Angel analysis on Kirit Parekh committee report

Angel Securities analysis on Kirit Parekh committee report.

The Kirit Parekh Committee on oil pricing reforms set up by the Finance Minster during the last Interim Budget, after deliberations and discussions with the different parties involved, has submitted its report to the Oil Ministry. Post perusal of the report by the Ministry, the same would be submitted to the Prime Minister and Cabinet for clearance. 

Impact Analysis: At current levels of global gasoline and diesel prices, the proposal if implemented would result in hike of the petrol and diesel prices by around Rs3.9/litre and Rs3.2/litre, respectively. The move will lead to nil under-recoveries on Auto fuels as the entire burden would shift to the consumers. However, we believe that while there exists a possibility of deregulation of the petrol prices, chances of deregulation of diesel prices are fairly slim on account of its impact on inflation given that 15% of the total diesel consumption is for agricultural purposes.

Proposal: Increase in SKO (kerosene) prices by Rs6/litre and Domestic LPG prices by Rs100/cylinder. The Committee recommends increase in the prices of SKO and domestic LPG in line with the per capita income.

Impact Analysis: Currently, under-recoveries on these products are Rs287/cylinder and Rs16.5/litre. The recommendation, if implemented, would result in reduction in the subsidy burden by around Rs7,020cr on SKO and Rs7,880cr on the domestic LPG, resulting in reduction in under-recoveries by around Rs14,900cr. However, we believe that the proposed reform in pricing and delivery of the subsidy in cooking fuels would be tough to implement. We await more information and clarity on how the mechanism would work on a continuous basis.

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Will the Kirit Parekh Committee proposals see the light of the day?

This is not the first attempt by the government to de-regulate petroleum product prices. In April 2002, in an attempt to phase out subsidy on petroleum products, the government dismantled the administered pricing mechanism (APM) paving the way for free pricing mechanism for petrol and diesel, while prices of kerosene and LPG were still kept under the Regulator's purview. Then the government had reined in the OMCs to revise the retail prices only within a band of +/-10% of the mean of rolling average of the previous 12 months and the previous three month's international C&F prices. Following breach of the band, the matter was taken up by the Finance Ministry for modulation in the Excise Duty rates, wherein the oil companies were allowed to determine the prices based on the international petroleum market. However, the euphoria of dismantling was short-lived, as when the crude prices started to increase in 2004 and oil companies wanted to pass on the same, the government interference was sought, which saw the free pricing of petrol and diesel regime ending in June 2004. Thus, past record of introducing and implementation of the pricing reforms has not been very impressive. It may be noted that the Kirit Parikh Committee recommendations are almost on similar lines of the Chaturvedi Committee Report submitted around two years back. The key differential between the reports is the timeline for implementation of the proposals. While the Chaturvedi Committee had emphasised on phased removal of subsidy on the domestic LPG by reducing the number of subsidised refills, the Kirit Panel does not mention any timeline for implementation of the reforms. We believe this is a negative. However, the report does suggest to hike the SKO and domestic LPG prices at one go. But, this is unlikely to happen at one go because of which we believe that the report lacks in specifying a phased timeframe to the proposal. Thus, unlike the Rangarajan Committee and Chaturvedi Committee reports, the Kirit Parekh report does not provide the timeline for implementation of the reforms.

Reforms if implemented, a positive for PSU Upstream companies, OMCs, Private Retailers We believe that the Kirit Parekh Committee proposals if implemented would be significantly positive for the PSU oil and gas sector companies, viz. ONGC, OIL and GAIL (Upstream Segment) and HPCL,BPCL and IOC (oil marketing companies (OMCs)) as well as the private oil marketers (RIL and Essar Oil). Upstream Companies: The Committee has recommended a cap of government-sharing of cooking fuel at Rs20,000cr per annum with balance been borne by the

Upstream companies. We believe, if implemented along with the Rs6/litre increase in the SKO prices and Rs100/cylinder increase in the domestic LPG prices, under-recoveries on cooking fuel would reduce by around Rs14,900cr to Rs21,600cr at the crude oil prices of US $70/bbl. Thus, the Upstream Segment companies would require to contribute around a mere Rs1,600cr per annum with the government taking up around Rs20,000cr of the subsidy burden. Thus, if implemented, it would be a positive for companies such as ONGC and OIL, if oil prices were to stay in the range of US $70-75/bbl. In such a scenario, net realisations of both ONGC and OIL is likely to see a significant increase. It is to be noted that net realistion of ONGC in the past, on an annual basis, has averaged at around US $45-52/bbl on account of subsidy burden. ONGC has proposed to share benefits of the increase in crude oil price on crude produced from blocks given to them (ONGC and OIL) on Nomination basis.

On the flip side, if ONGC's suggestions are not accepted, the structure could increase under-recoveries of Upstream oil producing companies in the event of any substantial increase in the crude oil prices on account of government cap on sharing cooking fuel subsidy. Pending more information we remain Neutral on ONGC.

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The Committee has not recommended any subsidy burden on GAIL. The move if accepted, would be a significant positive for GAIL as the Committee perceives GAIL to be a distribution company rather than an upstream company. The move would result in further value accretion of around Rs100/share (21.6% of our Target Price). We maintain our estimates and recommend an Accumulate on GAIL, with a Target Price of Rs463.

OMCs: The report is silent on the likely subsidy burden to be borne by the downstream companies or OMCs, which means that the OMCs would not be asked to share subsidy burden going ahead. Thus, implementation of the report would result in re-rating of the OMC stocks, viz. HPCL, BPCL and IOC. The case gets particularly highlighted given the low P/BV multiples commanded by these companies. The likely clarity if any over the subsidy sharing mechanism could act as positive catalyst for the stock prices going ahead. However, pending clarity we maintain our Neutral view on the OMCs.

Private Auto fuel Retailers: We believe that the proposed price de-regulation of the auto fuels is likely to result in re-entry of the private players into auto fuel dispensing. Reliance Industries (RIL) and Essar Oil (EOL), which had closed down their retail operations due to lack of level-playing field, are likely to benefit on account of the proposed de-regulation. EOL has already started to ramp up its entire retail outlet network, with majority of them having started and rest about to start. RIL has also started opening its retail outlets and the company would get more aggressive if the government policy is clear on auto fuel de-regulation. RIL, in particular, could ramp up its retail operations at a much faster pace, as in the past the company was able to ramp up its share in the diesel segment to 14% in a matter of three to four years. Given that the company has its retail outlets in place, regaining lost market share would not take much longer than 2 to 3 quarters. We have not built in the potential impact of the entry of private players in the auto fuel dispensing. Thus, there exists a threat of lower sales of petrol and diesel for the public sector OMCs. We believe that BPCL due to its overlapping presence with RIL in the highway segment is likely to be most affected on account of increased competition due to de-regulation of the auto fuel prices. Moreover, the Committee has also recommended that the private marketers should be provided with the subsidy for the under-recoveries on the sale of cooking fuel. This step, if implemented, would be positive for RIL and EOL. We maintain a Buy on RIL, with a Target Price of Rs 1,260.

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To read the report click on the attachment