Oil and gas: Well, well, well!
Fuel pricing reforms and the crash of crude oil have kept the oil and gas sector on a high. But there could be challenges ahead
The oil and gas sector in India has undergone transformative changes over the past few years. The bourses attest to this. The S&P BSE Oil & Gas Index, after deep hibernation, has surged more than 50 per cent since early 2014. Several of the sector’s stocks have done spectacularly well in this period.
The PSU oil marketers Indian Oil, HPCL and BPCL have tripled or more. So have city gas distributor Indraprastha Gas and gas importer Petronet LNG. PSU gas transmitter GAIL (India) and integrated behemoth Reliance Industries too are up a neat 40-45 per cent. Only public sector hydrocarbon explorers ONGC and Oil India have slipped between 2 and 7 per cent. But this too is not bad, considering that crude oil prices have halved since 2014.
Several factors have contributed to the good show the crash of crude oil, fuel pricing reforms, healthy refining margins, high priority to city gas distributors and favourable re-negotiation of terms with foreign gas suppliers.
The key structural change, though, has been pricing reforms. This has largely resolved a fundamental problem that afflicted the sector for long fuel price control and benefited public sector oil companies by slashing their subsidy burden. The government too has gained by the cut in subsidy outgo and a sharp increase in its revenue from excise duty hikes.
Pricing reforms bonanza
Soon after the Modi government took charge in mid-2014, the rout of crude oil began. This godsend enabled the Centre to build on the moves towards market pricing initiated by the UPA regime and bring about the most significant reform in the sector in decades — in October 2014, diesel pricing was freed. This turned around the fortunes of the PSU oil marketing companies as diesel accounted for more than 60 per cent of their under-recoveries from selling fuels below cost.
Besides, the cap on subsidised LPG cylinders to 12 a year for a household, direct benefit transfer of LPG subsidy and gradual price hikes in kerosene and LPG have reduced under-recoveries further. Petrol pricing was decontrolled way back in 2010. Now, only a small portion of fuels is under price control.
With their under-recoveries slashed thanks to the oil crash and pricing reforms, Indian Oil, HPCL and BPCL, which, earlier, had to wait long for government compensation ,saw a dramatic revival. Their borrowings and interest costs fell sharply, and marketing margins improved. This, along with good refining margins — the difference in the price of their fuel basket and crude oil — translated into huge profit growth for these companies. This has enabled them to undertake big expansion plans that should aid profit growth in the coming years.
Paradoxically, even the PSU hydrocarbon exploration companies ONGC and Oil India have benefited from the crude oil crash. That’s because these companies also bear a portion of the under-recoveries through product discounts to the oil marketers. With this burden sharply reduced, the net realisations of these companies improved despite a fall in their gross realisations.
Clarity in the subsidy sharing mechanism also helped. The government agreed to bear the subsidy up to ₹18 a kg on LPG cylinders and ₹12 a litre of kerosene. The rest was to be borne by ONGC and Oil India; GAIL was exempted. Of course, when crude oil went under $45 a barrel and further to under $30 a barrel in early 2016, the oil producers got squeezed. Even without the subsidy burden, their net realisations dipped lower than in previous years. But the subsequent price recovery to about $55 a barrel currently has eased the situation somewhat.
A good portion of the price recovery has happened after the late 2016 deals among OPEC and major non-OPEC nations to cut oil output. A further sharp rally could queer the pitch for the PSU oil companies and the government. But a rise above $60 a barrel seems unlikely. US shale oil could make a strong comeback around these levels, with support from the Trump administration, which is expected to follow a pro-US energy agenda and provide sops to the shale industry in the country.
Oilat $55-$60 a barrel seems to be a goldilocks range for India — the government is unlikely to backtrack on pricing reforms at these levels, and both downstream and upstream companies should make profits. The government, having earned a bonanza from raising excise duties regularly with falling crude oil prices, has refrained from cutting taxes when oil reversed course. This has enriched the exchequer. Consumers, of course, are not happy; the price they now pay for petrol and diesel is almost the same as in mid-2014.
High import dependency
While fuel pricing concerns have now been addressed to a large extent, the other big problem dogging the sector — stagnating domestic output and high import dependency — still poses a huge challenge. India now imports more than 80 per cent of its crude oil and 40 per cent of its natural gas requirement. Demand is rising with economic growth but domestic production has been falling. Old fields in decline, limited success on new discoveries, unfriendly exploration regime, and lack of pricing and marketing freedom are among the factors to blame.
The government, to boost domestic production, recently reallocated 31 discovered but not-yet developed small fields of ONGC and Oil India to bidders on favourable terms. It has also revamped the hydrocarbon exploration regime. But whether this will help remains to be seen. Among the several challenges are protests by farmers and the long-elusive pricing freedom for gas. (See ‘Hurdles to domestic production’).
Gas utilities on a roll
Artificially low domestic gas prices have benefited city gas distributors (CGD) such as Indraprastha Gas and Mahanagar Gas. These companies have been given top priority in the allocation of domestic gas for compressed natural gas (CNG) supply to vehicles and piped natural gas (PNG) supply to households. These segments account for a chunk of these entities’ business.
While their costs have dipped, volumes have soared due to price advantages vis-à-vis other fuels such as petrol, diesel and LPG. The regulatory push in favour of the environmentally cleaner natural gas has also helped. Good growth momentum is likely to sustain for these entities.
Gas importer and regasifier Petronet LNG has gained from the high demand and limited supply of gas in the country. It has also benefited from renegotiation of long-term contracts with major suppliers such as Qatar’s RasGas. So, the earlier high contract price has been reduced sharply in tune with prevalent lower international gas prices. Petronet has committed to buy more gas from RasGas. The under-utilisation of the company’s Kochi terminal due to lack of pipeline connectivity remains a concern, though.
Also, the operations of gas transmission major GAIL have been impacted due to low gas supplies. The company had ramped up its pipeline capacity in anticipation of a healthy increase in domestic supplies. But the declining gas output in the country, primarily from the KG-D6 fields of Reliance Industries, has left GAIL’s pipelines under-utilised. But the company’s petrochemicals business has gained from low gas prices. Exemption from fuel subsidy sharing has also helped.
The exploration business of Reliance Industries has been facing setbacks, both domestically and internationally, with low output and weak prices. But the company’s key refining and petrochemicals businesses have been doing quite well and have expanded capacities significantly. Also, with the recent announcement of tariff plans in its big-ticket telecom business from April, there is now the much-awaited revenue visibility. The stock has pepped up to the news, after a long somnolence.
Meanwhile, to improve the energy security of the country, the government has proposed two more strategic crude oil reserves in Odisha and Rajasthan in addition to the three reserves set up now at Visakhapatnam, Mangalore and Padur. This will take the country’s strategic reserve capacity to 15.33 million tonnes from 5.33 mt currently. But quick execution of the proposed projects, unlike in the past, is imperative if the country has to make the most of rapidly changing global crude oil price dynamics.
Also, PSU oil companies, egged on by the government, have been acquiring international energy assets that are available relatively cheap after the oil price rout. The recent acquisition of stakes in Russian assets by a consortium of Indian energy companies is a case in point.
Also, in the recent Budget, the government has proposed to create an integrated public sector ‘oil major’. Such an energy behemoth with enhanced financial muscle might be better placed in bidding for big-ticket foreign assets that see intense competition from major international players. Recent reports talk about the government selling its stake in refiner HPCL to explorer ONGC. There are mixed views, though ,on the desirability of such consolidation moves.