A crude problem

SMARTSHARE

A first glance at half-yearly results suggests that growth is slowing.

Sales turnover across 1,200-odd companies (collated by the Business Standard Research Bureau) is up substantially, with 18 per cent growth in comparison to H1, 2004-05. However, net profit growth has slowed - PAT has risen "only" 18 per cent.

That number is handsome in absolute terms. But it's lower than expectations. Since Q1, 2003-04 PAT growth has been running at over 25 per cent, while turnover growth has run at 20 per cent.

A second look pinpoints the problem area. The key underperformer is the PSU oil and gas sector. As a group, these companies have registered a 15 per cent drop in PAT.

The major refiners, BPCL, HPCL and IOC's marketing subsidiary, IBP, have registered massive losses. Profits from primary player ONGC and a recovery in the bottomline of IOC itself has not been enough to compensate.

If refiners cannot pass on price increases due to political policy, they will continue to be losers. If we exclude the oil PSUs, H1 results look much better.

Other manufacturing companies have recorded 30 percent-plus PAT growth along with 16 per cent gains in sales turnover (the PSU refiners recorded high turnover growth).

However, energy isn't just another sector. It contributes a huge proportion of India Inc's consolidated turnover and profits. Events here underpin everything.

High crude prices are directly responsible for the Current Account shifting from surplus into deficit. And it's also responsible for the rise in inflation, which has pushed the RBI into talking rates up.

How much longer can the economy shrug off high crude prices? This problem will not go away. India's crude imports will rise around 65-70 per cent in value terms this year.

Next year could see quantitative demand rising as well. Even if the mess in Iraq is sorted out tomorrow by some miracle, it will take a long time before production comes back onstream.

Until then, the global supply-demand equation will be very tight. This winter, the US may be forced to release strategic reserves to counter the demands of central heating.

It's very difficult for the government to simply free oil-pricing at this stage. If prices had been freed when oil was below $30/barrel not too long ago, the Indian economy would perhaps have gradually adjusted to rising energy costs.

If prices are freed right now, the one-time inflationary shock would be considerable. But if prices aren't rationalised, the oil navratnas will go into terminal decline. The government must therefore walk a very thin tightrope; ensure oil PSUs survive without crippling the overall economy.

An estimate by the IOC chairman is that diesel retails at Rs 3.48/litre below cost while petrol is under-priced by Rs 2.8/ litre. Kerosene is underpriced by Rs 13/litre and LPG by Rs 175/ cylinder.

Clearly refiners and marketers will be crucified if the subsidy mechanism isn't changed.

Can one take a contrarian view here? Indian governments don't make tough policy decisions until a crisis is on hand. It might change the oil-bond subsidy mechanism, cut excise duties, raise prices a bit or combine all these measures.

Any such changes would benefit the refiners. If the crisis is big enough, oil PSUs are worth buying on a gamble that the pricing policy will become less painful for them.