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Sell: Subsidy Sharing – What’s On The Government’s Mind?

■ Upstream vs. consumer on auto fuels — The government has announced plans to constitute a committee to fix the subsidy mechanism. A telescopic sharing structure on auto fuels could be one of the options, where upstream share increases progressively with crude px. We build various workable scenarios with the upstream share rising gradually to as much as 100% of incremental losses at crude >$85/bbl. Such scenarios could lead to ONGC’s FY10E EPS peaking at ~Rs135 according to our analysis, without factoring in meaningful downside risks from higher diesel cracks and/or possible review of LPG/SKO exemption.

■ Scenario I — In this scenario, we assume upstream bears a lower (25%) share of auto fuel losses at lower crude (US$60-75/bbl), a higher (50%) share between US$75-85/bbl, and 100% at >US$85/bbl. This presumes the remaining share is borne through consumer price hikes. We estimate this could lead to FY10E EPS of ~Rs125-139 and resultant net realisations of US$58-62.

■ Scenario II — ONGC’s FY10E EPS could be ~Rs115-125 if upstream bears 50% of auto fuel losses at crude <$85/bbl (net realisations of US$55-57). We also build a Scenario III with complete price deregulation (i.e. no sharing) until $75/bbl and 100% sharing beyond that, although this appears extremely unlikely (FY10E EPS could be ~Rs130-160).

■ Don’t forget the diesel spreads — We assume flat diesel cracks i.e. a $1 increase in diesel for every $1 of crude. This is rather simplistic especially if a further rise in crude is led by a pick up in distillate demand. A $2 increase in diesel crack from present levels could increase losses substantially, shaving ~Rs5-6 off FY10E EPS in scenarios I and II above. Besides, exemption from LPG/SKO subsidy for upstream needs to be reaffirmed more widely within government.

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