Investor's Eye: Update - Oil & Gas (Oil is not well)

 

Investor's Eye [August 29, 2013]  Sharekhan www.sharekhan.com

Summary of Contents     SECTOR UPDATE Oil & Gas Oil is not well Key points India's fuel subsidy bloats up owing to double whammy of spike in crude oil prices and steep depreciation in the rupee  India's fuel subsidy bill is likely to shoot beyond Rs2 trillion in FY2014 as against Rs1.3-1.4 trillion estimated at the beginning of the financial year and Rs1.55 trillion in FY2013. In addition to the spike in the crude oil prices (over $110 per barrel on an average), the double-digit depreciation in the rupee has added to the increased cost of importing crude oil into the country. On the other hand, the government has not shown the courage to pass on the burden to consumers leading to record under-recoveries in diesel and the possibility of a loss in even deregulated products like petrol. According to rough estimates, the under-recoveries in diesel at the prevailing crude oil prices, exchange rate and retail price would cross Rs15 per litre which is clearly not sustainable.  Oil and gas stocks have reacted negatively to the situation Given the scenario, the oil and gas stocks have corrected sharply in line with the emerging situation and market condition. The worst hit are the oil marketing companies Indian Oil Corporation (IOC), Hindustan Petroleum Corporation and Bharat Petroleum Corporation as the under-recoveries would put further stress on their balance sheet. In case of the upstream companies (ONGC India, Oil India and GAIL India), the expectations of a higher subsidy burden (and a lack of clarity on the subsidy sharing arrangement) have led to the de-rating of their valuations. Syria crisis could further push up crude oil prices; government would be unable to pass on the sudden increase in subsidy burden  The rising threat of the involvement of the western countries in the Syrian conflict has stirred concerns over the crude oil supplies from the Middle-East. Syria may not have a direct impact on global crude oil supply but it lies in close proximity to the pipelines and sea routes that transport much of the world's crude. Moreover, there is concern that the involvement of the western countries in Syria could prompt a wider regional conflict. Given the scenario, an attack on Syria could not be ruled out which could further inflate the crude oil prices from the current level for some time. With crude oil remaining at such elevated levels and the rupee depreciating against the dollar, the under-recoveries would continue to swell.  Outlook for public sector oil stocks challenging; situation favourable for RIL, Cairn India and Selan Exploration Worst still, we feel even a bulky hike in fuel prices will not make up for the sudden and sharp increase in the under-recoveries that are likely to be much higher than the budgeted figures for the year. Hence, despite the recent correction in the stock price of the oil marketing companies and upstream public sector companies, the near-term outlook for the oil and gas companies remains challenging and we advise caution to investors looking at them. However, the situation is favourable for Reliance Industries Ltd (RIL; we had released a note on the same earlier this week titled "Rupee's depreciation and new gas discovery augur well", dated August 27, 2013), Cairn India and Selan Exploration Technology due to their better blended realisations.  Click here to read report: Investor's Eye   Sharekhan Limited, its analyst or dependant(s) of the analyst might be holding or having a position in the companies mentioned in the article.

Regards, The Sharekhan Research Team

 

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