Windfall tax: ONGC and OIL India bleed

Soaring crude prices in the international market may have put the Indian economy in a spot, with inflation and rupee depreciation only adding to its woes. But one sector which is laughing all the way to the bank is the oil and gas industry. High global crude prices provided a big boost to the earnings of upstream exploration companies through higher realisation and downstream refining companies by way of higher refining margins.

The performance of oil and gas stocks also followed suit, with the BSE Oil and Gas Index gaining a phenomenal 130 per cent between March 2020 and April 2022. However, for oil exploration and refining companies whose stock prices were consolidating over the last two months after a stellar rally, the government’s announcement about windfall tax came as a big dampener.

The government on July 1 announced windfall tax on exports of diesel (at ₹13/ litre), petrol (at ₹6 per litre) and Aviation Turbine Fuel (at ₹6 per litre) by refineries. This includes even SEZs which were approved and incentivised by the government exclusively for exports such as Reliance Industries Ltd’s (RIL) Jamnagar facility (Gujarat). In addition to this, oil exploration companies will have to pay cess of $40 per barrel on domestic crude production. Following the announcement, stocks of exploration and refining companies nose-dived, even as BSE Oil and Gas Index declined by only 2 per cent since last Thursday. State-owned oil producer Oil India and Oil and Natural Gas Corporation (ONGC), which is the country’s largest crude producer, were the biggest losers. The stock of ONGC corrected by over 19 per cent, while Oil India shed almost 27 per cent since last Thursday’s close price.

This is because the revenue and profit impact for oil exploration companies is expected to be more pronounced compared to that of refiners for two reasons. One, for crude oil producers such as the State-owned ONGC, the announcement translates into a haircut of $40 on every barrel of crude produced. This means, the realisation for a barrel of crude for ONGC will reduce from the current India basket price of about $102 per barrel to $62 per barrel. This is besides the 20 per cent Oil India Development Board cess. All these can potentially lead to over 55 per cent reduction in ONGC’s crude realisation vis-à-vis international crude prices. For instance, if the international crude price is $110, the realisation for ONGC may be capped at $60 per barrel. ONGC being the country’s largest producer of crude oil with a total of 19.45 million tonnes in FY22, and accounting for two-thirds of the country’s total output of 29.69 million tonnes, this move will impact its per share earnings by about ₹30. Interestingly, the stock price has corrected from about ₹151 last Thursday to ₹121 levels this Friday.

Second, for refining companies, the additional tax is limited to the quantum of export of their downstream products. Hence, even as stocks of crude producers took a beating, those of refining companies were resilient. The stock of exploration and refining major RIL, which has considerable exports from its Jamnagar plant, yet managed to contain fall in its price to about 8 per cent. This is thanks to its other businesses such as gas exploration, telecom which are expected to shield its overall performance. Moreover, the operational efficiency of RIL’s refining business and conservative estimates by the street, should also help limit downside to expected earnings for RIL. For instance, even as the gross refining margin (GRM) impact for RIL is estimated at $7-8 per barrel, due to the windfall tax, compared to the current margin which is estimated to be $24-25 per barrel, the GRM estimates by brokerages is conservative at under $15/barrel, implying minimal downgrade risk.

For the refiners, it was a mixed bag. While refiners such as Bharat Petroleum (up 5 per cent), Hindustan Petroleum (up 11 per cent) bucked the trend, Indian Oil Corporation (down 2 per cent) and Chennai Petroleum (15 per cent) were the prominent losers.

The reason for the new export tax by the government is possibly three-fold. First, the government wants to restrict dollar outflow given that India is a net importer of energy products. Second, higher availability of domestic petroleum products will help reduce import subsidy bill and help moderation in global prices. Third, the government is looking for a share in the windfall made by exploration companies, given that oil and gas assets in the country are owned by the government.

This move by the government will help the ex-chequer clock an estimated income of over ₹1 lakh crore, if it is continued for the full year, which will compensate for the income loss on account of excise duty reduction on petrol and diesel.

While the market has reacted sharply to the news at least with respect to exploration companies, the extent of earnings impact remains to be seen, given the Revenue Secretary Tarun Bajaj’s statement that the government will review the tax rate every 15 days, considering the global crude oil price, exchange rate of INR against US dollar among other factors. While the government has said that it will withdraw the decision if crude were to correct by $40/barrel, it may consider lowering the windfall tax, from the current $40 per barrel, should the global price continue its downward trend. Interestingly, the analysts tracking crude price globally are divided on the price outlook. While Citi has a pessimistic view on crude, due to recession and demand slowdown and expects the liquid gold to fall to $65 levels by year-end, Goldman Sachs sees crude rising further to $140 levels on account of tight supply and steady demand.

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