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Economy

Diesel Deregulated, Gas Prices Finalized, Coal Auctions Soon: We Have Some Action

Reliance is going to be disappointed. The gas price hike that was supposed to be a huge benefit – and that was supposed to be double to over $8 per mmBTu (Million British Thermal Units). But the final price increase is only to $5.61. Which is not much from the current price of $4.2 in comparison with the increase expected. While this may be bad news in the short term for Reliance, it is good for the industry to have clarity on what will be paid. The new prices will be paid from November 1.

We don’t know yet if in Reliance’s case, there will be an upward revision in the prices of gas from Nov 1 – since they haven’t managed to produce as much gas as they had committed, they might have to make up for the difference with the older price and only then be paid the higher price. This is again, a short term negative.

However, the positive for the company and the sector is that gas prices will be revised every six months. This might be to provide appropriate market compensation too, but will provide the ability for increases should the market rates be very high.

Diesel Gets Freedom

In addition, Diesel has been decontrolled. Diesel is currently sold at a government determined rate, and if the public sector retailers see a loss, the government compensates it as a fuel subsidy. Decontrol removes that subsidy and means prices of diesel will also move with the market, like petrol. Diesel will remain cheaper than petrol because diesel has lower taxes. Still, the differential may no longer be substantial. Diesel has “over recovery” at this time – of Rs. 3.56 per liter, according to the latest release by the Ministry of Petroleum. So, on November 1, we can expect a price cut.

This is likely to push the public market refiners and retailers (HPCL, BPCL and IOC) to become more efficient, because they can no longer expect the government to subsidize their losses.

Will Private Players Step In?

Players like Shell have set up pumps for petrol. They could move to diesel as well, and this will increase competition. But for this to be successful the government has to ensure that they will never get petrol and diesel back into “control” mode again. Considering that decisions like this have been long awaited and the price of crude right now is low, there is no real immediate need for controlling diesel prices (which are politically sensitive). But what if companies (like Reliance for instance) spend all the money setting up their retail pumps, and crude spikes up to $120? Will the government put diesel back into control mode?

No government likes to reduce its power, but this particular one has said it is about less government – so will it enact a statute that the government will not control petrol or diesel prices, no matter what? That will be useful. (It is only required in this context; the government had earlier decontrolled petrol and then put it back under control, making Reliance lose all the money it put into building retail pumps along highways, which would have dramatically increased internal tourism).

Impact: Nice for Government, Great for PSUs

Subsidies will now move only to kerosene and LPG. This should come down substantially, because prices of gas and crude have also fallen in the international market.

This is hugely positive for Oil India, GAIL and ONGC, because as upstream companies they would take the subsidy hit on fuels, which will obviously come down.

The likes of HPCL, BPCL and IOC are trading favourites and will react positively, because they have been beaten down tremendously.

There is no further hit to the fiscal deficit anyhow due to diesel’s “overrecovery” right now, so there should be no further impact to government bond prices (which are anyhow at a high right now).

Finally, we see inflation coming down by March, if crude prices remain at this level. Also if more gas flows because of the price increase, natural gas based plants and fertilizer plants will be able to produce more, which is also positive for inflation.

The government’s beginning to move. Coal blocks will be auctioned in the next three months, which should provide some sanity to the mess that the industry is in right now. Even banks will be happy, as they can finally figure out what the hit to their loan book is and beg the RBI for appropriate mercy. In the immediate short term, we see a potential problem as the unwinding hits corporate balance sheets and banks, but this is great for the longer term (that is, for more than a year later).

What happened with the last few years of inaction has been that any action of the government, even if routine, sounds like a great thing. These kind of actions – listed above – should have been normally taken by governments and we shouldn’t have had to cheer. But like the PM said in his speech, we find it awesome that government employees come to office on time, which is a sign of how bad things had gotten. The true nature of government action, however, will come in the face of a crisis; and it is quite likely that one is around the corner internationally.