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Sector Update

Institutional Equity

NEUTRAL Oil & Gas March 3, 2006

Sensex: 10,595, Nifty: 3,147 Hopes lies ahead

We expect the government to consider the implementation of the
Rangarajan Committee recommendations in part or whole within the
next three months and address the core issues pertaining to this much
beleaguered sector. The lack of any budgetary measures/support to the
sector had resulted in a sharp decline in prices of oil stocks even as the
rest of the market rallied after the budget.
Till the time the government plans decisive action on the Rangarajan
Committee recommendations and addresses the core issues, we
maintain our Neutral stance.
In this report, we have given details of the Rangarajan Committee
recommendations and the different scenarios – if the suggestions are
implemented in whole or parts.
The Rangarajan Committee submitted its report to the government with
recommendations on the petroleum product pricing policy and related issues
in February 2006. The key recommendations of the report were:
♦ Shift from import parity pricing for petroleum products to a mix of
import and export parity pricing.
♦ Reduction in customs duty for MS and HSD.
♦ Specific excise duty for MS and HSD instead of a mix of ad valorem
and specific duty.
♦ Higher prices of MS, HSD, LPG and SKO.
♦ Removal of subsidy burden from upstream companies and increase
in cess on crude oil to compensate (partly) for it.
In our view, the government would not increase the prices of LPG and SKO
on the back of political issues. Assuming all other recommendations are
implemented, we expect:
♦ Adverse impact on refiners due to decline in ex-refinery prices.
♦ Lower overall subsidy burden, and the payment of subsidy through
cess would exclude the direct involvement of upstream companies
in subsidy.
♦ Positive impact on ONGC as a pre determined rate of cess would
depict a clearer picture in terms of net earnings of the company.
Currently, ONGC contributes to the subsidy burden on a quarterly
basis as determined by the government in an ad hoc manner.
Therefore, this would lead to better visibility of earnings.
Amit Agarwal
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Amit Agarwal 1 Oil & Gas

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♦ As the marketing capacities of BPCL, HPCL, IOCL are higher than

the refining capacities, we expect them to benefit marginally by the
shift from import parity pricing to trade parity pricing. BPCL, HPCL
and IOCL stand to gain to the extent of the differential in marketing
and refining capacities.
A quick glance at Rangarajan Committee’s recommendations:
Current Comments/implications
Ex-refinery pricing
Change from import parity pricing Import parity pricing Reduction in subsidies
To mix of import and export parity Negative for refiners
Pricing in ratio of 80:20 for ex-refinery price Positive for ONGC
Petroleum product price rise
Increase in prices of MS by Rs1.21/lt
Increase in prices of HSD by Rs1.96/lt
Increase in prices of LPG by Rs75/cylinder
Increase in price of SKO by approx Rs6.01/lt
Duty structure on petroleum products
Reduction in customs duty on MS and HSD Reduction of subsidy
To 7.5% At 10% Negative for refiners
Excise duty- MS to be specific at Rs14.75/lt 8% +Rs13/lt Neutral for Government
Excise duty- HSD to be specific at Rs5/lt 8%+ Rs3.25/lt At current rates
Cess to be Rs4, 800/MT on crude oil Rs1,800/MT Increase from
USD5.4/bbl to
Upstream not to be involved in subsidy burden Positive for ONGC
Source: MOPNG

We have analyzed the changes in the subsidy burden assuming three

scenarios to illustrate the possible impact of Rangarajan Committee on the oil
sector and its constituents.
These are
♦ Case A: The shift in the petroleum product pricing policy from
import to trade parity pricing and its impact. (Excluding the
recommendation to raise the prices of petroleum products)
♦ Case B: The full implementation of Rangarajan Committee
♦ Case C: Implementation of Rangarajan Committee
recommendations except for increase in prices of LPG and SKO.

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Case A: If the pricing policy is changed from import to trade parity

pricing and its possible impact
The Rangarajan Committee has recommended a shift from import parity
pricing (ex-refinery) to a mix of import and export parity in ratio of 80:20 (trade
parity). Assuming every thing else remains constant, we expect the subsidy
burden to decline from Rs413bn to Rs351bn in FY06E. Subsidy burden is the
difference between the import parity based retail price and the actual retail
price. A shift in this direction will reduce the ex-refinery price leading to lower
subsidy burden as shown in Table 1 below. The table below shows the
change in contribution from every participant after the committee report is
Table1: Change in subsidy burden based on change in pricing policy
Rs mn
Contribution to total subsidy New pricing (%) Old pricing (%)
Government 24,696 7 24,696 6
Upstream 115,852 33 136,578 33
Refinery 28,085 8 33,110 8
Oil bonds 94,788 27 111,746 27
Increase in prices 45,639 13 53,804 13
Marketing companies 42,006 12 53,940 13
Total 351,066 100 413,873 100
Source: IL&FS Investsmart

The Table 2 below gives the subsidy burden (Rs/per unit or litre) if the new pricing
policy is implemented.

Table 2: Change in subsidy burden In Rs per unit

Decline in the ex- Import New pricing Sale price Current New
refinery price parity policy (April FY06) subsidy pricing*
pricing subsidy

MS (Rs/lt) 50.3 48.2 44.5 5.8 3.7

HSD (Rs/lt) 36.3 34.6 32.8 3.5 1.8
LPG (Rs/cylinder) 457 444.3 295 162 149.3
SKO (Rs/lt) 22.9 22.1 9.01 13.9 13.1
Note (1): These estimates do not include the hikes in petroleum prices as recommended by the
Rangarajan Committee.
Source :IL&FS Investsmart, Media.

Amit Agarwal 3 Oil & Gas

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Case B: The entire Rangarajan Committee report

This scenario speaks of full implementation of the committee report –
including the hike in petroleum product prices and change in the pricing policy
The suggested price rise in petroleum products is given below in Table 3.
Table 3: Price rise suggestion
Increase in prices suggested by committee
MS (Rs/lt) 1.21
HSD (Rs/lt) 1.96
LPG (Rs/cyl) 75.00
SKO* (Rs/lt) 6.01
Note (1): We have assumed that only 40% of SKO is sold below poverty line. For above poverty
line the price is increased to Rs19.01/lt.
Source: IL&FS Investsmart, Media.

In terms of change in the pricing policy – one can assume the scenario played
out in case A. The customs duty is expected to be reduced on MS and HSD
from 10% to 7.5% while excise duty is likely to be fixed at Rs14, 750/KL for
MS and Rs5, 000/KL for HSD. Currently, the excise duty for MS is 8%+Rs13,
000/KL and HSD is 8%+Rs3, 250/KL.
Table 4: Impact on subsidy of Rangarajan Committee recommendations
Contribution to total subsidy New pricing - Rangarajan Current Percentage
(Rs mn) Committee (%) contribution (%)
Government 24,696 21 24,696 6
Upstream - - 136,578 33
Refinery - 0 33,110 8
Budget 69,650 60 111,746 27
Increase in prices 2,902 2.5 53,804 13
Marketing companies 18,835 16 53,940 13
Total 116,083 413,873
Source: IL&FS Investsmart, Media

Table 4 shows a decline in subsidy burden from Rs413bn currently to

Rs116bn in FY06E. Since change to the trade parity principle would lead to a
decrease in the ex-refinery prices, we have assumed that refineries would not
contribute to the subsidy burden. However, the cess on crude oil is expected
to be increased from Rs1, 800/ton to Rs4, 800/ton after the Rangarajan
Committee suggestions are implemented.

Amit Agarwal 4 Oil & Gas

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Sector Update
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Case C: All the recommendations in case B are implemented except for

the suggested increase in prices of LPG and SKO. Therefore, the scenario
as delineated in case B can be assumed for case C. This is expected to result
in a changed subsidy burden as given in table 5 below. We believe that the
government is going to choose this third option of case C.
Table 5: Expected change in subsidy burden
Contribution to total subsidy (Rs mn) New pricing Share (%) Current share (%)
Government 24,696 10 24,696 6
Upstream - - 136,578 33
Refinery - 0 33,110 8
Budget 166,271 70 111,746 27
Increase of prices 5,938 2.5 53,804 13
Marketing companies 40,625 17 53,940 13
Total 237,531 413,873
Source: IL&FS Investsmart

Impact of recommendations of the Rangarajan Committee report on the

upstream company – ONGC: The Rangarajan Committee has
recommended that the upstream sector should be excluded from direct
sharing of the subsidy. Instead, it has recommended that cess of Rs1,800/MT
should be increased to Rs4,800/MT and should be utilized by the government
for subsidy relief.
Table 6: Current subsidy burden on ONGC
Upstream (Rs mn) Upstream subsidy burden -existing pricing

ONGC 111,606
Oil India 8,170
GAIL 16,802
Total 136,578
Subsidy burden-ONGC (Rs mn) 111,606

Sales-mn bbls 172

Subsidy burden (Rs/bbl) 650
Exchange rate (INR/USD) 44
Subsidy burden (USD/bbl) 14.8
Source: IL&FS Investsmart estimates.

Currently, the upstream sector shares 33% of the total subsidy burden. The
share of the upstream subsidy burden is divided between the constituents in
ratio of the previous year’s profits. Table 6 shows the calculation of the
subsidy burden for ONGC for FY06E.

Amit Agarwal 5 Oil & Gas

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The table 7 shows the change as proposed by the Rangarajan Committee.

Table 7: Rangarajan Committee and its expected impact on ONGC
ONGC (USD/bbl) Current Rangarajan
Cess 5.4 14.7
Subsidy burden 14.8* -
Total 20.2* 14.71
* Estimated
Source: IL&FS Investsmart estimates.

Impact 1: Reduction in the total cess and subsidy burden

Currently, the total expense of cess (USD5.4/bbl) and subsidy burden
(USD14.8/bbl) is USD20.2/bbl on ONGC. If the Rangarajan Committee
recommendations are to be implemented, the subsidy burden is expected to
be nil. However, the total cess would increase to USD14.7/bbl. Therefore,
after implementation of suggestions by the Rangarajan Committee, the
burden would decline from USD20.2/bbl to USD14.7/bbl.
Impact 2: Better visibility of earnings

Also, the implementation of the Rangarajan Committee recommendation

would remove ONGC from direct subsidy burden - thus improving the visibility
of earnings.

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Sector Update
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Institutional Equity
Name of the Analyst Email Tel. No.
Sreesankar R Head of Research/
Strategy/Logistics/Shipping/Retail/Sugar 55069914
Sheriar Irani Telecom/IT 55069918
Amit Agarwal Oil & Gas/ Lifestyle 55069927
Ashish Aggarwal Telecom/IT 55069925
Devang Patel Cement/Banking 55069922
Jayesh Sundar Textiles/Chemicals/ Paper/Fertilizers/Power 55069944
Mihir Jhaveri Auto/Auto components 55069933
Milind Bhangale Pharma 55069940
Vishal Mishra Capital Goods/Building 55069943
Chaturya Tipnis Sugar/Ship Building/ Shipping 55069926
Gaurav Chugh Retail/Media 55069916
Kamal Gupta Logistics 55069917
Sameer Dalal Capital Goods/Metals/Infrastructure 55069921
Shardul Pradhan Textiles/Chemicals/ Paper/Fertilizers/Power 55069941
Anjali Verma Economist 55069946
Prachi Kulkarni Research Support 55069924
Ember Pereira Research Support 55069940
Rupali Ghanekar Editor 55069915
Charudatt Vartak Production 55069923
Amola Jhaveri 55069912
Dharmen Shah 55069919
Rita Pani 55069906
Sandeep Shah 55069907
Geetha Nair Sales support 55069947
Anish Marfatia 55069909
Anmol S. Shanbhag 55069903
Firdaus Ragina 55069905
Khozem Jabalpurwala 55069902
Mohan Joshi 55069910
Nipul Kenia 55069911

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