June 2014

CRISIL Opinion

Road ahead clears up for Oil PSUs

CRISIL Opinion

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Oil PSUs poised for structural improvement in profitability

Under-recoveries to halve with ongoing price revisions and softer crude prices
Under-recoveries on petroleum products are expected to decline by over 50 per cent from 2013-14 levels
over the next 2 years due to ongoing efforts to move towards market-linked diesel prices and the expected
decline in crude oil prices. This will have a significant positive impact on both upstream and downstream
PSU oil companies. PAT of downstream companies will increase by Rs 33-36 billion y-o-y in 2014-15 and by
another 7-10 billion in 2015-16 because their interest cost will decline and they wont have an under-recovery
burden. On the other hand, upstream companies, which typically share 40-50 per cent of the total underrecovery burden on petroleum products, will see a sharper improvement of Rs 105-120 billion y-o-y in profit
after tax (PAT) in 2014-15 and a further improvement of Rs 70-75 billion in 2015-16. This is because the
impact of reduced burden of under-recoveries will more than offset the impact of decline in realisations due
to lower crude prices. If we include the benefit from the potential hike in gas price to US$8.4 per mmbtu, PAT
of upstream companies will further increase by Rs 70-75 billion in 2014-15, resulting in an overall increase of
Rs 215-230 billion.

High under-recoveries hurt profitability of both upstream and downstream oil

companies
In the past few years, high under-recoveries on sales of petroleum products have left deep holes in the
financials of oil companies (both upstream and downstream). This is because, in India, petroleum products
such as diesel, LPG, and kerosene are sold by downstream public sector oil marketing companies (OMCs)
at regulated prices, well below the cost (petrol prices were de-regulated in June 2010). The resultant loss,
termed as under-recovery, is generally shared by three parties the government, upstream oil companies
(ONGC, OIL India and GAIL) and oil marketing companies (IOCL, BPCL and HPCL) in a proportion
determined by the government every year.
Trend in under-recoveries and its share absorbed by government, upstream and downstream
companies
Rs billion

782
600 - 700

461

800

60%

400

20%

9%

31%

39%

56%

52%

32%

1%
39%

1%

0%

0%

48%

50%

50%

51%

50%

50%

33%

40%

600

12%

2015-16P

80%

900-1,000

1200
1000

0%
21%

2014-15P

100%

2013-14

1400

1,386
1,033

2011-12

1600

1,610 1,400

2010-11

120%

1800

68%
46%

60%

200

Diesel

Domestic LPG

PDS Kerosene

Government

Upstream

2012-13

2009-10

2015-16P

2014-15P

2013-14

2012-13

2011-12

2010-11

2009-10

2008-09
Petrol

2008-09

0%

Downstream

Source: PPAC, CRISIL Research

CRISIL Opinion

The sharp increase in overall under-recoveries and, thereby, the governments contribution towards underrecoveries over the last few years has led to a surge in the interest cost of OMCs The interest cost has gone
up owing to a significant rise in working capital requirement, which is the outcome of delay in payments from
the government. Average delay in payments by the government has been to the tune of 3-6 months over the
last few years. Consequently, interest cost for OMCs more than tripled from Rs 30 billion in 2007-08 to Rs
104 billion in 2012-13 after declining to Rs 78 billion in 2013-14 (due to dollarization of rupee loans as well as
decline in under-recovery burden). Total debt also doubled to Rs 1,325 billion in 2013-14 from Rs 673 billion
in 2007-08. Also, short-term debt as a percentage of total debt has remained, on an average, around 75 per
cent since 2007-08 in line with rising working capital requirement. Due to conversion of rupee denominated
working capital loans to foreign long term loans (external commercial borrowings of minimum 3 year tenure),
share of short term debt declined in FY14.
Increase in gearing largely to cater to short term requirements of OMCs
Rs billion
1.5

1,000
1.1

1.4

800

1.3
1.2

1.2

600
400
200

832

702

970
714

407

355

Rs billion

Times

1.5

1,200

1.6

1,600

1.4

1,400

1.2

1,200

1.0

1,000

889

880

0.8

800

210

283

0.6

600

0.4

400

0.2

258

FY08

FY09

FY10

FY11

FY12

FY13

FY14

200

1,282
253

1,325

359

967

590

255

136

537

1,384

1,029
679

597

FY09

FY10

985
735

712

FY08

FY11

FY12

FY13

FY14

Government share of under recovery

Debt/Equity of OMCs (RHS)

Total short term debt

Total Long term debt

Source: PPAC, M oPNG , Company financials

As seen in the chart below, subsidy receivables by OMCs at the end of each year almost tripled from Rs 150
billion in 2007-08 to Rs 427 billion in 2012-13 resulting in an increase in their borrowings. More pertinently,
oil companies have used the debt to meet their working capital requirements rather than spend it on
expansions or acquisition of upstream assets.

Trend in government subsidy receivables of OMCs

(Rs billion)
500
427
400

353

300
200

183
150
119
83

100
0
2007-08

2008-09

2009-10

2010-11

2011-12

2012-13

Amount recoverable from the government at the end of every year

Source: Annual Reports, CRISIL Research

The sharing of under-recoveries between government, public sector upstream and downstream companies is
done on an ad-hoc basis depending on the financial position of both upstream as well as downstream
companies as well as government finances. Over the last few years, with under-recoveries soaring to Rs
1,400 billion in 2013-14 from Rs 771 billion in 2007-08, the contribution (in absolute terms) of upstream
companies towards under-recovery sharing has increased significantly to Rs 670 billion in 2013-14 from Rs
257 billion in 2007-08. Consequently, they have not benefitted from the combined effect of high crude oil
prices and the weak rupee.
Between 2008-09 and 2013-14, crude oil prices rose at a CAGR of 5 per cent to $108 per barrel. During the
same period, the rupee depreciated from INR 46/$ to INR 61/$ (6 per cent CAGR). However, upstream
public sector companies could not benefit from rising oil prices and weak currency as their net realisation
declined to $41 per barrel in 2013-14 from $48 per barrel in 2008-09 due to increased share in underrecoveries.

CRISIL Opinion
Upstream companies not getting significant upside from high crude oil prices and rupee
depreciation
Rs/barrel

USD/ barrel
140

112

120
100

60

38

36

16

63

66

4,074

3,965
3,399

4,000

2,000
48

6,025

3,000

40
20

5,627

6,000
5,000

63

72

80

107

89

86

6,457

7,000

117

2,654

2,450

2,622

2,604

2,479

FY10

FY11

FY12

FY13

FY14

2,195

56

54

55

48

41

FY10

FY11

FY12

FY13

FY14

1,000
-

FY09

Net realisation - ONGC

FY09

discount given to OMCs

Gross realisation (Rs terms)

Net Realisation

Note: Figures on top of the bar indic ates gross realis ation
Source: Annual Reports

As the above chart shows, while average crude oil prices increased by 16 per cent CAGR between 2009-10
and 2012-13, ONGCs net realisation (after removing discount offered to OMCs) declined by 5 per cent. In
rupee terms, ONGCs gross realisations increased at 21 per cent CAGR as against a 1 per cent decline in
net realisations. Even in 2013-14 when gross realisation declined by ~$5 per barrel, discounts actually
increased by $3 per barrel. Consequently, profit after tax (PAT) margins of upstream companies remained
more or less stable around 28 per cent as their contribution towards under-recoveries almost doubled to Rs
670 billion in 2013-14 from Rs 341 billion in 2008-09.
Increasing contribution towards under-recoveries for upstream PSUs restricting PAT margins
Rs billion

46%

50%
40%
30%

42%
38%

10.4%

43%

6%

13%
15%

10%

17%

604
541

600
500
400

20%
10%

670

700

39%
34%

800

341
246

300
26%

28%

28%

33%
26%

27%

148

200
100
-

0%
FY09

FY10

Actual PAT margin

FY11

FY12

FY13

FY14

Increase in PAT margins if no U/R was paid

FY09

FY10

FY12

FY13

FY14

Share of upstream companies in overall under-recovery burden

Note: Figures on top of the bar indic ates PAT margins if no under-recov ery was paid
Source: Annual Reports, CRISIL Research

FY11

Govt undertaking steps to ease under-recovery burden

To reduce the burden of under-recoveries the government has, in the recent past, taken quite a few
measures such as a calibrated increase in diesel prices, deregulation of bulk diesel prices, cancellation of
multiple LPG connections and a cap on the supply of subsidised LPG cylinders.
In 2013-14, with an increase of 50 paise every month, retail diesel prices have risen by Rs 6.90 per litre.
Around 10-12 million duplicate LPG connections, which account for 7-8 per cent of overall connections in the
country, have been cancelled over the last 18 months. Due to these measures, in spite of high crude oil
prices (~$108 per barrel) and a sharp 11 per cent depreciation of the rupee against the dollar, underrecoveries in 2013-14 have declined by 13 per cent y-o-y. The new government has also continued with
diesel price hike of 50 paise. CRISIL Research expects market alignment of diesel prices to continue as a
result of which diesel (like petrol) will also be eventually de-regulated.

Under-recoveries on petroleum products to halve over next 2 years

After declining in 2013-14, under-recoveries are expected to decline further by 30-35 per cent y-o-y to Rs
900-1,000 billion in 2014-15 and 25-30 per cent y-o-y to Rs 600-700 billion in 2015-16 on account of the
following factors:
a) A 8-10 per cent y-o-y decline in international petroleum product prices over the next 2 years
Over the next 2 years, global crude oil supply will outpace demand with growth in the latter continuing to
remain sluggish. Global demand growth is expected to be impacted by weak crude oil demand in North
America and Europe on account of increase in efficiencies and a shift towards natural gas as well as
relatively slower demand from developing countries such as China and India led by declining subsidies.
With relatively higher supply due to increase in output from Iraq, Iran and North America, crude oil prices are
expected to decline from $107.6 per barrel in 2013 to less than $100 per barrel in 2015 barring any major
geo-political event. Currently it is largely the unrest in Ukraine which is supporting prices despite weak
demand.
b) Gradual alignment of domestic diesel prices with international prices; slower growth in diesel
consumption
Under-recovery on diesel, which accounted for about 45 per cent of the total burden in 2013-14, is likely to
be eliminated by the end of 2014-15. This is due to the governments decision to increase diesel prices by 50
paise every month till domestic prices get aligned to international prices.
While the 50 paise price hike did not take place in April 2014 due to ongoing general elections, diesel prices
were increased by Rs 1.09 per litre on May 13, 2014, after the polls ended. Further, after the formation of the
new government diesel prices have been increased by 50 paise already.

CRISIL Opinion

Trend in under-recoveries on diesel

Rs/litre

Diesel under-recoveries

20.0

16.0

12.0

Decline in U/R due to

price increases and
fall in crude oil prices

15.5
11.4

Continued hike in diesel

prices once again
brought down U/R
13.3
10.4

9.6

9.1

8.0

9.7
6.5

5.7

5.6

4.0

Sharp rupee depreciation

raised U/R on diesel

3.8

2.8

Note: Under-rec overies are average f or the month; number for J une 2014 is as on 1

st

Jun-14

May-14

Apr-14

Mar-14

Jan-14

Feb-14

Dec-13

Nov-13

Oct-13

Sep-13

Aug-13

Jul-13

Jun-13

May-13

Apr-13

Mar-13

Feb-13

Jan-13

Dec-12

Nov-12

Oct-12

Sep-12

Aug-12

Jul-12

Jun-12

0.0

June

Source: PPAC, Press Information Bureau (PIB)

The increase in retail diesel prices narrowed the gap between diesel and petrol prices and reversed the shift
that was being seen towards diesel cars. The price hike along with slowdown in transportation segment due
to economic slowdown has helped rationalise diesel demand, which was growing at 7-8 per cent till 2012-13.
Post price increases, diesel demand is estimated to decline marginally by 1 per cent in 2013-14 and grow at
a relatively slower pace of 2-3 per cent over the next 2 years.
c) Marginal increase in LPG and kerosene retail prices coupled with cancellations of multiple LPG
connections and cancellation of PDS kerosene allocations
We also expect marginal increases in prices of LPG and kerosene over the next 2 years in line with the
increases in the past. Although the government has not increased prices of LPG and kerosene in 2012-13
and 2013-14, CRISIL Research estimates that retail LPG cylinder and kerosene prices will go up by Rs 4050 per cylinder and Rs 1-2 per litre, respectively per annum, over the next 2 years as was the case prior to
2012-13. This, along with cancellation of multiple LPG connections and cancellation of public distribution
system (PDS) kerosene allocations, will help to contain under-recoveries in future.
Outlook on under-recoveries on various petroleum products
Year\Product

Diesel (Rs billion)

LPG (Rs billion)

Kerosene (Rs

Overall

billion)

Under-recoveries
(Rs billion)

2012-13

921

396

294

1,610

2013-14

628

465

306

1,399

2014-15P

210

513

277

1,000

2015-16P

388

229

617

Source: PPAC, M OPNG, CRISIL Research

Lower under-recoveries to add Rs 175-190 billion to PAT of upstream companies by

2015-16
With the expected reduction in under-recoveries over the next 2 years, and assuming that upstream PSUs
share 50 per cent of the burden in line with the past, the discount to OMCs by upstream PSUs will reduce
from Rs 670 billion in 2013-14 to Rs 450 billion in 2014-15 and Rs 300 billion in 2015-16.
Due to the decline in under-recoveries, net addition in profit after tax (after adjusting for royalty payment and
taxes) of upstream companies will be Rs 105-120 billion y-o-y in 2014-15. PAT will increase further by Rs 7075 billion in 2015-16 due to the fall in under-recoveries.

Gas price hike to add to profitability

PAT of upstream companies will also get a boost due to an increase in gas prices during 2014-15. Although
the revision in domestic gas prices was expected from April 1, 2014, the Election Commission deferred the
decision and left it to the new government to take a decision.The new government is deliberating the same.
The extent of revision is awaited.
The potential increase (as per the Rangarajan committee formula) of the natural gas price to US$8.4 per
mmbtu from $4.2 per mmbtu will increase the PAT of upstream companies (ONGC, Oil India) by Rs 110-115
billion in 2014-15. The combined effect of lower under-recoveries and the gas price hike is expected to lift
PAT of upstream companies by about Rs 215-230 billion in 2014-15.
For upstream PSUs, the increase in PAT has been calculated on the assumption that they will not be asked
to share the subsidy burden of the government in other sectors such as fertiliser and power or significant
change in proportion of subsidy shared which is potential downside to our assumptions.

Profitability of OMCs to also get a boost with decline in interest burden

After rising to Rs 250 billion in 2010-11, capital expenditure by OMCs declined sharply to below Rs 100
billion in the subsequent 2 years due to a significant increase in interest costs. Higher interest costs were
due to an increase in working capital requirement caused by delayed subsidy payments. Subsidy receivables
from the government increased almost three-fold over the 5 years ending 2012-13. The lack of growth in net
profit has also impacted the ability of these companies to undertake capital expenditure.

CRISIL Opinion

High under-recoveries restricting capital expenditure plans of OMCs

Rs billion

Rs billion

PAT

140

Capex

300

131

250
120

108

105

100

250
200

86

80

144

150

62
60

98

91

FY12

FY13

100

39

58

40

50
20

0
FY09

FY10

FY11

FY12

FY13

FY09

FY14

FY10

FY11

Source: Company financials

Other things remaining the same, the decline in under-recoveries in 2014-15 and 2015-16 will improve
OMCs PAT by 26-28 per cent to Rs 161-164 billion in 2014-15 and by another 4-6 per cent to Rs 168-171
billion in 2015-16. Although OMCs shared Rs 21 billion under-recoveries in 2013-14, we have assumed they
will not share any under-recovery burden in 2014-15 and 2015-16 due to significant decline in overall under
recovery burden going forward. Over the next 2 years, as gross refining margins (GRMs) of OMCs are
expected to remain similar to 2013-14 levels of $3-4 per barrel, the improvement in profitability will largely be
on account of the decline in under-recoveries
If the above-mentioned initiatives pan out as expected, and oil prices stay soft, the entire sector will receive a
much-needed shot in the arm and encourage investments.
Impact of lower under-recoveries and gas price hike on PAT of upstream and downstream
companies

Improvement in PAT (y-o-y)

2014-15

2015-16P

Total benefit

Upstream companies (excluding gas price hike)

Rs 105-120 billion

Rs 70-75 billion

Rs 175-190 billion

Upstream companies (Including gas price hike)

Rs 215-230 billion

Rs 70-75 billion

Rs 285-290 billion

Downstream companies

Rs 33-36 billion

Rs 7-10 billion

Rs 40-43 billion

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Rahul Prithiani

Kelvin Shah

Director, CRISIL Research

Associate Director, CRISIL Research

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