ONGC and Reliance to roar after windfall tax cut: Morgan Stanley

Representative Image

A surprise cut in additional taxes imposed on fuel exports and crude oil production has spiked energy sector prospects, said global brokerage Morgan Stanley.

“A quicker than expected restart to reverse the windfall taxes on the sector should normalise equity multiples steadily higher. While windfall taxes are not yet zero, we believe government action provides clarity on the path ahead. Reliance Industries, ONGC, and Oil India are key beneficiaries,” said Mayank Maheshwari, equity analyst at Morgan Stanley.

There were talks of the government considering reducing or eliminating taxes but not many expected it would come this soon. The surprise move had the stock market opening with gains on July 20.

At the opening, BSE flagship Sensex jumped 587 points or 1.07 per cent to 55,355 driven by over two percent jump in Reliance and some heavy buying in large-cap IT names. ONGC was up five percent, Oil India seven percent, Mangalore Refinery five percent and Chennai Petroleum over eight percent.

The Centre reduced the windfall tax on diesel and aviation fuel shipments by Rs 2 per litre and scrapped a Rs 6 per litre levy on gasoline exports. It also cut the tax on domestically produced crude by about 27 percent to Rs 17,000 a tonne.

“While in absolute terms the windfall taxes are still high, we believe steady normalisation in local fuel availability (a key energy security concern for the government), stability in oil prices, more normalised global fuel margins, and currency stability will help further reduction in windfall
taxes under fortnightly review,” said Maheshwari.

The taxes were imposed to get a pie of windfall gains that oil companies were making due to high international prices of crude oil and oil derivatives. Refining margins of some companies had reached record high.

Now that taxes have been partly rationalised, Reliance, Oil India, and ONGC will see a reduction in overhang and equity valuations should start pricing in high sustainable energy margins as the government intent gets clear, said Maheshwari. The tax cut also lowers investor concerns on a potential downgrade cycle for the stocks in a recessionary demand environment.

“We believe Reliance should get priced at $13-15 per barrel (bbl) sustainable refinery margins while ONGC gets priced at $75-80 per bbl oil and $6 per mmbtu commodity deck. The two should imply 25-40 percent upside to equities as energy markets are expected to remain tight despite the current volatility in oil and reduction in global fuel margins from peak levels,” he added.

Morgan Stanley estimates current gross refining margins for Reliance at $13 per bbl. ONGC, it estimates, is seeing profit per bbl at $25, 20 percent above last year's levels.

Disclosure: Moneycontrol is a part of the Network18 group. Network18 is controlled by Independent Media Trust, of which Reliance Industries is the sole beneficiary.