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The concerns over the subsidy burden on upstream oil companies like ONGC seem to be easing. A variety of factors, such as diesel price hikes in small doses, a correction in Brent crude oil prices and an appreciation in the rupee’s value against the dollar, are responsible for this.
Also, news reports suggest the petroleum ministry has proposed a revised subsidy-sharing formula, under which the government and upstream companies would share the burden equally. If that is indeed true, there would be further clarity for investors and sentiment would get a boost. There also are expectations that the upstream companies might be given some relief on the payment of Oil Industry Development (OID) cess, currently paid on nominated fields. These are all seen as positives, especially for ONGC, which bears the bulk of the subsidy burden shared by upstream players. According to analysts, if the new formula is applied, ONGC’s earnings for 2015-16 would rise by up to eight per cent. Nevertheless, even if some of the developments don’t fructify in the near term, an improving environment and declining subsidies, along with ONGC’s efforts to raise output, should lead to better performance.
The benefits of a gradual increase in diesel price — of 50 paise a month — are already showing in the form of the expectation of a lowered subsidy burden. Analysts expect the total underrecoveries — the difference between the actual cost and selling price of fuels like diesel, kerosene and LPG — for 2014-15 and 2015-16 to come to Rs 92,000 crore and Rs 80,000 crore, respectively — much lower than Rs 1,40,000 crore in 2013-14. However, usually there is no clear picture on upstream companies’ share in the overall subsidy until the end of a financial year. So, a clarity on the upstream companies’ share in subsidy, possibly a fixed formula to enhance predictability, will be welcome. Against the backdrop of lower subsidies, analysts expect ONGC’s net oil realisations to increase.
According to the estimates of analysts at Bank of America Merrill Lynch, of the overall subsidy burden of Rs 80,000 crore in 2015-16, the share of upstream companies like ONGC, Oil India and GAIL would come to Rs 64,800 crore by the current formula. However, it would come to a much lower Rs 40,000 crore under the 50:50 subsidy-sharing formula. Also, even if recommendations of Parikh committee (given in 2013-14) are taken into account, the subsidy burden would still come to Rs 46,800 crore.
ONGC’s share in the subsidy burden, at $59.3 a barrel in 2013-14, is estimated to come down to $44.4 a barrel in 2014-15, if the Parikh committee formula is implemented. However, it will stand even lower, at $38.8 a barrel in 2015-16 under the 50:50 formula. Accordingly, ONGC’s net oil price, which was $41 a barrel in 2013-14, is expected to be higher at $57-60a barrel in 2014-15 and 2015-16 under the 50:50 formula. Nevertheless, even in the current situation, declining subsidies would lead to higher net realisations.
Further, if the OID cess is removed, some analysts, such as those at Sharekhan, expect the net subsidy burden of upstream companies to come down by around Rs 10,000 crore a year. While it might not be easy for the government, given its fiscal situation, if the proposed changes are implemented, there would definitely be benefits. For now, analysts are awaiting more clarity, and, so, are not pricing those in.
While softer crude oil prices might impact the fortunes of ONGC’s foreign subsidiary, ONGC Videsh, whose earnings are strongly linked to global prices, the declining subsidy burden will more than offset the impact. Efforts to raise domestic output, including from marginal fields, is also seen as a positive. Additionally, if gas prices are raised on the existing output, it would have a rub-off on ONGC.
Overall, analysts remain bullish on ONGC. Consensus target price of Rs 484 for stock trading at the Rs 438 level means an upside of another 11 per cent. If the measures mentioned earlier are implemented, the company’s prospects would be boosted and there would be room for further re-rating of its stock. Analysts at Deutsche Bank observe that ONGC is set to emerge as the biggest beneficiary of a dramatic reduction in the fuel subsidy over the next five years.
