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Policy Confusion, Weak Rupee to Keep Investors At Bay

  • With BP’s expertise in deepwater drilling, the deal is expected to improve gas production from RIL’s D6 block in the Krishna-Godavari basin, India’s largest gas findMumbai: Despite two landmark deals in 2011, foreign and domestic investors are likely to stay away from the oil and gas sector in the new year with high crude prices, a weak rupee and policy confusion expected to weigh on the sector.In February, London-listed energy firm BP Plc. picked up a 30% stake in the oil and gas assets controlled by Reliance Industries Ltd (RIL) for $7.2 billion, the largest foreign direct investment in India till date.
  • With BP’s expertise in deepwater drilling, the deal is expected to improve gas production from RIL’s D6 block in the Krishna-Godavari basin, India’s largest gas find. Declining production from D6 this year emerged as a big concern.“The RIL-BP deal will send out a positive signal to international investors who will be keen on looking at newer opportunities,” said Akhil Sambhar, associate director, oil and gas practice, with international audit and consulting firm Ernst and Young.
  • “The RIL-BP deal showed international oil and gas companies another route to enter India apart from bidding for assets under the National Exploration Licensing Policy (Nelp),” said Alok Deshpande, oil and gas sector analyst with Elara Securities (India) Pvt. Ltd.“Going through Nelp may not be attractive any more as the data available with the government regarding blocks being auctioned are often inadequate and risks are high,” Deshpande said.Another important deal in 2011 was Vedanta Resources Plc.’s acquisition of Cairn India Ltd. Though the deal was announced in August 2010, it had to overcome serious regulatory hurdles and could be closed only in December 2011.
  • Voicing its displeasure at the long time taken by the government to approve of the deal, the Cairn management told shareholders through its 2010-11 annual report that the delay had caused uncertainties in managing the business.There were other instances of a tussle between the government and the industry in 2011. The year also saw RIL, India’s largest company by market value, the oil ministry and the directorate general of hydrocarbons spar over issues such as cost recovery at D6, where the government feels RIL hasn’t done enough to raise production, and pricing of coal bed methane gas.
  • “It (differences between companies and regulators) is the single biggest issue facing the industry,” said Arvind Mahajan, executive director (energy and natural resources practice) at international audit and consulting firm KPMG. “There appears to be a lack of alignment between the thinking of the private sector and the government. This needs to change within the framework of the law,” he said.The biggest concern for investors, foreign and Indian, was making investments in such an uncertain regulatory environment, Mahajan added.
  • Another concern for the sector in 2011, especially for downstream oil marketing companies (OMCs), was the price of crude and the depreciation of rupee. From January till date, the price of Brent crude has risen by about 15% and analysts expect it to stabilize at $105-110 a barrel in 2012. The high prices were largely a result of supply disruptions and political turmoil in oil-rich nations such as Libya.R.K. Singh, chairman and managing director of Bharat Petroleum Corp. Ltd (BPCL), a state-run oil marketing company, said the financials of fuel retailers were hit in 2011 due to the higher crude prices and the rupee’s depreciation against the dollar. The rupee declined almost 20% in 2011.State-run OMCs like BPCL are required to purchase crude from international markets in dollars and sell finished petroleum products like diesel, kerosene and liquefied petroleum gas (LPG) at government-regulated prices below cost to keep inflation in check.The government usually subsidises a significant portion of the under-recoveries on account of selling fuel below the market price and fuel marketers have to absorb the rest as losses.
  • According to the latest data with the government’s petroleum planning and analysis cell, OMCs are facing an aggregate under-recovery of Rs. 388 crore a day on sales of diesel, kerosene and LPG. Between April and September, such under-recoveries totalled Rs. 64,900 crore.Mounting under-recoveries are a matter of great concern and the government should work out a strategy, such as cutting duties on the sale of petrol and diesel, to help OMCs, said Singh. The government brought down the duty on crude imports to zero in June, providing some relief to fuel retailers.
  • The duty cut helped reduce the estimated under-recovery for fiscal 2012, pegged at around Rs. 1.6 trillion earlier, by around 30-40%, Deshpande of Elara said.“A strong depreciation of the rupee against the dollar has led to higher inventory losses since crude is bought mostly in dollars,” Singh said. “Higher interest costs have also impacted financials heavily as OMCs have to borrow money to buy crude since the compensation from the government towards under-recoveries will only come later next year.” Since January, the Reserve Bank of India (RBI) has raised policy rates by two percentage points to 8.5%. The actual cost of borrowing for BPCL is at 10% now, from 6-7% at the beginning of the year.
  • “In such a situation, fresh investments become unattractive in the oil and gas sector even as consumers suffer paying higher prices for fuel,” said Sambhar of Ernst and Young.Deshpande said foreign investors will like to conserve cash for the time being. “Also, prices of crude may have peaked in the medium term and any potential deal at present may have to happen at a very high valuation,” he said.OMCs are hoping the government will push ahead with key reforms and deregulate diesel prices in 2012. Industry experts have often called upon the government to deregulate diesel as it accounts for a majority of sales for an OMC. In June 2010, the government deregulated prices of petrol.
  • The delay in diesel deregulation continues to harm private refiners “who have invested heavily to develop a retail network but are facing an uneven playing field,” said a spokesperson for Essar Energy Plc., which has fuel retailing operations in India.“In 2011, they (private sector fuel retailers) fared favourably in petrol retailing when compared with their public sector unit (PSU) counterparts, but took a severe beating in diesel where they have had to sell at market determined rates while PSUs could sell at low prices, made feasible by subsidy from the government,” the spokesperson said in an email. “We look forward to full diesel deregulation in 2012.”
  • Analysts, though, say diesel deregulation is unlikely anytime soon. “I don’t think diesel deregulation will happen in the foreseeable future,” said an oil and gas consultant with an international consulting firm. He did not want to be identified as he is not authourized to speak to the media.“Many states are going into elections next year and general elections are due in 2014. Also, considering the current price of crude and the rupee-dollar situation, inflation has to be kept in mind,” he added.

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