The government’s decision last week to reduce fuel prices through a mix of state and centre tax cuts and price cuts taken by oil marketing companies (OMCs) may have far-flung impact on the domestic oil industry, according to a Moody’s report. The immediate impact, according to the rating agency’s note would be a credit negative for the OMCs.
Moody’s in its note raised concerns over increased borrowings for OMCs, rating downgrades, further directives to absorb fuel prices and pressure on upstream companies to increase in shareholder returns or subsidise crude oil prices.
On October 4, the government (Baa2 stable) reduced petrol and diesel retail selling prices by Rs 2.50 per litre, through cuts in excise duties by Rs 1.50 per litre and asking OMCs to absorb the remaining Re 1 per litre price cut.
“The government’s decision to reduce fuel prices is credit negative for the three rated OMCs – Indian Oil Corporation (IOC), Bharat Petroleum Corporation (BPCL) and Hindustan Petroleum Corporation (HPCL) – because they cannot fully pass on higher crude oil prices to consumers and their earnings will be negatively affected,” the note said. Moody’s estimated the government’s decision will reduce the combined Earnings before interest, taxation, depreciation and ammortisation (EBITDA) of the three OMCs by Rs 65 billion in fiscal 2019, ending March 2019, which is around 9% of their total EBITDA of Rs 692 billion in fiscal 2018.
The note added, despite the negative earnings effect of the government’s decision, we continue to expect the three OMC to report higher EBITDA in fiscal 2019 versus fiscal 2018, given higher sales volume, stable refining margins and the depreciating rupee. However, borrowing for these OMCs is likely to increase.” Still, credit metrics will weaken because their borrowings will increase at a faster pace than their EBITDA. Increasing borrowings will be driven by rupee depreciation, higher working capital requirement given elevated oil prices and the companies’ ongoing capital spending needs,” the note said. It added, increase in borrowing could be lower if OMCs defer capital spending and lover dividend payouts in the current financial year.
Of the three OMCs, Moody’s expects credit metrics of BPCL and HPCL to be weaker compared to IOC, with a possibility for the two OMCs to cross the downgrade thresholds.” Credit metrics of BPCL and HPCL could weaken below our downgrade thresholds for their respective standalone profiles, while IOCL’s credit metrics will remain well positioned for its standalone,” the note said.
Moody’s also sees a possibility of trouble for the upstream oil companies. “The step taken by the government reverses the price deregulation of diesel and petrol and increases the likelihood that the government may ask upstream companies Oil and Natural Gas Corporation and Oil India to share the fuel subsidy burden. Upstream companies could be asked to give discounts on crude oil sold to the OMCs,” the note said.
As an alternate Moody’s expects the government may also look at higher taxes and shareholder payout for upstream companies. “Alternatively, the government could impose higher taxes or ask for an increase in shareholder returns,” the report said.
There is also a word of caution that such retail price cuts may dent private interest in the sector. “Further, the effective reversal of fuel price deregulation will also constrain future investments in the sector by non-government owned entities,” the note added.
