352 NA
PDS Kerosene95 144 179 191 NA
Domestic LPG84 102 107 155 NA
Total201 400 494 771 2,453
Source: PPAC, Press Information Bureau, GOI

At these levels, the management of Indian Oil went on record saying they would run out of funds within the next 6 months without a relief package. BPCL and HPCL had funds for an even shorter duration.

Under recoveries of downstream companies
Rs bnFY06FY07FY08
Oil bonds70 139 115
Subsidy from GOI14 15 11
Upstream(ONGC, GAIL) discount72 119 89
Discount from refiners29 6 0
Net underrecovery54 22 65
Gross under recovery239 300 280
Oil bonds225262
Upstream discount364536
Gross under recovery579782
Oil bonds234977
Upstream discount324254
Discount from refinersNA20
Net underrecoveryNA8NA
Gross under recovery56101131
Source: Companies; For BPCL, FY08 figures are for Apr-Dec2008

The hike
On June 4, 2008, the government announced the following measures:

  • Price hiked by: Rs 5 per litre on petrol, Rs 3 per litre on diesel, Rs 50 per cylinder on LPG and no hike on kerosene.

  • Excise duty reduced by: Re 1 per litre on petrol and diesel

  • Customs duty reduced from: 5% to nil on crude oil, 7.5% to 2.5% on petrol and diesel and 10% to 5% on other petroleum products.

After the hike
Although, the hike in fuel prices will lessen the burden of the OMCs, they will not entirely wipe out the underrecoveries.

Gross underrecoveries per litre
Rs Before After
Petrol (per litre) 21 16
Diesel (per litre) 32 29
Kerosene (per litre) 20 20
LPG (per cylinder) 353 303
Source:Press information bureau, GOI
FY09E under recovery pie (Rs bn)
Price hike 211
Duty cuts 227
Upstream discount 450
OMCs 200
Oil bonds 1,350
Total 2,438
Source: Indicative figures

In fact, it will take a combination of factors - substantial cool down in crude prices, greater autonomy in pricing as well as capital expenditure decisions - before the OMCs become viable businesses.

What to expect?

IOCL has capital expenditure plans to the tune of Rs 510 bn for FY07-FY12 (Source: Company), BPCL has capital expenditure plans of Rs 41 bn over a period of two years (Source: Company) and HPCL has capital expenditure plans in excess of Rs 100 bn over the next two years (Source: Company). These outlays are non-discretionary in nature because of regulatory and efficiency/competitive requirements.

In this backdrop, operating losses are a major cause of concern. Spiraling crude prices on the one hand and government intervention in product pricing decisions on the other, means that the return on incremental capital is likely to be poor going forward. In the long run, the performance of the stock price moves in line with the performance of the underlying business. Hence, we are of the opinion that long term investors should steer clear of the OMCs.

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