The Hindu Business Line : Oil companies over the barrel

The government's compulsions to maintain retail prices of the two fuels and its inability to foot no more than a small share of the subsidy on LPG and kerosene is costing the oil companies dear. Their finances are under severe strain and major projects are being put on hold. It is not surprising that the recent market rally has given oil stocks the go by, and that investors are waiting for better times in the industry.

ARE the oil companies in danger of turning sick? Reports say that the Petroleum Secretary, Mr S. C. Tripathi, has written to the Cabinet Secretary, Mr B. K. Chaturvedi, pointing out that the four refining and marketing companies could well turn sick if the current state of affairs is allowed to continue.

Indian Oil, Bharat Petroleum, Hindustan Petroleum and IBP have posted massive losses in the first quarter of the current fiscal and piled on some more in July.

The immediate prospects certainly don't look too good for them right now with crude prices moving up once again — they have shot past the $65-a-barrel mark — and the Government vacillating on the crucial issue of raising the retail prices of petrol and diesel.

The fact is that the government's compulsions to maintain retail prices of the two fuels and its inability to foot no more than a small share of the subsidy on LPG and kerosene is costing the oil companies dear.

They may not turn sick tomorrow but there is no doubt that their finances are coming under severe strain and major projects on the drawing boards are being put on hold.

For instance, Indian Oil has had to borrow Rs 2,000 crore in the last three months alone and most of it has gone towards servicing working capital.

It is unprecedented for oil companies, which are known to be cash-rich, to borrow to finance their day-to-day funds requirements.

The government has to step in now with corrective measures to ease the burden on the oil companies.

There are three options open before it: Raise retail prices, reduce taxes and duties on petro-products, and spread the subsidy burden across the industry, which means including the standalone refiners, such as Chennai Petroleum, Kochi Refineries and Mangalore Refinery, and the private refiner, Reliance Industries.

Given the latest spurt in oil prices, it appears that only a combination of all the three options can deliver the desired results.

According to the calculations of the oil companies, an increase of about Rs 6 per litre of petrol and Rs 5 a litre of diesel is necessary to stem their losses. It is highly unlikely that the government will approve such a big increase.

One way of keeping the quantum of increase within manageable limits is to combine this with a further reduction in Customs duties on petrol and diesel, which are at 10 per cent now. Further, the subsidy bill on kerosene and LPG is also ballooning along with the rise in oil prices.

Estimates are that the total subsidy bill on the two products could be Rs 25,000-30,000 crore; the Government has budgeted a paltry Rs 3,500 crore as its share of this subsidy. The balance has to be borne by the oil companies in a ratio determined by the government.

With global oil prices rising inexorably, the subsidy burden is proving too much for these companies to bear.

The government may have to soon either agree to an increase in the retail prices of kerosene and LPG or at least provide more from its kitty to ease the burden on oil companies.

We are probably headed for an era of higher average global oil prices than what we have been used to till now and it is therefore imperative that the government frame a strategy to deal with the issue on a long-term basis. At present the issue is being addressed in an ad hoc manner when things get too hot and the oil companies complain.

Even if the government were to agree to a price increase immediately, the oil companies may still report a loss for the second quarter ending September, as half the quarter has gone by.

These companies are all listed on the stock market and have attracted a high degree of investor interest. Given the state of affairs in these companies, it is not surprising that the recent rally in the market has given oil stocks the go by.

It may be prudent for investors to refrain from taking fresh exposures in these stocks for the time being and wait for better times to return to the industry.

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