Under-recoveries (losses incurred on selling regulated fuels like diesel, LPG and kerosene below their cost prices) on petroleum products are expected to decline by over 50 per cent over the next 2 years from 2013-14 levels due to decline in crude oil prices as well as ongoing efforts to move towards market-linked diesel prices. This will have a significant positive impact on the profitability of oil PSUs and the exchequer as well.
CRISIL Research believes that international crude oil prices and thereby petroleum product prices will slip by 8-10 per cent over the next two years to about $100 per barrel in 2015 from an average of $109 per barrel in 2013, barring any major geo-political events, fuelled by supply glut, waning demand growth and increased use of cleaner fuels.
While crude oil output from Iraq, Iran and North America will increase, global demand is expected to be impacted by weak consumption. The tepid consumption growth will be on account of better efficiencies and a shift towards natural gas in developed regions like North America and Europe, as well as relatively slower increase in demand from developing countries such as China and Indonesia because of reduction in subsidies and slower economic growth.
The benefits of declining crude oil prices on Indian oil PSUs are already visible. Together with continuous monthly increase in retail diesel prices (since January 2013), the under-recovery on the sale of diesel has been eliminated in September 2014.
This is expected to provide huge relief as losses on diesel accounted for about 45 per cent of the total under-recovery burden in 2013-14. Consequently, we expect under-recoveries to halve to Rs.600-700 billion by 2015-16 from Rs.1,400 billion in 2014-15.
The under-recovery burden is shared by the government and oil PSUs — both upstream (oil and gas producing companies) and downstream (oil marketing companies) — .
Declining under-recoveries will help increase the profits of the downstream and upstream companies as well as improve the government’s finances by lowering oil subsidies and containing the oil import bill.
The profit after tax of downstream PSUs is likely to increase by Rs.35-40 billion year-on-year in 2014-15 and by other Rs.7-10 billion in 2015-16 because their interest costs will decrease with the decline in their working capital requirements, and they would not have to any under-recovery burden.
Upstream companies, which typically share 40-50 per cent of the total under-recovery burden on petroleum products, will see a sharper improvement of Rs.105-120 billion year-on-year in net profit in 2014-15 and a further improvement of Rs.70-75 billion in 2015-16. This is because the impact of the reduced burden of under-recoveries on upstream companies will more than offset the impact of decline in realisations due to lower crude oil prices.
The net realisations of upstream companies are expected to increase by $20-25 per barrel over the next two years. Moreover, if we include the benefits arising from potential hike in domestic gas prices there could be a further upside in the profitability of upstream oil PSUs.
The good news does not just end with better oil companies’ profitability. Even India’s oil subsidies and net oil import bill will decline over the next two years as compared to a significant increase in the past two years.
This will be a huge relief for the economy as oil imports comprised the single largest item, accounting for nearly one-third of India’s import bill of $450 billion in fiscal 2014.
Between fiscals 2012 and 2014, the oil import bill rose 12 per cent a year (CAGR) because of rising prices and a weak rupee.
The author is Director, CRISIL Research
