INDIA: ENERGY: OIL - REFINING (GOLDMAN SACHS)

OMCs to depend on bonds despite reform; govt likely benefits most

Enthusiasm on potential pricing reforms has lifted OMC stocks
The stocks of Indian oil marketing companies (OMCs) have moved up sharply in the last few weeks on media reports (e.g., Reuters) suggesting that the government could free up auto fuel pricing up to oil price of US$75/bbl, (without reforms in cooking fuels). Though the petroleum minister is yet to take office, the government has remained noncommittal on this issue; as such, we remain unconvinced about the reforms actually happening, but take a look at how the OMCs would be impacted by potential reforms.

Partial reforms may not help OMCs; gov't likely main beneficiary
We believe that deregulation of only auto fuels may not boost the earnings of OMCs, since oil bonds and upstream payments would still remain critical for them due to large losses from cooking fuel sales. We find it hard to believe that the government would issue a large quantum of oil bonds to increase OMC profits and add to the fiscal deficit in the process. Collection from any windfall tax on oil producers would also likely be less than cooking fuel losses. Hence, we believe that partial reform would improve cash flows of OMCs but may not impact earnings.

The government could be the biggest beneficiary from this, in our view, as it would likely look to reduce issuance of oil bonds and also potentially increase upstream subsidy burden. We also believe that private refiners (RIL, Essar) could be included in the subsidy scheme going forward, rather than the government initiating pricing reforms to encourage private participation in domestic petroleum retailing.

With stock prices moving on expectations of reforms and oil price rising, significant scope for disappointment going forward
With hardly any impact on earnings on OMCs likely from partial reforms and the recent run-up in these stocks, we believe there is scope of disappointment in these stocks in the near term. Moreover, rising oil prices could make partial reform itself unlikely. We believe this sentiment-driven rally in OMC stocks is unlikely to get fundamental support.

Neutral on OMCs on lack of policy direction; move out on rallies
We remain Neutral on IOC, HPCL and BPCL with P/B-based 12-m TPs of Rs415, Rs260, Rs325, respectively, as we wait for some policy direction from the gov’t. We believe investors should reduce positions on any news flow-driven rally in the run-up to the Union budget in early July.

To see full report: OIL SECTOR