The Government of India deregulated diesel prices and increased the Gas prices to USD 5.61 per million metric British thermal units (mmBtu). The raised Gas prices would be effective from 1st November 2014 and would be revised after every six months. The previous Government had suggested raising domestic Gas prices to USD 8.4 per mmBtu from the current USD 4.2 per mmBtu. The raised gas prices would make the investment in drilling and exploration feasible for production and would not sharply increase the burden on the pockets of the customers.
Upstream companies like Oil and Natural Gas Corporation are completely into exploration and extraction of crude oil while downstream companies such as BPCL, HPCL and IOC are into refining, marketing and distribution of petroleum products.
Before the deregulation of diesel and petrol prices the Upstream and Downstream companies were compensated by the Government through subsidies on petroleum products. Deregulation of Diesel prices recently and petrol in the year 2010 has entirely reduced the subsidies on these products and the new prices would be totally market determined. A change in the crude oil prices in the international market would be immediately reflected in the local prices for diesel and petrol.
During the Government controlled prices regime the oil producing, refining and marketing companies were compensated by subsidies, but still under recoveries were increasing due to difference in the cost of production and selling price for petroleum products.
The total deregulation of petrol and diesel prices for upstream and downstream companies is extremely positive and the financials that have already started showing improvement will show a multi fold jump in the near future.
Financials are expected to show significant improvement in comparison to previous years due to the profit these companies would earn because of deregulation in prices. The debt burden would also see reduction in the immediate and near future as a result of increased operating cash flows. Interest expense would also see reduction as the long term debt gets reduced for these companies. Working capital required for management of under recoveries would also see drastic reduction and result in improved short term debt servicing. More amount of cash would induce producers and refiners to compete in a free market environment and would incentivise use of new technology in the time to come. The increased profitability and revenues would reflect in increased earnings per share for the upstream and downstream companies, which would benefit the shareholder.Valuations would rise to a new benchmark level as these companies constantly remained undervalued due to the controlled industry dynamics in the past.
To give an example the recent sharp fall in international Brent crude oil prices to USD 83 per barrel had increased the profit on the sale of diesel for the first time in the history of these companies. The prices were eventually reduced by Rs.3.37 by the Government as they were in the form of additional profits for the oil marketing companies. The increased profits would eventually reflect in the increased revenues in the coming quarters in FY 2014-15 for the upstream and downstream companies. Before this scenario the diesel under recoveries amounted to thousands of crores of rupees because of the sale of diesel below the cost of production and refining for these companies. For example the diesel under recoveries were to the extent of Rs.14.5 per litre in the month of September 2013 and were reduced to Rs.0.08 per litre in the month of September 2014. The losses are expected to be Rs.1400 billion in FY 2014-15 due to under recoveries in the sale of petroleum products for the oil refineries.
Competition in the Oil and Gas sector especially from the private side is expected to intensify as they were facing constraints in selling at a higher price in comparison to the Government companies. Gross Refining Margins (GRM) and Net Refining Margins (NRM) are also expected to improve as new technology gets implemented in the long term. Marketing margins on the sale of petroleum products by the downstream companies are also expected to improve consequently. Stable exchange rate is also positive for Oil and Gas sector as it keeps a check on the cost of imports for crude oil.
The increased gas prices would compensate the gas producers and a revision every time would further increase the benefit. Benefit would accrue in terms of increased revenues and profitability in the production and sale of gas for these companies. The increase in the prices of gas is expected to marginally impact volumes but show increase in revenues for gas distribution. Exploration and Drilling activity is expected to rise on account of improved economic incentive for the companies.
Increase in the prices of Gas is expected to impact volumes and revenues for companies in the City Gas Distribution space. The increase in the prices of Gas usually reduces the volume of gas that is sold through city gas distribution but shows an increase in the revenues as an effect.
The use of higher priced gas is negative for the Fertilizer and Power sector as it translates into higher input costs and lowers the operating profit for them. It would also raise the fertilizer subsidy for the government but the increased income from higher gas price is expected to offset the additional burden.
Reliance would not get the new price for gas from its two producing fields – D1 and D3 – in the KG-D6 block as the difference would be deposited into the gas pool account operated by state-run gas utility GAIL until the massive shortfall in gas production from the Krishna-Godavari basin is overcome.
The benefit for the Government is also very large as a reduced subsidy burden reduces the expenditure which in turn reduces the fiscal deficit for the Government. The fiscal deficit is expected to reduce and be 4.1% till March 2015 due to deregulation in prices for petrol and diesel. As 80% of the requirement for Oil is directly imported from foreign countries, reduced prices for crude oil reduces the Current Account Deficit (CAD) for the Indian Economy.