Gas price to be next big trigger for sector: Moody's

“The credit metrics will improve because we expect borrowings to come down because of the lower subsidy burden, which will have a more profound impact than actual decline in subsidy,” he said.

Halan said he expects the upstream discount to remain constant at Rs 60,000 crore and government portion to come down to Rs 40,000 crore – with the total subsidy burden coming down to Rs 100,000 crore in FY15. He sees interest cost reduction for OMCs at around Rs 1000-1500 crore and expects OMCs to pay out short-term debts. Moody’s sees IOC to benefit the most from subsidy burden reduction, while ONGC and Oil India too are likely to benefit from it.

The agency expects crude to average around USD 105/bbl in FY15 and feels gas price will be the next big trigger for the companies. Halan however doesn’t see a hike in LPG prices in the near term.

Below is the verbatim transcript of Vikas Halan's interview with Latha Venkatesh and Sonia Shenoy on CNBC-TV18 

Latha: Can you take us through the argument? Do you see these companies now suffering les interest cost?A: The story that we are written about is that we expect the credit profiles to improve for these oil marketing companies and the credit profile means both the credit metrics and the debt structure. So the credit metrics will improve because we expect the borrowings to come down because of the lower subsidy burden and this is going to have a more profound impact than the actual decline in subsidy because we expect the upstream discount to remain constant to about Rs 60,000 crore and we expect the government portion to come down to Rs 40,000 crore.

So overall subsidy will be about Rs 100,000 crore in fiscal 2015 versus Rs 140,000 crore in fiscal 2014. So the OMCs had to fund the government portion for a larger period of time because they had to get it for six months. That portion will come down from Rs 70,000 crore to Rs 40,000 crore, so a reduction of about Rs 30,000 crore that means assuming a six months funding period that borrowings will come down about Rs 15,000 crore. So that is a big chunk of Rs 140,000 crore borrowing that oil marketing companies carry under books. That is one source of improvement. The other as you rightly pointed out, there is going to be reduction in interest cost because of lower borrowings. We expect that to be around Rs 1,000-1,500 crore so that will increase the net earnings of these oil marketing companies depending on which borrowings they decide to pay and what is the effective interest cost saving.

Latha: What you are saying is that at the moment, their borrowings were Rs 140,000 crore, of this Rs 15,000 crore less will be borrowed?

A: That is correct. The other part of the story was we have always maintained that the OMCs have borrowed a lot on short-term basis, which is affecting their liquidity profile in our assessment. So with the subsidy burden coming down and because of that borrowings coming down, we expect the companies to pay down their short-term debt first because that is going to mature first and that will improve their overall debt structure and again will benefit their credit profile. That is the overall story for the OMCs.Latha: You remain more positive on OMCs and you are not changing your view on the upstream companies, the likes of Oil and Natural Gas Corporation (ONGC) and the Oil India Ltd (OIL)?A: From a credit perspective, ONGC and OIL are going to benefit a little bit from subsidy burden coming down off last year. So last year they had Rs 67,000 crore as the subsidy burden put on them. This year we are expecting it to be about Rs 60,000-61,000 crore, so there will be some reduction. There will be some softening of oil prices. We are expecting that oil prices probably will remain the same as that of last year. So last year it averaged at about Rs 105 for the full year. This year till date it is about Rs 106 but that was because of that Middle East spike that we have. So if we assume, the rest of the year to be with no Middle East crisis and it is going to be averaging around that same so they will benefit but they have already borrowed a lot last year because of acquisitions in Mozambique so their credit metrics have deteriorated a bit and will not improve substantially unless the gas prices provides us with some positive earnings boost which we do not expect as our base case at the moment given how the government has moved on that front.

Latha: This interest cost reduction of Rs 1,000 crore to Rs 1,500 crore that you are expecting from the OMCs, what is your hierarchy? Whose credit profile is better than the other?A: It is going to be Indian Oil Corporation (IOC) because it bears almost 50 percent of the subsidy burden. So they will benefit the most from reduction and Bharat Petroleum Corporation Ltd (BPCL) and Hindustan Petroleum Corporation Ltd (HPCL) will largely remain equal on that front. So IOC will benefit most from this.Latha: What is your next event that you are looking for? Are you expecting that there could be liquefied petroleum gas (LPG) price increases or would gas be the next big trigger?A: The next one certainly would be gas prices in our view because they are scheduled to be reviewed at the end of September. So that is definitely first one. We do not expect a same move from the government on LPG front because government’s own subsidy is coming down from Rs 70,000 crore to Rs 40,000 crore and because state elections are coming, I don’t think there is going to be an increase in LPG prices yet maybe next year.