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Brokerages bullish on oil stocks as crude prices drop

Wednesday, 20 August 2014 - 7:10am IST | Agency: dna

Analysts expect 20-25% upside in OMC shares over next one year, though much depends on govt's subsidy sharing mechanism

Shares of oil and gas companies, especially state-owned oil retailers and upstream companies, continued its northward rally on Tuesday, riding a sharp fall in international crude prices. Global brokerage and credit rating firms like Goldman Sachs, Deutsche Bank and Moody's have turned bullish on oil marketing companies (OMCs) and are expecting around 20-25% upside in their stock prices over the next one year.

Shares of Hindustan Petroleum, Bharat Petroleum and Indian Oil rose 1.5-4% on local bourses. Brent crude oil fell by more than $2 a barrel on Monday to around $100, lowest level in a year, which are likely to bring down the under-recovery on sale of diesel rapidly.

The Petroleum Planning and Analysis Cell in a recent statement said that losses on sale of diesel rose to Rs 1.78 per litre after hitting all-time low of Rs 1.33 a litre at the end of July. However, this statement came before the start of the downward revision in Brent crude prices.

"We expect almost no losses on diesel after September price hike. We estimate that losses on retail diesel sales are now down to Re 0.8/ltr, from Rs 1.3/ltr in the first fortnight of August 2014 and Rs 2.5/ltr in the second fortnight of July 2014, and will fall to Re 0.3/ltr after the price hike on September 1, assuming oil prices and diesel cracks remain around current levels," Goldman Sachs said in a report on Tuesday implying that effectively monthly cycle of diesel price increases will be done away with in two months and the widely consumed fuel will be completely deregulated.

"We also see significant share price upside of 102%-263% for OMCs as divestment plays under our blue sky scenario," the brokerage said.

The credit rating agency Moody's Investors Service expects Indian refiners' credit metrics to improve over the next 12 month. "We expect total under-recoveries for the three state- owned oil marketing companies to decline to Rs 1 trillion in fiscal 2014-15 from Rs 1.4 trillion in 2013-14. This would result in a fall in the borrowings of these marketing companies of about Rs 10,000-15000 crore and a fall in interest expenses of about Rs 1,000-1,500 crore," Moody's said.

"At present, even though the refiners are nearly fully compensated for their under-recoveries, the six-month delay between the realisation of the under-recoveries and the government's reimbursement means that IOC and BPCL rely heavily on short-term borrowings to fund the under-recoveries in the interim. Furthermore, the government does not reimburse the interest incurred on these loans," it added.

A word of caution, however, for investors would be that a lot also depends on government's subsidy sharing mechanism. At present, diesel, domestic LPG, and kerosene are sold by OMCs at government-controlled rates which are below the market price. Losses are made good through subsidy which is shared by oil retailers, government and upstream companies like ONGC and OIL.

In the last fiscal, OMC's share of subsidy burden increased to Rs 2,000 crore from Rs 1,000 crore in fiscal 2012-13 even as overall oil subsidy declined to Rs 1,39,870 crore from Rs 1,61,029 crore. The government may want to reduce its own burden of subsidy share and use those funds for other growth revival measures.

"Looking at the past trend and financial condition of the government, I don't believe government will pass full benefit of lower under-recoveries to OMCs and upstream companies," Dhaval Joshi, an analyst with Emkay Global, said. Also, upstream companies have been pushing the government to reduce their subsidy burden to improve net price realisation. ONGC has been demanding a net price realisation of $65 a barrel.

"There will be more clarity on subsidy sharing mechanism at end of this fiscal. Actual benefits of lower under-recoveries will be more visible in next fiscal rather than this fiscal as diesel under-recoveries would be zero, while kerosene and LPG under-recoveries could be around Rs 75,000 crore," Joshi added.

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