Playing the petro price change

By : Devangshu Datta
Last Updated: Tue, Jun 05, 2012 19:40 hrs

One theme that could take centre-stage over the next few days is the price of crude oil. On one hand, a slowing world economy means that crude oil prices have softened. How-ever, the West Asia–North Africa region, key to global supply, is in political turmoil. That may lead to a sudden spike in prices on fears of supply disruption.

Whatever happens to the price of crude oil, the government has tied itself in knots by its confused subsidy policy. There are massive under-recoveries (read losses) on diesel, kerosene and natural gas. If the current price structure is maintained, there would be losses even if the price of crude fell 15-20 per cent.

There is a reluctance to raise prices to compensate. There is also a reluctance to cut or rationalise taxes, especially so on the part of state governments. As a result, there is massive pressure on government accounts, including the external balance of payments. The entire PSU refining and oil marketing sector is on life-support.

In the economic sense, the simplest thing would be to raise retail prices. Ideally, prices should be freed. India has excess refining capacity and if prices were freed, competition (including the entry of new retailers) would ensure no company could charge a massive premium.

However, the government believes this is politically impossible. In the political sense, higher crude prices may actually, be easier to handle since that would provide an obvious reason to raise retail prices. If crude oil prices drop, the government will find it difficult to raise prices, even though it should.

The impact of this push-and-pull on an entire group of energy PSUs is interesting. BPCL, HPCL and IOC are directly in the line of fire. If crude oil prices drop, their share prices could rise. If controlled retail prices are raised, their share prices will rise. If retail prices are raised and then rolled back, their share prices will first rise, and then fall. GAIL will also respond in this fashion, since the company has to bear part of the burden of under-recoveries.

The cases of OIL and ONGC are more nuanced. Both companies should stand to gain if global crude oil and gas prices rise. However, they also have to share the burden of under-recovery. We’d need to know specific policy details and the nitty-gritty of price structure before being able to figure out whether a given change in crude oil/gas price versus a given change in retail pricing will be beneficial or not to OIL and ONGC.

The resulting volatility could be very useful for traders who are prepared to move in either direction. If diesel prices are indeed raised, long positions in BPCL and HPCL will pay off. If not shorts could pay off.

The author is a technical and equity analyst

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