IOC Disinvestment: A chance to deregulate
New Delhi 22-Nov-2010
Disinvestment in IndianOil (IOC), scheduled for the fourth quarter, is a golden opportunity for the government to act on its promise to deregulate the retail pricing of diesel. If the government squanders the chance, deregulation would become more difficult post-issue.
Freeing diesel pricing would help the government get optimum valuation for its shares in IOC. “Deregulation of diesel will be a huge positive, which would result in the re-rating of the sector, benefitting IOC in the form of stable cash flows, more liquidity and interest from domestic and foreign institutional investors, and a positive sentiment in the market. We believe, with deregulation, IOC has a further upside of 12-15% with a potential price target of Rs 450,” Madhumita Ghosh, vice-president, PMS and research, Unicon Financial Intermediaries Pvt Ltd, said.
Deregulation will also send the right signal to private players keen to invest in the oil retailing business and lead to the development of the industry and greater competition in the market, ultimately benefitting fuel consumers. Besides, deregulation should also cheer ONGC's shares. After IOC, the government plans to dilute its stake in ONGC, and it stands to benefit if the company's share price goes up.
Thanks to the auto fuel subsidy regime in place, IOC's stock price has stagnated over the years even as the company saw exponential growth in its revenue. This punishes investors who had bought IOC shares. While the pricing of petrol has been freed and the company can now take its own decision on price determination, diesel pricing is still being regulated by the government. Since sales volume of diesel is much higher compared to petrol consumption in the country, controls on diesel pricing suppress the share value of all oil marketing companies (OMCs), including IOC. The government needs to restore the confidence of IOC investors to realise the true value of its stake in the company before the follow-on public offering.
Valuations aside, deregulation of diesel pricing will also help reduce the petroleum subsidy burden of upstream companies like ONGC and Oil India Ltd. ONGC has to contribute a significant share of its revenue to share under-recoveries of OMCs on diesel sale. For example, ONGC had to shell out as much as Rs 11,554 crore towards sharing OMCs' under-recoveries in 2009-10. The company earned revenues of Rs 60,205 crore in the 2009-10.
Not only that, nobody knows exactly how much ONGC will have to fork out a year, as the final subsidy share is decided by the petroleum ministry at the end of each year.
Freeing ONGC of the subsidy burden would help investors take a view on the company's valuation when the government divests 5% of its stake in ONGC, after the IOC public issue. Globally, international crude oil price is a proxy for an upstream company's profitability. However, this thumb rule cannot be applied to ONGC as it is required to share the petroleum subsidy burden.
The government had opened up the fuel retailing sector with an eye on private investment. However, private players are not keen to invest in the sector since the government continues to subsidise diesel sale. Reliance and Essar, which had entered fuel retailing with high hopes, now find themselves at the receiving end of the government's policy to subsidise diesel. They were forced to shut their retail outlets in 2007-08 when crude oil prices spiked in the international market. These private players have since resumed operations. But world crude oil prices have again started hardening in recent weeks on the improving prospect of global economic recovery. Oil prices have already crossed $80 a barrel and may well hit $100 a barrel soon if the trend continues. In that case, private retailers might be forced to shut their operations once again.
These private players had entered into auto fuel retailing business on the hope that the government would soon end the petroleum subsidy regime. However, that has not happened. The planned IOC public offer would be an opportunity for the government do justice to both public and private sector oil marketers.
