'Royalty payout to Gujarat,Assam credit positive for ONGC,OIL'

The Centre's decision to pay over Rs 14,000-crore royalty claimed by Gujarat and Assam from ONGC and Oil India is credit positive for the two state-owned companies, Moody's Investors Service said today.
The Supreme Court had earlier this week disposed of royalty claim case filed by the state governments after the Centre agreed to pay the royalty amount claimed by Gujarat and Assam.
"The central government's decision will likely set a precedent for similar claims from other state governments in India," Moody's said in a report.
Oil and Natural Gas Corp (ONGC) and Oil India Ltd (OIL) pay royalty at the rate of 20 per cent on the crude oil produced from a state. This amount, the companies calculated based on the net price they realised after paying for Central government mandated fuel subsidies. But initially Gujarat and later Assam wanted royalty to be paid on gross or pre-subsidy price.

After coming to power, the BJP-led government at the Centre agreed to this but since ONGC and OIL could not be asked to pay royalty on a price they never realised, it agreed to bear the amount claimed by the state governments.
"This settlement is credit positive for ONGC and OIL because it removes the uncertainty over Rs 26,100 crore of contingent royalty liability for both companies without resulting in any further cash outlay from these companies," Moody's said.

The rating agency said royalties on crude-oil production from onshore fields are paid to state governments, while royalties on offshore blocks are paid to the central government.

At the same time, India's fuel subsidy is borne by the central government and central government-owned oil companies.
"ONGC and OIL bear part of the subsidy burden by giving discounts, as determined by the central government, on crude oil sold to the central government-owned refining companies.
"Until March 2008, based on directives from the central government, the royalties have been paid on the pre-discount price of crude oil. Since May 2008, however, the central government directed oil companies to pay the royalty only on post-discount prices," it said.
"As of December 2016, ONGC and OIL reported contingent
royalty liabilities of Rs 15,700 crore and Rs 10,400 crore, respectively, for production from April 2008," it said.

In July last year, the central government directed ONGC and OIL to pay royalties to all crude-oil-producing states at pre-discount prices on onshore production since February 2014.
Consequently, ONGC and OIL paid Rs 2,560 crore and Rs 1,150 crore respectively to the state governments on account of royalty difference between pre-discount and post-discount prices for onshore production since February 2014.
Based on this, the likelihood of the government requiring ONGC and OIL to pay the entire claimed amount did rise at the time.
However, the central government has now decided to pay the remaining royalty claims for production between April 2008 and January 2014. "The amounts already paid, which have been treated as deposits by the companies, will no longer be recoverable and will lower the companies' pre-tax incomes for the fiscal year ending March 2017 by the respective deposit amounts," Moody's said.

Since October 2015, the central government hasn't asked ONGC and OIL to provide discounts, given low oil prices and consequently low fuel subsidies.
"Thus, there was no difference between pre-discount and post discount prices, and no additional royalty claim on onshore production since then," it said.
If Brent crude-oil prices increase and stay above USD 60-65 a barrel for a prolonged period of time from USD 56 per barrel as of February 21, ONGC and OIL may be asked to share the subsidy burden once again and there will be a difference between their pre-discount and post-discount prices.
"If ONGC and OIL are asked to pay royalty on pre-discount prices in future, it will reduce the companies' profitability. The impact on OIL, in such a case, will be more negative than ONGC because OIL derives its entire production of crude oil in India from onshore blocks whereas ONGC derives less than half of its production of crude oil in India from onshore blocks," it said.

However, Moody's expected that the Centre will determine the share of any future subsidy burden after taking into account the difference in royalty claims of ONGC and OIL.
Thus OIL's share of subsidy per barrel may be lower than ONGC's to compensate it for higher royalty payments.
"Over the next 12-18 months, we expect the fuel subsidies to remain low as we expect the oil prices will not increase and stay above USD 60 per barrel for a prolonged period of time. Thus, the royalty issue will not be a concern for at least next 12-18 months," the report added.