The Financial Express [FRONT PAGE][ECONOMY]

Sunday, July 6 1997

Downstream oil industry will be freed: study


MUMBAI, July 5: Leading investment bank SBC Warburg believes that deregulation of India's downstream oil industry is inevitable, although unlikely before the end of the century.

This premise has been made keeping in view the correlation between a robust oil industry and strong economy, and recognising that deregulation is a necessary precursor to attracting sufficient investment in the oil sector.

In both the current highly regulated environment, and in the anticipated deregulated market, SBC Warburg believes that two of domestic major oil refiners and marketers, Hindustan Petroleum Corporation (HPCL) and Bharat Petroleum Corporation (BPCL), are well positioned, and are attractive investments.

In its Indian oil sector review, and two company updates released on Friday, SBC Warburg examines the structure of the strategically important Indian downstream oil sector, and concludes that while deregulation of the industry is imperative to generate necessary investment, the deficit on India's oil pool account (peaking in 1997 at $5 billion) will make it difficult for the government to deregulate in the short term.

The bank also analyses HPCL and BPCL, India's second and third largest downstream oil companies, and its fourth and fifth largest companies in terms of sales - in the context of their earnings potential under the current administered pricing mechanism, and their positioning in the event of reform of the industry.

"The faster India's domestic economy grows, the faster will be the rate of growth in energy demand," said Sanjoy Bhattacharyya, director at SBC Warburg. "With demand for oil already expected to rise by 6-7 per cent per annum over the rest of the decade, failure to boost domestic crude oil production and refinery capacity to match demand may eventually impact India's economic growth and balance of payments position.

Considerable investment is needed to achieve this boost, and we believe that deregulation is the only real option to attract investment of this size".

According to SBI Warburg, speculation on the timing of deregulation is difficult, and exactly what form it will take remains to be seen.

"While momentum for reform is gathering, the government's delicate political position could result in slow progress, as the sector contributes 4.3 per cent to the wholesale price index, and petroleum product prices generally have a multiplier effect of more than two," said Bhattacharyya.

"The political sensitivity of any price increases, therefore, coupled with the oil pool account deficit, mean that when deregulation is announced it is unlikely to be fully implemented for several years".

Considering the key determinants of company profits in the current regulated environment - equity investment in operating assets, outperforming regulatory targets, financing costs and profits earned on controlled products - SBC Warburg believes that refiners and marketers HPCL and BPCL have strong earnings potential. The bank further projects that when the industry is reformed, the two companies are strongly positioned to take advantage of the situation.

"HPCL has aggressive new investment plans which should lead to 22 per cent per annum earnings growth over the next few years, and, upon deregulation, the company's two coastals refineries, distribution facilities and retail network of 4,215 sites will represent a significant logistical advantage over potential competitors, particularly in southern India," said BP Singh, research analyst at SBC Warburg.

"BPCL also has major investment plans, which will give rise to 14 per cent growth in earnings in 1997-98 and 27 per cent in 1998-99. The company is well placed for reform.

Copyright © 1997 Indian Express Newspapers (Bombay) Ltd.





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