Petrobras versus petro subsidies

1 OCTOBER 2010

The Government should take a cue from the phenomenal success of Brazilian Petrobras, which recently floated the largest ever IPO in history, to raise $ 70 b. Much of this would be spent on oil exploration, to secure Brazil's future energy needs and also become an exporter. The Government should, in enlightened self interest, refrain from burdening it, and other energy companies, with bearing a burden of subsidising certain petro products, a burden that morally belongs to the Union Budget.

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Consider that a company makes a profit of Rs 100 and is valued at Rs 1700, giving a pe multiple of 17. From this profit, the management takes out Rs 10, for whatever reason. The valuation drops by Rs 170, to Rs 1530. The owner then sells 10% at 1530, fetching him 153 or Rs 17 less than if he had not taken out the Rs 10. Its simple maths; not rocket science. In earlier days, private promoters used to siphon off the Rs 10, in order to save on both corporate tax and on wealth tax, both of which were kept foolishly high. Now companies like ONGC are having to bear that burden, at the behest of Govenment, the majority owner. Which is why an ONGC, in the same line of business as a Petrobras, would never be able to raise $ 70 b. and would thus never be able to spend $50 b. of that to secure India's energy future.

Incidentally, ONGC and IOC are both slated to raise follow on offers this year, combining an offer for sale by Government and a fresh issue. The Government would, in its offer of sale, have fetched far far more than the amount it saved by asking ONGC to share the subsidy burden. A rational way would, therefore, be to take the subsidy burden in the Budget and enhance the valuation of the firm.

For the oil marketing companies, IOC, BPCL and HPCL, the situation is worse. Not only are they to bear a part of the subsidy burden, but the Government is capping the amount they would be reimbursed. These companies have had to borrow because of the 'under recoveries' a eupheism for losses due to subsidies. This obviously curtails their ability to invest. Nonetheless, BPCL has drawn up ambitious plans to invest Rs 50,000 crores, including Rs 28,000 crores on refinery expansion and the balance on exploration and production in foreign countries.

The same policy mess is seen in the case of urea. Of the three types of fertilisers, N P and K, it is only the nitrogenous fertilisers, or urea, that continue to get subsidised. Because they are subsidised, there is an overuse of it, which inevitably leads to soil degradation. So, instead of helping the farmer by providing cheap urea, the subsidy actually hurts him.

Years ago, when Yashwant Sinha was Finance Minister, he tried to correct the situation by raising prices of urea by Rs 1/kg, and was booed down for his efforts. After so many years, yet another committee has been set up to look into urea pricing and to recommend nutrient based subsidy, because it leads to soil degradation, a fact that has been known for many years. It seems that good ideas are left by Government to germinate until either a crisis or a favourable political situation allow them to manifest themselves.

There have been some reader comments for my last column, about the usurious interest rates microfinance companies charge, of 35%, which the RBI asked banks lending to these MFIs at much lower rates, to see that they did not exceed 24%. As Swaminathan Aiyar has correctly pointed out, the borrowers borrow for a few days when they see an opportunity to earn something. For example, if a villager can buy, say, fresh vegetables for Rs 10,000 and sell them in another village for, say Rs 12,000 the same day, he will not mind paying 35% interest if he is getting the money without delays. For, at 35%, the interest per day is less than Rs 10. In effect, therefore, NOT giving the villager an opportunity to borrow at 35%, considered usurious, is actually DENYING him the right to sieze an opportunity and thus of inclusion in economic growth.

The RBI is asking State Governments to stop directing new business (such as tax collection and certain payments) to private banks. But then the Government cannot, in the same breath, protest against the US for asking its States not to outsource to countries like India.

The market surged on Friday, after a balanced judgement delivered by the Allahabad High Court in the Ayodhya dispute, dividing the land three ways. Thankfully there has been no disruption of the peace. The sensex soared 375 points on Friday, ending the week with a 399 point gain at 20445. The Nifty ended the week up 126, at 6143.

The other important development of the week was the release of the first batch of UID (unique identity) cards by the Prime Minister. This should help stem the leakage in delivery of largesse in the public distribution system, thus helping curb the fiscal deficit. The fiscal deficit has fallen, but that's thanks to the money received for sale of 3G spectrum and not due to curtailment of expenditure.

Another potentially exciting technology development is the possibility of a cheaper way to transport natural gas. This is being done currently by liquefying it, transporting it either through pipelines or in refrigerated ships to the destination, where it is re-gassified. This is expensive and risky. The new technology traps the gas in the form of methane hydrate, which is faster, and cheaper. Now India has been blessed with large reserves of natural gas and, if this technology succeeds, it can be beneficial to India and, of course, to the companies discovering it.

India has faced, thanks to some hostile elements, danger from explosives like RDX, which, not being metal, are difficult to detect. Here, too, new technologies are being developed by Israel, which faces similar threats, that uses nanowire arrays in handheld devices that are far more sensitive than dogs, at sniffing explosives. Instead of buying expensive toilet paper for the CWG, the money would have been better spent on such devices.

The market is heading towards its peak of 21,200 in January 2008. It will act as a resistance and could result in a dip. The dip would be a buying opportunity. The Chairman of Blackstone, the largest private equity player, wants to invest $ 2b. in India. He quotes the former World Bank President James Wolfenson, who maintains that by 2050 India and China would account for 40-45% of global GDP. They used to be at that level some 300 years ago, before the industrial revolution and the foreign rule. But good governance is needed to get there, and logical decisions for the good of the country.

Note : The author is travelling and would not be in a position to submit this column next Saturday.

J Mulraj is a stock market columnist and observer of long standing. His weekly column on stock markets has run for over 27 years. An MBA from IIM Calcutta, he has been a member of the BSE. He is Conference Head - India, for Euromoney. A keen observer of events and trends, he writes in a lucid yet readable style and takes up issues on behalf of the individual investor. Nothing pleases him more than a reader who confesses having no interest in stock markets yet being a reader of his columns. His other interests include reading, both fiction and non-fiction, bridge, snooker and chess.

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9 Responses to "Petrobras versus petro subsidies"


Oct 17, 2010

If 40-50% of global GDP was achieved 300 yrs. ago, better we aspire for that. More such astonishing facts pls. I remember our elders saying that India had the capacity to weave a silk saree and pack it in match box.


S K Menon

Oct 8, 2010

The concept of MFI is nothing new to the villages. Private moneylenders have been providing finance - FAST but at HIGH interest rates.
The MFI's will benefit the poor common man if they give finance at almost 24%; the prime objective of MFI's should not be to maximise profits.


Vinod Malhotra

Oct 4, 2010

In this issue of subsidies, we forget that the public sector is the worst user of resources. BSNL and MTNL have already squandered away some of the reserves and are having losses while efficient private players are doing well and will continue to do well.
In the petroleum sector, there is ample scope for corruption. First the buying of crude is done from "approved" vendors and that takes care of competition. The wastages and pilferages are conveniently loaded on to the subsidy. Volumes are becoming big and so is the corruption and the honest citizen of the country have to bear the burden. Kerosene for the poor at subsided rates is not delivered to them and is sold in the market. Let there be competition and that is really in the National interest and in the interest of National security. Once the sector is opened up, we will be able to valuations like Petrobras.


Vinayak M Prabhu

Oct 3, 2010

Dear Sir,

What will happen if foreign investers pull the money from the markets.

Thanking you,

Kind regards.



Tikam Patni

Oct 2, 2010

All points are well made. But who cares. It is power thru votes that counts. Long live VOTE POLITICS.


Sachin Wagal

Oct 2, 2010

Subject Microfinance Companies: Well in that case you should stop complaining about village money lenders too, as they too are offering short term business opportunity as MFI's.
Pity... business idea from B School educated in suit boot sitting in plush office is considered as Messiah where as same thing driven from village is considered mafia.



Oct 2, 2010

Mathematics of Rs.7 (17-10)loss is interesting.What I understand is that not only owner in loss but investors are also getting loss by less valuation ?
I am not agree with Swaminathan Aiyer's view on micro finance,if sombody is ready to pay at 35%,and with RBI step same finance will be available to him at 24%, so naturally it is beneficial for him.


Ubed Shipra

Oct 2, 2010

Dear Sir,

The article provides immense knowledge in simple words & the different aspects you have mention was excellent. But my point is that if government had not asked ONGC to share the subsidy burden than they might be forced to sell stake in ONGC / PSU for economic purpose, say to keep BOP intact etc.

Again, Government can sell stakes to a certian limit, so this is not the solution. As per me the price deregulation is a good measure which they have started which i think should have started earlier, similarly government can reduce the different taxes imposed on these firms which might reduce the price by almost 40% or more.

Waiting for you kind reply with more inputs.

Best Regards,


Sanjay Negi

Oct 2, 2010

The RBI governor as an ex IITian and should be ashamed of promoting curtailment of market freedom by asking state governments to keep private banks out of legitimate business...other bureaucrats are of course past masters at it...If he has issues pertaining to regulation, integrity and fair play in "government-business transactions" which is often the case, they should be addressed directly not by throwing away the baby with the bath water....

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