ONGC: A smaller subsidy bill

The ONGC stock has underperformed the Sensex since the lows of March 2009, gaining 78 per cent to the Sensex’s 96 per cent. But with the government sparing the oil major the burden of cooking fuel subsidies, the stock should do well.

The government has decided not to pass on the losses incurred by oil marketing companies on account of higher cost of production and lower retail price of cooking fuels to ONGC. Instead, it will take on the burden and issue oil bonds to the oil retailers. However, ONGC will continue to shoulder a part of the losses that downstream oil companies make because they sell auto fuels, such as diesel and petrol, at a retail price that is not enough to cover the cost of production.

The actual amounts would, of course, depend on the price of crude oil and the selling price at the pump. It’s possible that ONGC, together with GAIL, may bear as much as half of these under-recoveries, though in the past they have picked up a third of the bill. Analysts estimate the subsidy bill in the current year could be around Rs 4,500 crore. With the price of gas expected to be raised, ONGC stands to gain; its average realisations in 2008-09 were $2.3 per million British thermal unit. The stock currently trades at Rs 1,188 and Kotak Securities has a price target of Rs 1,400, based on a price-earnings multiple of 10 times on estimated 2010-11 earnings.