Fitch: Oil India's Net Price More Stable After New Subsidy-Sharing Scheme

Fitch Ratings says India's new subsidy-sharing framework for kerosene and liquefied petroleum gas (LPG) provides the two state-controlled upstream producers, Oil India Limited (OIL, BBB-/Stable) and Oil and National Gas Corporation, with more stability in their realised oil prices net of discounts.

The overall subsidy burden on the state and the state oil and gas companies have reduced substantially after diesel prices were deregulated in October 2014. The two state-controlled upstream companies were previously required to provide their oil to refiners at substantial discounts not directly related to oil prices - as high as USD56 per barrel - as part of India's state-directed energy subsidies for end-users.

Following the deregulation of diesel prices, the government said that for the fiscal year ending March 2016 (FY16), the maximum state subsidy to oil marketing companies to sell fuel below market prices will be limited to INR18/kg for cooking gas (LPG) and INR12/litre for kerosene; any additional subsidy will have to be borne by the oil producers. The net realised prices that the upstream companies receive on the sale of oil produced (market price of crude less discounts to refiners) will vary less under this new mechanism because the discounts they provide increase and decrease with the movement in global crude oil prices.

Assuming an average Brent oil price of USD55/bbl in FY16, OIL's net realised oil price after subsidy discounts would be around USD51/bbl. This would be about 8% higher than the USD47/bbl reported in FY15. However, if Brent averages USD40/bbl for the remainder of FY16 (average FY16 price of USD51/bbl), OIL's net realised oil price would be little changed at around USD48/bbl, as the discount also falls. Conversely, if Brent averages USD60/bbl for the rest of the financial year (USD59/bbl on average in FY16), the net realised price by OIL would be around USD53/bbl after adjusting for a higher discount.

Our estimates assume that OIL's oil output would be 3% lower yoy in FY16, based on its 1HFY16 results. We have used a USD-INR exchange rate of 64.5, based on 1HFY16 average.

As for the oil marketing companies, they would be compensated fully by the government for selling LPG and kerosene below market prices under this arrangement. The above arrangement is through March 2016; it is yet not clear if the government would make any significant adjustments to the mechanism or the thresholds for the next fiscal year.