Likely Hikes in Diesel, LPG Prices to Control Under-recoveries - India Ratings

New Delhi, September 6, 2013: India Ratings & Research (Ind-Ra) says diesel and LPG prices could be increased in the coming days to control under-recoveries on petroleum products.

“The significant increase in under-recoveries in the past few months is likely to lead the government of India (GoI) to effect a one-time increase in the price of diesel and subsidised LPG cylinders", says Abhinav Goel, Senior Director, Ind-Ra.

Under-recovery on diesel has increased to INR12.12/litre from INR9.03/litre in beginning of the year despite an increase of 50p/litre/month since January 2013. The under-recovery on diesel had fallen to INR3.73/litre (fortnight effective 16th May 2013) due to a fall in crude oil prices. Under-recovery has been ballooning since then because of unfavourable movements in crude oil prices and USD/INR exchange rates. The Indian crude oil basket and exchange rate in the second fortnight of August 2013 was USD110.09/bbl and INR64.91/USD, respectively (USD101.21/bbl and INR54.32/USD in the first fortnight of May 2013).

The current daily gross under recovery (GUR, effective 1st September 2013) is INR4.7bn compared with INR3.89bn a fortnight ago and INR2.52bn in the fortnight effective 16th May 2013. GoI estimates that every one rupee depreciation against the dollar increases GUR by around INR80bn. The current tension in Syria is also keeping crude oil price on the boil.

GUR on the three regulated fuels – diesel, domestic LPG and kerosene (public distribution system) - going by the current rate could cross the record level of INR1.6trn as witnessed in FY13. GoI shared around 60% of GUR in the past two years (FY12: 60%; FY13: 62%). Assuming the same subsidy sharing ratio, GoI’s total subsidy burden for FY14 could well exceed its FY14 budget of INR650bn. Diesel accounts for bulk of GUR (FY13: 57%; FY12: 59%). To keep this in check, GoI may ask oil marketing companies (OMCs) to increase diesel and subsided LPG prices (current LPG subsidy INR470/cyl vs INR378/cyl in the fortnight effective 16th May 2013).

Like in the past, if GoI provides for a majority of the subsidy burden in H2FY14 and postpones subsidy cash outflow, OMCs’ debt burden will rise. This coupled with the current high interest rate scenario would further increase interest costs for OMCs. Total debt and aggregate interest expense of the three government OMCs increased to INR1,656bn in FY13 (FY11: INR1,139bn) and INR120bn (INR52bn), respectively.

To reduce volatility in the forex market, the Reserve Bank of India has provided OMCs with a dollar swap arrangement. OMCs on an average buy USD300m daily to meet oil import requirements and this swap facility would take out demand temporarily from the system. However, clarity is awaited if OMCs will have to bear the forex rate difference at the end of the swap period.

Upstream companies, who shared close to 40% of GUR in FY12 and FY13, have also been severely affected by increasing GURs; Oil and Natural Gas Corporation Limited’s net crude oil realisation in Q1FY14 was USD40.17/bbl (FY13: USD47.85/bbl, FY12: USD54.71/bbl, FY11: USD53.77/bbl) against the prevailing Brent crude price of around USD115/bbl. Production costs of existing fields and finding, development and acquisition costs of new fields have been increasing over the years. This would make it difficult for upstream companies to invest adequately for future if net realisation remains subdued.

However, Ind-Ra’s ratings on OMCs are likely to remain stable as they are based on the strategic importance of the sector to the sovereign and the strong likelihood of government support. The under-recovery burden on OMCs has been negligible in the past two years (FY12, FY13) and Ind-Ra expects the same to continue in FY14 as well. The agency rates both Indian Oil Corporation Ltd and Hindustan Petroleum Corporation Limited at 'IND AAA' with a Stable Outlook.

(Source: Manager – Corporate Communications and Investor Relations, India Ratings & Research -A Fitch Group Company.)