A recent policy move by India's BJP-led government to raise prices of subsidized kerosene and LPG signals New Delhi's strong commitment towards further lowering its fuel subsidy burden and freeing up upstream companies' cash for projects, which would ultimately ensure better supplies in the longer term.
"The financials of oil marketing companies and upstream oil companies, which foot the subsidy burden along with the government, will improve considerably," said Sri Paravaikkarasu, senior consultant and Asia downstream specialist at Facts Global Energy.
"The companies will channel the realizations towards competitive investments, which will complement their long-term growth strategies," she added.
India deregulated diesel prices in October 2014, but continues to subsidize LPG and kerosene prices.
The subsidy burden is shared between the government and upstream companies.
Upstream companies share the subsidy burden by way of discounts on the price of crude oil sold to state-owned refiners and marketers.
India's state-run oil marketing companies since last month have raised prices of subsidized LPG twice.
Last week, LPG prices were raised by Rupees 1.9 (2.8 US cents)/cylinder in Delhi, accounting to a 0.5% increase. And kerosene prices were raised by Rupees 0.25/liter, or about 1.6%.
"The magnitude of price increases is small and requires several years to fully remove under-recoveries. However, the intent of the government's policy is a key positive," Credit Suisse said in a research note.
"The price increases are positive for upstream stocks -- although there is always a risk that the government can ask for a share of the subsidy savings."
Under-recoveries refer to the loss of revenue from selling kerosene and LPG at below market cost.
TOUGHER ON KEROSENE
In addition to the price rises, there are reports that the government has also given the go-ahead to state-run companies to raise prices of kerosene, which accounts for more than 40% of total petroleum subsidies, by similar amounts every month until April 2017. "The step to gradually increase SKO (superior kerosene oil) prices every month is a major reform considering the politically sensitive nature of the product," said K. Ravichandran, senior vice-president at ICRA.
"It's credit positive for PSU (public sector undertaking) upstream oil companies as it will reduce the subsidy sharing burden."
The move to raise retail prices of subsidized kerosene by Rupees 0.25/liter per month for 10 months would lead to a reduction in gross under-recoveries by Rupees 7.6 billion in the financial year 2016-17 (April-March) and by Rupees 20.4 billion in 2017-18, ICRA said.
As kerosene under-recoveries beyond Rupees 12/liter are expected to be borne by state-run upstream companies, those companies would be major beneficiaries of the reform especially at current or higher level of crude oil prices, ICRA said.
"At an Indian basket crude oil price of $44-$45/b, the kerosene subsidy tends to be around Rupees 12/liter, implying no subsidy burden on PSU upstream companies," it added.
In addition, ICRA said the step to increase retail prices of subsidized kerosene would lead to a reduction in diversion for "unintended purposes", such as adulteration of auto fuels.
The government has capped its share of the subsidy burden up to Rupees 12/liter for kerosene and Rupees 255/per LPG cylinder.
While the balance for kerosene would be shared by upstream oil companies, for LPG, there is lack of clarity as to whether the state-run companies would bear the subsidy or it will be passed on to the consumers in case global crude oil and LPG prices increase significantly from the current levels.
"The cap in LPG subsidy for the government of India at Rupees 255/cylinder is likely to be adequate up to the crude oil price of $60/b, which provides comfort to oil marketing companies over the medium term," ICRA added.
In its effort to promote cleaner fuels, the government has been aggressively promoting the use of cleaner fuels, such as LPG, for cooking.
This has led to kerosene demand in India falling by more than 3% year on year to 6.89 million mt in 2015, from 7.13 million mt in 2014.
Kerosene demand also fell more than 5% year on year to 3.27 million mt in first half of 2016, from 3.46 million mt in H1 2015. It was the only oil product that witnessed negative growth in demand last year and in the first half of this year.
Analysts said that with the plan to raise kerosene prices gradually over the next 10 months, the government aims to kill two birds with one stone -- the move will not only help to reduce kerosene consumption, but will also help to cut oil under-recoveries.
"While the market anticipated such bold moves, the timing of the announcement came as a surprise," Paravaikkarasu said.
"The successive price hikes of subsidized kerosene will not only ease the subsidy burden, but also discourage consumers using the fuel. The government is working hard to move away household consumers from using kerosene to LPG," she added.
LPG demand continues to grow at a healthy pace, rising by 8.5% year on year in June to 1.61 million mt. Cumulative growth in H1 2016 was 9.6% year on year at 10.06 million mt.
The government has announced 2016 as the "year of LPG consumers" and has set an ambitious target to open 10,000 new LPG dealerships across the country this year, in addition to the 16,000 that already exist.
New Delhi also has ambitious plans to provide additional subsidies to provide 50 million new connections among lower-income families, with another 15 million being added this year.
"Various structural changes are been already made to LPG pricing. Between LPG and kerosene, the government will prioritize deregulating kerosene prices even though it is tougher, and keep targeted LPG subsidies in place," Paravaikkarasu said.http://www.platts.com/latest-news/oil/singapore/analysis-indias-new-oil-price-recipe---short-27642288