>INDIA: ENERGY: OIL - REFINING (GOLDMAN SACHS)

Fuel price hike a surprise, but indicates no reform and no oil bonds

India raises auto fuel prices 6%-9%; but losses continue
The Indian government today (July 1) increased retail prices of gasoline and diesel 9% and 6% respectively in an unexpected move. While this is likely to draw political opposition, we note that oil marketing companies (OMCs) are expected to continue to lose Rs1.6-2.0/lit on fuel sales despite this hike. The prices of cooking fuels (LPG/kerosene) were unchanged.

Hike implies government intention to issue fewer oil bonds in FY10
We believe that the swift price hike reflects the government’s intention to keep its share of the subsidy low. The oil ministry has indicated that upstream companies would bear the entire subsidy burden from cooking fuel losses (source: Wall Street Journal, July 1), implying that the
government would minimize issuance of oil bonds going forward as it tries to keep the fiscal deficit under control.

Fuel price de-control looks unlikely now; also oil prices going up
The ad-hoc increase in auto fuel prices also puts to rest, in our view, recent excitement about structural reforms in fuel pricing. We believe the government indicated that while it is ready for some difficult decisions on fuel pricing, it is unlikely to leave this entirely to market forces at a time when oil prices are likely entering an upcycle. The Union Budget on July 6, 2009 should provide clarity on the subsidy structure for FY10, which we believe would make the government the biggest beneficiary.

Retain Neutral on OMCs; but they are running out of good news
While it is not clear whether OMCs would have lower net under-recoveries in the new subsidy structure, cash flows should improve if the government minimizes deferred subsidy payments, i.e. oil bonds going forward. Though the price hike news is positive for sentiment on OMC stocks, we believe they are running out of good news. As a result we retain our Neutral ratings and target prices on IOC, HPCL and BPCL.

Upstream to bear entire cooking fuel loss = negative for ONGC
If upstream co’s are asked to bear the entire subsidy for cooking fuels, it would be a major negative surprise for ONGC. The upstream subsidy payout has been lower than cooking fuel losses in all the years so far. We remain skeptical on whether the govt would allow ONGC to make more profit at the cost of oil bonds and as a result maintain a Sell rating.

To see full report: OIL SECTOR