Crude Oil Cess impact on Oil Companies

Higher international crude prices since the start of 2012 have kept the shares of oil producing companies specially Cairn, ONGC and Oil India, buoyant on the hope of better realization. But budget 2012 brought surprise for these companies and investors. 

The finance minister seemingly wanted a share of the pie. The cess on crude got increased from Rs 2,500 a tonne to Rs 4,500 a tonne. This effectively means a decline of $5 a barrel in crude oil realisation. While this will add Rs 7,500-8,000 crore to the government’s kitty, the cess will negatively impact earnings of companies like ONGC, OIL and Cairn. Deutsche Bank estimated the negative impact on earnings at 15 per cent for Oil India, nine per cent for ONGC and seven per cent for Cairn India.

The current cess hike adds to the pain of govt. owned OIL and ONGC which are sharing a major part of subsidy burden of selling the fuels at a prices below the cost of production. The actual government subsidy for FY12 would be Rs 85,000 crore and the subsidy share of upstream companies would be close to 40 per cent.

Oil in not well - Nymex Crude tops $105

In the recent run up in stock markets all over the world there is something that bulls have completely ignored which is oil. Oil prices jumped to a nine-month high near $105 a barrel today in Asia after Iran said it halted crude exports to Britain and France in an escalation of a dispute over the West Asian country's nuclear programme.


With Nymex crude topping $105 and brent crude crossing $120 per barrel, bulls in India at least are expected to run out of steam. Oil is a significant threat to Indian fiscal situation which is already under strain and that threat could halt the rally that we are seeing in Indian stock markets. Couple of points to consider:


1. High oil prices increases the risk of passing on some escalation in cost to end consumers which will in turn escalate inflation which is still over RBI's comfort zone. So rate cuts that markets have discounted might not come which could disappoint investors. So the rate sensitives which has had the biggest rally could retrace some of their gains.


2. High oil prices means even higher subsidy and consequently higher fiscal deficit which is already expected to be way beyond govt's own projection of 4.5%. With budget round the corner, the finance minister will have very little flexibility in provide any sops to the industry or markets. In fact there is possibility that budget might be oriented towards increasing some or the other tax to reduce the fiscal deficit.


Hence investors should be very cautious at current levels and avoid chasing the rally.