Need clarity from government on sharing of under-recoveries: Kirit Parekh

In a chat with ET Now, Kirit Parekh, Expert, Oil & Gas, shares his views on the government’s new subsidy-sharing formula which is in the offing as well as his outlook for ONGC. Excerpts:

ET Now: We understand that the government is working on a new subsidy-sharing formula which would ensure adequate realisations to ONGC. What are your thoughts on this?

Kirit Parekh: I have read this news. I do not know what the government is thinking about it. But certainly, that would be a very good measure. One of the problems that have been with ONGC and other state-run upstream companies is that the sharing mechanism for under-recoveries has never been clear. There has always been uncertainty around it. If the government is going to ask subsidy contribution from ONGC and other upstream companies, then it should clarify at what level and at what rate will it charge it.

That clarity would be extremely useful for investors and others to value ONGC and Oil India. There is always an uncertainty about the crude oil prices that will be prevailing globally, which adds further uncertainty to the government policy. The removal of this uncertainty would be really beneficial to both ONGC and Oil India. They can plan their actions, their measures, their investments, and other things with a clearer perspective than otherwise.

We had recommended in our last report in 2013 that the government should have clearly defined the policy. Of course, we were asking them to restrict ONGC’s burden to the production it gets from blocks that were allocated to it on a nomination basis long ago and not on the new blocks which ONGC has won through the bidding process (where a profit sharing mechanism is already there). So, once the profit sharing is there, the company should have no further liability of meeting the government’s under-recovery burden.

In any case, if the diesel prices remain deregulated, then the subsidy burden would only correspond to LPG and kerosene. At least, the kerosene burden can be wound out gradually. As far as the subsidy on LPG is concerned, once the direct benefit cash transfer takes place, it would also be reduced. It would be a well-defined scheme. I feel that the under-recoveries on kerosene and LPG should be borne solely by the government from its budget. It should not put any burden on upstream companies or even the oil marketing companies.

This would completely free up the oil sector from any subsidy burden and under-recovery calculations. That would be very good for the sector and would certainly be good for the investors.

ET Now: So if the subsidy sharing is indeed clarified, do you see ONGC share sale go through safely? This is because the subsidy sharing issue has been bit of a sticky point for the government.

Kirit Parekh: ONGC’s shares really do depend on what the international crude price is. But it is not very largely dependent on that because whatever crude it imports, it is really anywhere using it, it is paying a high price and that is the price it recovers when the crude is given to refineries and others.

So I feel international prices do affect ONGC like other oil producing upstream companies, and its valuation do go down when international crude prices decline. But that is a part of the game. So, if one were to divest ONGC’s shares, the question would have been, should the government do it now or should it wait till the overall market prices come up?

I think a small amount of divestment should be done now because, in any case, that would really bring in certain measures of competitive efficiency in the system.

ET Now: What are the other measures that you believe the government can adopt in order to improve the valuations because that is the need of the hour? If the divestment process has to go through, there needs to be something that is done to make these gems look a lot more attractive?

Kirit Parekh: What the government should really do is to say that all under-recoveries on kerosene and LPG henceforth will be borne by itself from its own budget.

That is one statement it could announce. Secondly, it can say that the diesel price would remain deregulated, while excise duty can periodically be raised, in case the international prices keep coming down. This step will help the government past the under-recovery burden.

That would be fair and legitimate. Beyond that it should really help the companies determine what the price should be, based on international prices. So, free them up completely. This could be a big step. Say that you would not impose further burden. In my opinion, these are the things the government can do. Of course, all public sector companies have the same problem — to what extent they are truly independent and truly board-driven companies, and how much interference the government makes in their operations. I am not saying that there is a lot of interference in ONGC’s functioning, but if any sort of possible inferences could be removed, then the valuations would go up.

ET Now: The government has also kick started IOC's stake sale by inviting bids from merchant bankers. It will be issuing shares at a 5 per cent discount to the company's employees. Do you see that share sale to go through smoothly, since diesel is deregulated and the stock market is not punishing the stock today, it is quoting modestly lower in an otherwise very strong market?

Kirit Parekh: There are some questions of how much money can ONCG make this year. But I do believe that if the market is free and if IOC is going to face competition from Reliance and Essar and other private companies coming into the retail business, then obviously its valuation would be affected by that.

IOC would have to show that it is agile and flexible enough to deal with that competition.

Once that happens, its valuations should go up. At the moment, I can understand why people are sort of wary about the valuation of IOC simply because there is the burden of oil inventories added at higher prices earlier. Secondly, there is the question of potential threat from competition.