The government allocated INR650bn for petroleum subsidies in FY14, of which INR450bn was used to pay oil marketing companies for the subsidy gap incurred in the previous financial year. This leaves the government with INR200bn to meet its share of the shortfall between the subsidised price and the market price, known as under-recovery. This is likely to be insufficient, and it is likely that the state will have to tap around INR450bn from next year's budget.
For the first half of the current financial year, the total under-recovery from diesel, public distribution kerosene and household liquefied petroleum gas (LPG) was INR609bn, with diesel accounting for INR283bn. Assuming the under-recovery in the subsequent two quarters is around INR400bn each, the total FY14 under-recovery would be INR1,400bn (FY13: INR1,610bn).
In January 2013, the government took steps to further deregulate the petroleum sector by allowing diesel for industrial use to be priced at market prices, and also allowed refining and marketing (R&M) companies to increase the prices for retail diesel by INR0.5 a month. This led to a steady decline in the diesel under-recovery. The government also limited the number of subsidized LPG cylinders (on which it incurred an average subsidy of INR408 each) to nine per family per year, which will likely reduce the subsidy for the LPG segment in 2H FY14.
The math of how FY14's subsidy on petroleum products will be shared between the government, the upstream players - ONGC , OIL India and GAIL Ltd (BBB-/Stable) - and the R&M companies - Indian Oil Corporation Limited (BBB-/Stable), Bharat Petroleum Corporation Limited (BBB-/Stable) and Hindustan Petroleum Corporation Limited - is still fluid. With a general election in early 2014, the government's ability to pass on sharp petroleum price increases to consumers on top of the usual small monthly increases would be limited. At the same time, though, the government is under pressure to reduce its budget deficit, to which petroleum subsidies are a large contributor.
In Fitch's view, the upstream players will likely be required to shoulder a greater portion of the total under-recovery. In 1H FY14, ONGC and OIL India were asked to pay 52.5% of the total under- recovery of INR609bn, compared with less than 40% in previous years.
If the upstream companies bear a larger share of the under-recovery, the cash flow position of the R&M companies would likely improve because the upstream firms are likely to make the subsidy payments faster than the government.
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However, if the R&M companies are also required to bear a part of the under-recovery - they bore 8%-10% of the under-recovery in FY10 and FY11- their profitability, liquidity and credit profiles will be materially impaired. Fitch believes the ability of the state-owned R&M companies to take on the under-recovery has reduced since 2011 because of the weakening of their standalone financial strengths. This may reduce the risk of the government directing the R&M companies to take on a sizeable share of the under-recovery.
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