Oil Import Cost Hits Record 7,000/bbl

Falling rupee, rising crude set to escalate PSU oilcos’ losses as well as the budget deficit

In a double whammy, a depreciating rupee and rising international crude oil prices have taken India’s cost of importing oil beyond a historic high of . 7,000 per barrel. This is bound to increase losses at public sector oil companies as well as further bloat the government’s budget deficit, which is already at unsustainable levels, unless diesel prices are revised upwards.
A barrel of crude oil, which India imported for . 5,500 per barrel in April 2013, now costs 27% more to over . 7,000/barrel, in August. The increase is due to a combination of factors — a 7% rise in international crude oil prices and a 19% decline of the rupee against the US dollar. Needless to mention, this has put enormous pressure on India’s current account deficit — nearly 80% of India’s oil is imported — as also fiscal deficit — since the government pays for keeping domestic retail prices artificially low.
The situation is bad for the public sector oil companies. The three oil marketing companies — Indian Oil, BPCL and HPCL — would have incurred a combined loss of . 3.38 lakh crore in the past three fiscals, had they not been compensated by the government and upstream companies, informed P Lakshmi, minister of state for petroleum in Rajya Sabha on August 27. The government paid two-thirds of this or nearly . 2.25 lakh crore.
In the April- June 2013 quarter, the three OMCs have lost . 27,638 crore, when the average crude oil import price was . 5,665 per barrel. If the crude oil prices were to stay above . 7,000 per barrel for the rest of the fiscal, other things being equal, the under-recovery bill could rise to . 1,30,000 crore for FY14.
The Union Budget for 2013-14 provides . 65,000 crore as under-recovery compensation to the oil PSUs. Out of this, . 18,000 crore are expected to go towards short provisioning of previous year. As a result, the rising oil prices could raise budget provisions by . 31,000 crore assuming the government will fund 60% of the total under-recoveries.
Media reports suggest the government is mulling an over a . 5-a litre increase in diesel prices. However unpalatable it may be politically, this could prove a welcome move for the industry as well as the economy, since at 45% of total petroleum consumption, diesel is the largest consumed product in the country.

CAIRN INDIA: Rajasthan Work, Re Slide to Benefit Co

Cairn India has emerged as a value creator for investors after the quarter to June results season, in sharp contrast to other petroleum companies whose stocks dropped as much as 11% after they reported their earnings. But for Cairn India, the outlook appears positive. The company’s profit for the Apr-June 2013 quarter was down 18% y-o-y, but the stand-out feature was higher production at akey Rajasthan block during this quarter. The Cairn India stock had lost almost 12% in May and June 2013 after it became clear that production in Rajasthan stagnated during the second half of FY13 raising doubts whether it would drop before rebounding later. Yet, during the Apr-June ’13 quarter, the company was able to marginally raise output in Rajasthan to almost 173,000 barrels per day (bpd) — close to 3% higher than the year-ago period — and scale it up further to 180,000 bpd by the time of the June earnings announcement. The stock has gained 4.3% since reporting earnings for the quarter to June. The company was also able to substantially improve output from its small CB/OS-2 field in Cambay Basin, which had fallen over 18% y-o-y during FY13. The field’s oil production jumped 81% y-o-y to 8,554 barrels per day during the quarter. Similarly, the Apr-Jun ’13 quarter was the first full quarter of natural gas sales of an average rate of 4 million cubic feet daily. Industry analysts are hopeful of more exploration activity in Rajasthan. “Cairn has drilled only 3 exploration and appraisal wells in Rajasthan so far and did not report much news on exploration results. However, it plans to drill 34 E&A wells and targets half of the 530 mmboe risked prospective resources in the year. It has awarded contracts for three more exploration rigs, which are all expected to arrive by the end of the calendar year,” says a report from Jefferies. A weak rupee and the rise in international oil prices are positives for the oil producer. “Cairn’s earnings outlook in the rest of FY14E is much better due to weakening of the rupee and rebound in oil price in the last few weeks. ….We see significant rise in reserves in its main Rajasthan asset as the main share price driver,” a recent Merrill Lynch report said. That should be comforting for long-term investors in Cairn India.

India’s Petroleum Consumption Growth Nosedives

The strong volume growth seen in India’s petroleum consumption over the last two years has slowed. Given that India is the world’s fourth-largest petroleum consumer this should soon start reflecting in global oil consumption growth. However, the problems related to subsidies back home are not easing due to a weak rupee.
Domestic consumption data released by the Petroleum Planning and Analysis Cell shows the growth in consumption of petroleum products, which was 5% in FY12 and 4.9% in FY13, slumped to 1.6% in the April-June 2013 quarter. The data shows that only decontrolled products such as petrol, aviation fuel contributed to volume growth.
“Excluding minor decontrolled products (Petcoke & others representing 11.1% of total in quantity terms), which are insignificant in value terms, the growth in consumption fell 3.1%,” according to the analysis cell.
“There has, no doubt, been a slowdown in domestic petroleum consumption, particularly starting this fiscal,” N Srikumar, executive director, Indian Oil conceded. A number of factors are at play, including overall slowdown in economic activities, according to him.
Diesel consumption grew 6.7% in volumes last fiscal due to a spurt in diesel vehicles, power shortages and even a switch to diesel from industrial fuels on account of its artificially lower prices. Diesel volumes have tapered off from April this year as these factors are no longer in play. Similarly, kerosene consumption volumes are steadily declining as some states are moving towards a ‘No-kerosene’ status and consequently promoting the use of LPG as an alternative. “In Aviation Turbine Fuel, too, the volumes are muted due to the exiting of airlines like Kingfisher and due to route and aircraft rationalisation by airlines,” he says.
Given that India is a large petroleum consumer, a slowdown in domestic consumption is bound to impact global aggregates. “...oil demand growth has been revised down by 11,000 bpd in 2013... due to weaker oil demand from India and Indonesia — driven by a rather lacklustre economic data in India,” said a recent monthly report from OPEC.
India’s growth projections for FY14 is now being revised. In July, the IMF cut India’s growth forecast to 5.6% from 5.8%, while RBI cut its growth forecast to 5.5% from 5.6%. For the April-June 2013 quarter, economic growth is expected to have touched a low of 4.8%. This is bound to impact fuel consumption across the board. “Going forward, unless the economy picks up and overall sentiments improve, petroleum product consumption is not expected to ramp up in a hurry,” says IOC’s Srikumar.

ESSAR OIL Co’s Huge Debt a Key Concern

The huge loss reported by Essar Oil in the quarter to June was on expected lines, as its growing dollarised debt necessitated mark-to-market losses on rupee depreciation. Yet this is a notional loss. However,the key concern is the company’s failure to reduce its debt, partially due to small tranches of capital expenditure that it incurs and sales tax liability installments. Essar Oil’s net loss of . 863 crore was mainly on account of a write-off of . 913 crore towards mark-to-market foreign exchange losses. The operating profitability was also down because of an adverse movement in its raw material prices, which depressed its gross refining margins, or GRM — the differential between revenues from finished products and cost of raw materials or crude oil per barrel. The company posted a GRM of $7.01 per barrel for the June quarter, down from $9.06 in the March quarter and $9.75 in the December 2012 quarter. Refining is a cyclical business. Declining GRMs, therefore, should not be a cause of worry. In fact, there are indications that the GRMs for the July-Sept quarter will be better compared with the June quarter. Essar Oil’s foreign debt, which was at $481 million at the end of March, has risen to $821 million now given the rupee’s depreciation of over 10% in the June quarter. On the flip side, this will mean the company’s inventories will fetch a higher price and the GRMs will translate into higher profits in rupee terms. What will also help is that the company will need to raise $450 million less when it converts its remaining $2.5-billion debt to a dollar-denominated one. The company’s debt of Rs 21,751 crore at the end of March translated into $4 billion then; it is $3.56 billion now. Essar Oil was not able to reduce its debt during the June quarter as it incurred some capital expenditure on refinery and also met its sales tax repayment liability. Its E&P business, particularly the CBM blocks, is in a growth phase and needs significant capital expenditure. The company’s ability to generate more cash over and above these commitments will determine how fast it can reduce its debt burden. Similarly, its ability to achieve full dollarisation of debt will lower its interest burden and extend the overall tenure of its debt, boosting liquidity.

OIL MARKETING COS: No More an Attractive Investment

The earnings of the three oil marketing companies (OMCs) — Indian Oil, BPCL and HPCL — for the quarter to June indicate that their troubles will continue, making them unattractive investments. The higher subsidy burden that upstream or state-owned exploration firms have to bear also makes them poor bets. For the April-June quarter, the government underwrote just 34.3% of the industry’s total underrecovery of Rs 25,579 crore, while upstream companies bore 65.7%, a reversal of trend compared to the earlier practice of the government funding 62.5% of FY13 underrecoveries and 60.4% in FY12.
Yet, OMCs ended up absorbing a part of the under-recoveries. Within the trio, BPCL’s ability to trim expenses significantly enabled the oil major to report marginal profits. However, Indian Oil and HPCL both reported losses.
These state-owned companies have lost between 15% and 35% during the past three months and are no longer attractive from a long-term investment perspective.

ONGC: Stagnant Output Still a Concern

State-owned oil exploration company ONGC disappointed with its earnings in the June quarter, with a sharp 33% drop in net profit owing to a jump in expenses without any matching growth in revenues. The subsidy burden remained high too, but without much of a change from the figure a year ago. ONGC’s operating costs surged 21% year-on-year while revenues dipped 4.3% to . 19,218.3 crore. The company reported a 78% jump in staff costs, 31% growth in exploration write-offs and 44% increase in other expenses. Overall, the company ended up spending more, but failed to maintain revenues. As a result, operating profits dipped 33% and pre-tax profits slipped 35% to . 2,332.5 crore, as higher depreciation (16.8%) too weighed. The company’s subsidy burden remained above . 12,000 crore for the seventh consecutive quarter — it has been at these levels in nine out of the past ten quarters — but it was just 2.2% higher y-o-y, and hence, was not the primary reason for the disappointing numbers. ONGC’s crude production dipped 0.5% during thequarter to 5.1 million tonnes, while natural gas production was 2.5% lower at 5.77 billion cubic meters. The company has for long been battling stagnation in production, but expects FY14 to show a reversal in trend. But the results are yet to show. When compared with the Jan – March 2013 quarter, its performance was better, thanks mainly to a 67% drop in exploration write-offs. However, the company typically books a large chunk of such expenses in the last quarter of the financial year. After surging to . 340 in mid-May 2013, the ONGC stock has lost over 18%, closing at . 277 before the results were unveiled on Monday. The results for the June 2013 quarter offer little to cheer about, which means that the under-performance of the stock could well continue for a while. 

Govt May Rethink Compulsory Cost Audit as Industry Not Keen

Though the mechanism can help curb profiteering, cos have opposed it citing compliance costs and data theft 

    Even after a November 2012 government order that made it mandatory for all companies with a turnover exceeding . 100 crore to hire a cost auditor, there is resistance from certain quarters. 
Unlike in the case of a financial auditor, whose appointment is ratified by shareholders, the appointment of a cost auditor has to be cleared by the government. The Institute of Cost Accountants of India (ICAI) noticed something was amiss when the website of the ministry of corporate affairs (MCA) did not accept appointments of cost auditor. “On November 6, 2012, the government came out with an order superseding all earlier orders regarding cost audits. However, the ministry’s e-filing mechanism has never accepted cost auditor’s appointment under it,” said Ashish Thatte, chairman, western india regional council, ICAI. 
Since its inception in 1965, the need and necessity of cost audits has been time and again emphasised. The mechanism of cost audit establishes the link between all input factors such as raw materials, labour, power, etc., and the product price to find out the gross margins. Thus, the data is crucial in cases where the government wants to curb profiteering.
A case in point could be the National Pharmaceutical Pricing Authority fixing the price of drugs. Similarly, in the much-talked-about Fiat India excise duty case, it was the cost audit, that enabled the excise department to conclude that goods were sold below cost.
However, the ministry, faced with e-presentations from corporate houses, may be taking a relook into the matter. According to Mohan Joseph, additional secretary, ministry of corporate affairs, “The ministry has received several representations from industry associations requesting a review of the notifications issued by the cost audit branch in November, 2012. These notifications are currently being reviewed by the ministry.”
But the Institute of Cost Accountants of India — a body established by law of Parliament — is clueless about this. “The reason for the inability to appoint cost auditors has not been communicated by any concerned authority till now,” confirmed ICAI’s Thatte.
The question that crops up is whether corporate houses are resisting a compulsory cost audit to hide some of their inadequacies. Gathering cost data of all players in an industry, year after year, can help in benchmarking, which will highlight outliers.
“In steel billets or ingots manufacturing it takes around 1,000 units of power to process one tonne. However, if some company is consuming substantially more or less power , it will be a clear case to probe for possible irregularities,” said Dhananjay Joshi, a practicing cost accountant and a former president of the institute.
A company booking false invoices for purchase of raw materials, and thereby availing extra CENVAT credit and simultaneously also lowering taxable profits, would be exposed through cost audit because its process loss would overshoot the average. 

Helpful for Govt The cost audit mechanism helps various authorities and departments in the government access essential information in preventing profiteering or tax evasion. The Fact Finding Committee set up in 1997 under Justice Rajindar Sachar had observed that mandatory cost audit is necessary to serve social objective and consumer protection. Justice Sachar also warned that unless cost audit is done, the government would not be in a position to control high prices of pharma and several essential items.
Similarly, SK Shingal, the then chairman of the Central Board of Excise and Customs, had said in 2008 that cost audit reports provide the perfect basis for cross verification by central excise officers. “But since this report is not available for many units manufacturing excisable products, it puts the department at a great disadvantage,” he had observed.
The committee on subordinate legislation under the 14th Lok Sabha had recommended extending the scope of cost audit to even the services sector. It acknowledged the importance to authenticate cost database to various government agencies, revenue authorities, regulatorybodies, banks as well as financial institutions, particularly, “in view of a number of cases of financial irregularities in the corporate sector recently coming to light.”
Industry Opposes Nevertheless, the industry associations continue to resist the mechanism. “Given the time and resources involved in complying with such (cost audit) orders, these regulations clearly serve no valuable purpose. It’s a retrograde step,” mentioned Arbind Prasad, director general, Federation of Indian Chambers of Commerce and Industry (Ficci).
According to Subodh Kumar Agrawal, president of Institute of Chartered Accountants of India , “…it (the cost audit order of Nov 2012) also increases the burden on the part of companies in covering and conducting cost of audit of so many activities.” He further added that many companies are not comfortable with sharing the cost information through cost audit report to a third party due to fear of data theft.
“The industry has been posing the same set of objections for all these years,” said Dhananjay Joshi. “In reality, compliance cost of cost audit is hardly anything for a company and needs to be measured against the socio-economic benefits for the country as a whole. The companies which are law abiding, selfdisciplined and possessing a respect for accounting data find no difficulty in complying. In fact, hosting a party would cost more than a cost audit.” He also pointed out that the new cost audit rules have considerably reduced the disclosure requirements and hence addresses the confidentiality issue as well. Ministry officials did not respond to ET’s queries on whether any independent study has been conducted in checking the industry’s claims. One of the industry representative bodies confirmed on condition of anonymity that no study has been conducted to estimate the cost of compliance. Cost accounting professionals fear the audit mechanism could die a natural death, if the ministry gives in to industry pressure. Their fears may not be unfounded.
According to Mohan Joseph, the ministry has already formed a consultative mechanism of stakeholders to reexamine and recast all existing rules under the old Companies Act to align with the new Companies Bill 2012, which has been cleared by Parliament and is awaiting ascent from the President. “We have made strong representations to the Ministry of Corporate Affairs. If there is rethinking in the ministry, a significant change is possible in cost audit rules,” said a senior industry official who’s in touch with the ministry on the matter.
The Institute of Cost Accountants of India, however, doesn’t have any representation on the informal committee deliberating the new rules. In an election year, when the black money circulation in the economy typically goes up, these developments assume a greater significance. 

Oil Slick Ahead, But Price Hikes Likely to Cushion Impact

While higher crude prices will raise the subsidy bill for FY14, diesel price hikes mean under-recoveries won’t shoot to record high

The price of crude oil has risen to a historic high in August 2013 for India’s imports, thanks to rupee’s unprecedented depreciation. In the first week of August India’s cost of crude oil jumped beyond . 6,500 per barrel, as the rupee fell over 14.5% in the past three months.
This cost is probably higher than even July 2008 when prices spiked to a record high of $145 per barrel. Then, the rupeedollar rate at 43 meant imports cost below . 6,300 per barrel. The current crude oil price isover 25%lower than that price but the rupee’s fall has negated all beneficial impact.
While this is bound to increase the government’s subsidy bill for the current fiscal, the series of diesel price hikes means under-recoveries won’t shoot to record high. Petroleum retailers are losing . 379 crore every day starting August 2013 versus . 403 crore of August 2012. The losses on diesel are down to . 9.29 per litre compared to . 12.9 per litre a year back.
The industry reported a revenue loss of . 25,579 crore for the April-June 2013 quarter. This should jump to . 33,500 for the July – September ’13 quarter. Still the under-recovery for FY14, at an estimated . 126,000 crore, will not cross the . 161,000 crore figure of FY13.
The three oil marketing companies — Indian Oil, BPCL and HPCL — are set to suffer the most, which is visible in the 35-40%fall in marketcapitalisation over the past three months. Although, higher oil prices should benefit ONGC and Oil India, they are expected to bear the biggest brunt of the incremental losses, which is why they too have lost 16-20% in the past three months.

Government in a Quandary as Family Silver Loses Value

‘Selling the family silver’ may be a metaphor applicable to the government’s plans of raising . 55,814 crore through divestments to reduce government borrowings but even that silver is going cheap.
A sharp fall in valuations od stateowned companies and steadily deteriorating market sentiment are bound to make the government sell more volumes to make the same revenues.
The BSE PSU index, which gauges the performance of 60 listed PSUs, has already lost nearly 22% in the first four months of the current fiscal. Some of these companies have lost up to 50-60% of their worth.
The government has so far in August ’13 mopped up . 395 crore through stake sales in Neyveli Lignite, India Tourism Development Corporation and State Trading Corporation.
This is in addition to . 901 crore raised by selling stakes in Hindustan Copper, MMTC and National Fertilisers in July. It still needs . 54,518 crore to meet its target for the year.
The total market capitalisation of all PSUs — where the central government directly holds stake — is around Rs 944,000 crore of which the government’s stake is worth . 7,05,000 crore. Assuming the government were to lower its stake to 51% in all these companies it is still possible to raise . 2,24,000 crore.
The government kept a steep target
    this year as it could mop up only . 23,830 crore from divestments compared to original target of . 30,000 crore in the last fiscal.
The list of companies likely to hit the market is long but the government has already been dealt a blow when it scrapped plans to sell stake in Bhel due to plunging valuations.
The government wants to sell stake in IOC but here again, falling valuation, due to the rupee, is likely to spoil the government’s plans. Besides, there could be a few unlisted companies coming with IPOs. The market is surely not going to encourage any of these moves presently. 

Foreign Investors Take a Fancy to Listed Firms Going Cheap

In the last 4 quarters, FIIs have raised stakes in at least 10 cos that have seen a big value erosion 

    Foreign institutional investors (FIIs) have steadily raised their stake over the last four quarters in several listed companies, the stock values of which have eroded considerably during this period. 
The shareholding pattern data for the period ended June 30 shows that among the several listed companies where FIIs have steadily raised stake in the last four quarters, there are at least 10 that have lost massive value. In MCX, for example, FIIs raised their stake from 8.8% a year ago to 18.2%. Yet the stock is down 51% from a year ago. In Wockhardt as well as Muthoot Finance, foreign funds nearly doubled their holdings over the last one year to around 10.4%, but these stocks have lost 55% and 44%, respectively. Most of these companies are trading near their 52-week or all-time lows.
“Last year, the widely-held view of a prolonged period of easy monetary policy ahead, both globally and locally, attracted investor interest in cyclicals, which has turned sour now,” says Vikram Dhawan, director, Equentis Capital — a UK-based investment analytic and advisory firm. Dhawan says that anecdotal evidence suggests that FIIs tend to favour relative performers in all sectors.
However, what is puzzling is the fact that some foreign porfolio investors are actually raising their stake in companies for whom the going has been tough. These include companies such as Gitanjali Gems and Wockhardt whose stocks have hit the lower circuit in the last few days besides Muthoot Finance, Sintex Industries, MCX, CARE and BGR Energy — all of whom reported new lows. All these stocks are now down between 50% and 90% from their peak valuation in the last one year. From the perspective of some of these foreign funds, it could also be a contrarian view on troubled companies as they may be betting on a turnaround to earn high returns. For instance, the holding of FIIs in GTL Infra has risen from just 0.5% last June to 12.65% at the end of June. A single fund, US-based Elm Parks Fund, picked up a 7.8% stake in it during the June 2013 quarter, in line with its objective to invest in out-of-favour companies. The debt-laden telecom tower infrastructure company is finding it tough to stay in the black.
Similarly, in the case of JP Associates, FIIs may be building their stakes on hopes of a reversal of the interest rate cycle to boost its fortunes. Daljeet Kohli, head of research, IndiaNivesh Securities, points out that long-gestation infrastructure projects need upfront investments, which justifies their high debt. “The company has assets in the form of a land bank and cement plant, which it can sell off to retire a meaningful portion of its debt,” he says. Extreme low valuations could also be a reason for bargain hunting by these funds.
“Some of these companies have been beaten down on the markets beyond what they deserve fundamentally,” says G. Chokkalingam, Chief Investment Officer, Centrum Wealth Management. Wockhardt is trading just 2.2 times its book value compared to 14.4 times a year ago, while the P/BV ratio has halved for other firms during the same period.
According to Vikram Dhawan of Equentis panic or disillusionment could result in further liquidation of some of these stocks. Centrum’s Chokkalingam concurs. According to him, a couple of stocks in the list may finally go belly up, but stocks such as MCX and Wockhardt have relatively strong balance sheets. “One shouldn’t form conviction based on FIIs’ buying behaviour,” he says. 

CASTROL INDIA: Well-oiled, But the Road Ahead is Tough

For a company dependent on imports to flourish in the current scenario, where the rupee is sliding and the economy is slowing, is a tough challenge. However, Castrol India has done that by improving profit margins over the past few quarters.
The company has been facing several challenges. Its sales volumes are under pressure due to the slowdown in the OEM and non-automotive segments. It imports all of its raw material, base oil, which is getting costlier as the rupee depreciates and crude oil prices remain strong.
The company is focusing on strong marketing programmes targeted at consumers, trade and other stakeholders to drive sales. And it has achieved results, with volumes in the personal vehicles segment, especially twowheelers, growing. This, along with the launch of new technology products, has enabled it to pass on a part of the costs to consumers. With tight control over other costs, Castrol has improved margins in the first half of 2013.
In spite of the resilience it has shown so far, the going will be tough. In a weak demand scenario, it has only limited ability to pass on the cost increases to its consumers without hurting demand. Yet the company has the potential to surprise on the positive side.