No more hedging on oil

SMARTSHARE

In June 2003, global oil prices were averaging around $28 per barrel. Last month, prices hit $60. Natural gas prices have a similar pattern. There are many reasons for this surge. There's the Iraq mess. There is increased demand created by growth in India, China and the US.

In other parts of the world, oil and gas exploration and production companies are seeing bumper profits. At the same time, refiners and retailers are hurting because they cannot pass on the price increases fully.

In India, the entire sector is bleeding. This paradox is explained by price controls. In theory, the administered pricing mechanism was removed in April 2002. In practice, it is still there.

Also in theory, the energy sector PSUs are supposed to be operating independently as profit-making entities. In practice, they are carrying the burden of enormous subsidies.

In November 2004, retail prices of petrol and diesel were grudgingly raised "" at that time, the Indian crude basket cost around $39. The next hike has come with the basket at $52 and this time, gas prices were also hiked.

In the 2004-05 Budget, the kerosene/domestic LPG subsidy was estimated at Rs 3,500 crore. The subsidy actually ran to around Rs 18,000 crore and energy PSUs absorbed the Rs 14,500 crore deficit. There is little reason to believe the bill will be lower in 2005-06 "" the Q1, 2005-06 subsidy is estimated at Rs 9,700 crore.

Massive pricing anomalies remain. Gas is sold to various sectors in a measure that harks back to the era of lunacy. There's a huge subsidy on kerosene and domestic LPG. Conversely, aviation turbine fuel (ATF) is sold at a big markup. ATF charges constitute perhaps 40-50 per cent of the operating incomes of domestic airlines while ATF is around 15-20 per cent of operating expenses for airlines abroad.

The government is, in theory, committed to removing the subsidy on kerosene and LPG by March 31, 2007. It has not indicated how it intends to do this and given the Left's inclinations, it may not.

As a result of absorbing the subsidy, 2004-05 was annus horribilis for energy PSUs. IOC's net profits dropped 30 per cent; BPCL and HPCL saw NP drop by 42 per cent and 34 per cent respectively. ONGC and GAIL also took major hits.

The first quarter of 2005-06 has also produced terrible results. The GoI has just come through with subsidy-sharing details. ONGC and Gail get some relief though they share the burden. The major refiners face unremitting pressure.

Private entities like Reliance and Essar have been kept out of the subsidy loop. However, price control could impact retail rollout plans. At the pump, RIL and Essar cannot charge more than the PSUs and hence, there's an effective price-cap.

Given the large public floats in PSUs (including FII holdings), one would assume that the GoI was answerable to these shareholders for its decision to foist an enormous burden on them. Obviously the GoI disagrees with this assumption.

What's most irritating is that the subsidy removes the hedging options for a small investor. You, me and the chap next door will all face hardship due to rising crude prices "" that's unavoidable. But the subsidy means that one cannot even hedge price rises by buying into ONGC with any degree of confidence.