Mounting pressure on the fiscal front prompted the government to announce several reforms in the petroleum sector last year. These measures will have considerable impact on the fortunes of public sector oil companies.

Most importantly, oil marketing companies (OMCs) have been permitted to raise the price of diesel every month and gradually link it to international prices.

The government has also deregulated bulk diesel prices (which constituted about 18 per cent of the overall diesel consumption during April-December, 2012). The supply of subsidised LPG cylinders has also been capped at nine per household annually. Further, a scheme to directly transfer cash subsidies to domestic LPG consumers is being implemented so as to eliminate duplicate connections.

These policy initiatives will reduce under-recoveries, which, in-turn, will improve government finances. Moreover, these measures will improve the profitability of upstream public sector oil companies as they have to share 33-40 per cent of the under-recovery burden. The pressure on cash flows and working capital of OMCs will come down as well, as delays in the release of the government’s share of under-recovery burden will be alleviated.

Impact on consumption pattern

High diesel subsidies led to a significant increase in sales of diesel cars. The proportion of diesel car sales in the overall car sales rose to around 55 per cent in 2012-13 from 32 per cent in 2006-07.

As the gap between diesel and petrol prices narrows, the proportion of diesel car sales will fall. In the past as well, whenever the domestic prices of individual petroleum products were raised or deregulated, the demand for the product was affected.

For example, after being deregulated in June, 2010, petrol prices have risen by about 35 per cent till date. Consequently, the growth in demand for the fuel shrunk to a CAGR (compound annual growth rate) of 5.5 per cent over the last two years vis-a-vis a healthy growth rate of 10.4 per cent CAGR over 2005-06 to 2010-11.

Similarly, the average growth in demand for diesel (which accounted for 45 per cent of the overall fuel consumption in 2012-13) fell to 3.7 per cent during October-February, 2012-13, from 10.5 per cent in the previous six months.

This sharp decline was largely due to increase in diesel prices in September, 2012, (Rs.6 a litre), gradual monthly price hikes from January, 2013, and deregulation of bulk diesel sales.

In fact, diesel sales declined by 2 per cent year-on-year in February, 2013, a first in the last five years. Lower diesel sales also pulled down overall demand for petroleum products by 1.5 per cent in February. Although, the fall in diesel prices can be, to an extent, attributed to the overall slowdown in the domestic economy, a large part of it is because of policy reforms and the subsequent increase in prices.

Under-recoveries

A sharp rise in crude oil prices, a steep depreciation of the rupee vis-a-vis the dollar, and the lack of corresponding policy actions have pushed up under-recoveries over the last two years.

The OMCs recorded the highest-ever under-recoveries of Rs.1.39 lakh crorein 2011-12, and have already reported under-recoveries of Rs.1.25 lakh crore during April-December, 2012-13. the OMCs are expected to end the fiscal with under-recoveries at Rs.1.50 lakh crore to Rs. 1.60 lakh crore. In the absence of reforms and policy actions, the under-recovery in the second half of 2012-13 would have been higher by Rs.30,000-40,000 crore.

In January, 2013, before the government allowed OMCs to periodically make small revisions in diesel prices, the under-recovery on diesel (which contributed more than 60 per cent of the total under-recoveries in 2011-12) was as high as Rs.11 a litre.

However, subsequent policy actions and fall in crude oil prices have lowered this figure to Rs.6.50 a litre in April. In 2013-14, CRISIL Research expects under-recoveries to fall by 50 per cent to Rs.70,000-80,000 crore.

This sharp fall will be on account of average crude oil prices declining to $100-105 a barrel in 2013-14 from $112 a barrel in 2012-13, diesel prices increasing by Rs.3-4 a litre, and a cap on subsidised LPG cylinders.

In the last two years, the government shared bulk of the under-recovery burden. However, delays in cash subsidy payouts by the government has led to increased working capital borrowings for OMCs, pushing up their debt levels and interest costs. Going forward, as under-recoveries decline sharply, the OMCs’ working capital requirements will decline. Consequently, their profitability and liquidity position will improve, led by better cash flows and a lower reliance on short-term loans to fund working capital requirements. CRISIL Research expects their interest cost to decrease by Rs.2,500-3,000 crore in 2012-13, which is around 50 per cent of their net profits in 2011-12.

The profitability of upstream companies (ONGC, Oil India and GAIL) will also improve significantly as their share in the under-recovery burden will nearly halve to Rs.25,000-35,000 crore in 2013-14 from an estimated Rs.50,000-60,000 crore in 2012-13.

Over the same period, the government’s share in under-recoveries is likely to dip to Rs.35,000-45,000 crore from an estimated Rs.80,000-90,000 crore, which, in-turn, will help the government improve its financial position by reducing the fiscal deficit.

The author is Director, Crisil Research, a division of Crisil.

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