Impact Analysis of Fuel price hike, duty cuts on ONGC.

Impact Analysis of Fuel price hike, duty cuts on ONGC.

Government hikes fuel prices, cuts duties: On June 24, 2011, the Empowered Group of Ministers (EGoM) announced to raise retail fuel prices. As expected, the government not only took price hikes but also surprisingly re-jigged the duty structure. The government hiked diesel price by `3/litre. Prices of cooking fuels, LPG and Kerosene, were also hiked by `50/cylinder and `2/litre, respectively. The resultant price hikes will help reduce under recoveries of OMCs by around `21,000cr. The duty cuts will cost the exchequer a whopping `49,000cr.

Under recoveries to fall, but still remain high: With these measures, we now estimate under recoveries to remain at `97,551cr in FY2012 and `102,484cr in FY2013. We estimate the Indian crude oil basket to remain at around
US$95–105 in FY2012 and FY2013.

No clarity on subsidy-sharing mechanism yet: Although the government has pegged subsidy-sharing burden of 33.0% of under recoveries for 1QFY2012, there is still no clarity on the policy of the subsidy-sharing mechanism. Given that crude price is at around US$100/bbl, we continue to peg FY2012 and FY2013 subsidy sharing for downstream companies at 38.7% of under recoveries.

Outlook and valuation: We anticipate ONGC’s incremental production from marginal fields to more than offset any decline in production from the ageing fields. OVL is also expected to report increased volumes by 2013 at ~12mn tonnes on account of incremental productions from Myanmar, Sakhalin-1 and Venezuela coming on stream. Deregulation of diesel and resolution of the royalty issue with Cairn could be significantly earnings accretive for ONGC. Higher gas price from extant fields and mark-to-market prices from incremental production could accrete earnings further. Significant discoveries in the high-potential Cambay, KG basin and Mahanadi fields (still under appraisal) could further boost valuations. Although there is an FPO overhang on the stock in the near term, we believe increased volumes and net realisation should offset these concerns. We recommend an Accumulate view on the stock with an SOTP-based target price of `325.