Simpler subsidy maths to jazz up ONGC,IOC floats
New Delhi   30-Oct-2010

India’s largest share sale—IndianOil’s (IOC) 19,000-crore issue—as well as Oil & Natural Gas Corp’s (ONGC) offering next year will get a shot in the arm as the government is preparing to make its ad hoc subsidy-sharing scheme more systematic and transparent, making the blue-chip energy firms more attractive for institutional investors.

ONGC and Oil India, which gain when crude prices rise, are asked to share the subsidy burden of oil marketing firms such as IOC when fuel prices are not increased in step with rising crude oil prices to keep inflation under control. But the government’s decision on the extent to which upstream firms share the losses in fuel retailing can be unpredictable and opaque, making large equity investors edgy as they are unable to get a grip of the companies’ earnings outlook.

The new system would have a clear formula to assess how much subsidy burden ONGC would have to bear unlike the current arrangement in which the company or equity analysts tracking its shares have no idea how much subsidy would be paid, and the government’s own cash subsidy is decided in discussions between the finance and oil ministries.

Government officials say the finance ministry has proposed that the extent to which refiners are compensated for selling fuel at low rates should be calculated on the basis of refining costs, not the current “trade parity” system in which retailing revenue losses, called under-recoveries, are calculated on the basis of international prices of fuels as well as the freight rates and Customs duties a retailer would pay if he imported the fuel instead of buying it locally.

“The finance ministry is in favour of calculating under-recoveries on cost basis as it doubts that trade-parity pricing escalates losses,” another official with direct knowledge of the matter said requesting anonymity.

The cost account branch of the finance ministry and the petroleum planning & analysis cell of the oil ministry are preparing the new cost-based system, which officials say would be strictly adhered to.

“The whole idea is to have a fixed system based on cost of production, and to end the current ad hoc arrangement,” said an official directly involved in formulating the new subsidy-sharing formula.

This will give comfort to institutional investors, whom the government will be wooing when shares of ONGC and IOC will be sold next year to help meet the target of raising 40,000 crore from stake sales this fiscal.

ONGC has also demanded a clear and systematic subsidy-sharing arrangement. “Ad hoc subsidy-sharing mechanism is a concern for public sector oil companies,” its chairman & managing director, RS Sharma, said.

“The issue of under-recovery should be addressed soon as it would negatively impact investor sentiments,” he told ET, referring to the company’s forthcoming public issue.

Fund managers are keenly awaiting the new dispensation. “What the current system does is it gives a huge amount of uncertainty to the earnings stream as the government policy has a lot of uncertainty. This is not what the market wants,” said a foreign brokerage’s fund manager, who did not want to be identified as he is not authorised to speak to the media.

ONGC has suggested that the subsidy burden should be clearly linked to crude oil rates. It has proposed that if crude oil prices are between $60 and $70 a barrel, the company should pay 20% of its incremental price towards fuel subsidy. The percentage should increase to 40% if crude prices range between $70 and $80, and 60% when they are hovering at $89-90 a barrel. Above $90 a barrel, 80% of the incremental gains should be used for meeting fuel subsidy as upstream discount. Officials at refining companies say it is difficult to assess the exact cost of producing fuel.

“It is impossible to calculate the exact cost of producing one litre of any fuel. Therefore, debating on the two systems is pointless. Whatever the government does should be transparently implemented,” a top executive at a private refining firm said.