Ad-hoc subsidy mechanism needs to be resolved: RS Sharma

Below is the verbatim transcript of RS Sharma's interview with Anuj Singhal and Ekta Batra on CNBC-TV18.

Anuj: What is your reaction on the news that in Q4 at least the upstream companies will not have to face any subsidy burden and to be honest, I don’t think they would have had the space to share that as well but going forward, do you think they are getting into a better position compared to what they were about two years back about their overall financial numbers or do you think this ad hoc mechanism will continue even in the new regime?

A: The news is very positive, it has to be welcomed. After a long time even on quarter-on-quarter (Q-o-Q) basis, when the subsidy sharing is getting decided for almost 8-10 years, we have seen that the clarification has come well in time so that is the good news.

What maybe the one compulsion for the government would be that they have to go ahead quickly for further dilution of Oil and Natural Gas Corporation (ONGC), so the right kind of sentiment has to be created in the market.

It is only a question mark that going forward whether this ad-hoc mechanism - will it continue or again there is going to be uncertainty. What we hear in the news is that it is said that the liquefied petroleum gas (LPG) subsidy burden for the next fiscal or fiscal 2016 will be absorbed by the government. So in case it is only that burden for the kerosene oil to be shared, which is even at USD 60 per barrel crude prices, that is going to be about Rs 13,000 crore. So sharing of that by the upstream companies is not a very big deal. So that market would welcome.

However, the worrisome issue is that now crude oil prices have been inching up. What happens if crude prices go up, whether the government will still honour its commitment to absorb all the under-recoveries on LPG and only the kerosene under-recoveries will be passed on to the upstream? So these are the kind of clarifications, the market would be expecting especially when the government goes ahead with selling the stock when they assess the market, when they talk to investors, investors would like to have clarification on these issues but just to stop, I must say as of now the news has to be very much welcomed.

Anuj: Isn’t it ironical that at Rs 450, ONGC looked undervalued and now at Rs 325, you need all this kind of clarifications even for this quarter for an issue to go through and secondly, in your opinion do you think there will be demand if the ad hoc mechanism continues? At the end of the day, the investors are also smart, they will also realise that things could again change if crude even inches back to USD 75-80 per barrel?

A: Somehow this ad-hoc mechanism has been continuing. I wouldn’t say that effort has not been made in the past, the government constituted different committees, first one was the Rangarajan committee then BK Chaturvedi committee then Kirit Parikh Committee, all had submitted their recommendations on the subsidy sharing mechanism but due to uncertainty, due to extreme volatility in the crude prices, those kind of mechanisms could not be accepted by the government.

Going forward whether the government would be able to take a call, it all depends how the crude prices behave. In the short-run they seem to be in the range of USD 60 per barrel but I am afraid in the long run based on fundamentals, crude prices have to move up so they could be USD 70-80 per barrel and then what happens is the under-recoveries -- to what extent the under-recoveries will be there, to what extent government will share that as of now the government has provided only Rs 30,000 crore in the current fiscal for sharing the under-recoveries out of which this Rs 5,300 crore goes away. So it has to be seen that how much the commitment the government will show in times to come.

Ekta: What your expectation is from brent crude prices especially in the scenario, which seems quite tentative and uncertain at this point in time in terms of geopolitical risks arising from the likes of Yemen?

A: I will compare the current situation to 2008 and 2009. in 2008, in the month of June, crude prices had gone up past USD 140 per barrel up to USD 147 per barrel and by December 2008, with the global economic slowdown, the sentiment changed and the prices started crashing, by December 2008 they came down to less than USD 40 per barrel.

However, then we saw thereafter constantly prices have been moving up. Here also, we compare the same situation. Now we have seen that the prices have gone down right up to USD 45 per barrel for brent and brent currently is now in excess of USD 60 per barrel. It has been moving up. Personally I feel based on fundamentals, the crude prices are going to further firm up, they could be in the range of USD 70-80 per barrel, short-term moves by sentiments but long-term moves by the fundamentals.

Even in US crude the drilling activity has come down to almost one-third so that would reflect on the oil production. The latest news as of yesterday, Reliance is cutting down its shale oil and gas expenditure, so likewise all operators are doing, so in effect the shale oil production would come down and again the fundamentals of demand and supply come into play, I feel a price of USD 70-80 per barrel would be more reasonable in the long run.

Anuj: The other issue is that if we assume - if crude oil prices go back to between USD 50 per barrel and USD 60 per barrel, in that case if the government is taking on the burden of LPG, the direct benefit transfer, only kerosene would be left. Do you think in an environment where crude is between USD 50 per barrel and 60 per barrel, do you think there is a possibility that the government says let the oil marketing companies (OMCs) make some positive margins in both diesel and petrol that in turn cuts down the overall subsidy burden for kerosene, do you think that would be a welcome scenario?

A: Yes, definitely. I agree with you. That would be a welcome scenario but as of now based on the current USD 60 per barrel, the estimate is for the current year for the kerosene under-recoveries about Rs 13,000 crore, so distribution of that would not be a major issue. These are the prices, which are quite sustainable for ONGC's bottomline also -- ONGC anytime would be happy to have a retention price higher than USD 50 per barrel. So this news is quite stable and the market should take it positively.