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Raghuvir Srinivasan

OIL companies have always been subject to a high regulatory risk in India caused by governmental actions.

That risk was demonstrated yet again last week when the Government reduced duties on petrol, diesel, cooking gas and kerosene.

The reduction was necessary in order to prevent yet another increase in the retail prices of these products following the sustained rise in global crude oil prices.

Oil prices, that began the week at $46 a barrel had risen to $49 by the end of the week and there is nothing to suggest yet that this upward trend will reverse anytime soon.

Therefore, despite the Government reducing duties now, it may be confronted with the need to increase retail prices yet again in the next fortnight or two.

Of course, given the heavy taxes that petroleum products are subject to, there is room still for the Government to manoeuvre duties to keep prices under check. Apart from central taxes, petroleum products suffer high rates of sales taxes imposed by States and it is time that States review and reduces these.

While these issues will soon come to the fore if oil prices continue their upward journey, the question that investors may want an answer for is: What does the last week's duty adjustment mean for the oil companies?

Differing impact

Oil companies in India can be split into three categories — upstream companies, such as Oil and Natural Gas Corporation (ONGC) and GAIL; refining and marketing companies, such as Indian Oil Corporation, Bharat Petroleum and Hindustan Petroleum; and companies owning stand-alone refineries such as Chennai Petroleum, Kochi Refineries and Bongaigaon Refinery. Reliance Industries, which operates a 33 million tonne refinery will, for the moment, fall in the third category as it has yet to build an independent marketing network of its own.

Now, the impact of last week's duty reductions will be different for each of the three categories. For the first category comprising ONGC and GAIL, there will be only a limited impact restricted to their production of LPG.

Both these companies produce some LPG and the duty reductions will mean lower realisation for their LPG sales. But given that revenues from this business is minor compared to their main businesses, the impact on their revenues and earnings will not be significant.

For the integrated refining and marketing companies, the impact will be almost neutral. Till last week's duty reductions, their marketing margins were under pressure.

The prices paid by them for the four products to their refineries were rising in tune with global trends while the selling prices were not raised correspondingly causing a dent in marketing margins. However, thanks to the same rising product prices, their refineries witnessed exceptionally high margins that not only compensated for the loss of marketing margins but also left them with a handsome surplus.

This is the main reason why Indian Oil and Hindustan Petroleum posted impressive earnings in the first quarter of this fiscal. The one exception to this was Bharat Petroleum which, despite being an integrated refining and marketing company, suffered because of its relatively lower refining capacity (7 million tonnes) compared to Indian Oil (41 million tonnes) and Hindustan Petroleum (14 million tonnes).

Bharat Petroleum's refining profits were not enough to compensate for the lower earnings on the marketing front.

Following the duty reductions, there will now be a transfer of margins from the refining divisions of these companies to their marketing divisions.

For these companies, therefore, the impact will be almost neutral subject to some differences caused by their respective strengths in the two activities.

The group to be affected the most from the reduction in customs duties now is the third one comprising companies with stand-alone refineries without a marketing network. These companies that were enjoying very strong refining margins in the last few quarters will now find that falling.

Of course, if the trends in global oil prices in the last three days after the duty reductions were effected is any indication, rising refining margins could make up for the loss caused by the duty reductions.

The key factor will be the direction and momentum of global oil prices in the next few weeks.

Soon it will be time for the Western countries to start stocking up for the winter which will be an additional factor pushing up global oil prices. The Government will then be called upon once again to wield the fiscal tool to keep prices under check. And the regulatory risk for the oil companies will thus continue.

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