While clarity on the income-tax benefit to natural gas producers would benefit RIL, the potential de-regulation of petro-product prices would be encouraging for the whole sector, including public and private companies. We see a high probability of the income tax benefit being extended to natural gas producers though deregulation of petro-product prices might not occur.
Expectations
Key market expectations from the Budget for the oil and gas sector are (we expect No. 1 and 3 to be the most likely):
1. Income-tax exemption might be extended to natural gas producers. The Ministry of Finance might clarify the tax exemption available to exploration and production companies on hydrocarbon production from the NELP blocks. At present, natural gas producers have been excluded from availing of the seven-year tax holiday otherwise available to crude producers.
2. Roadmap for de-regulation of petro-product prices or a more transparent subsidy-sharing mechanism may be announced. The oil-marketing companies (OMCs) might be given some sort of pricing freedom on regulated auto-fuels (gasoline and gasoil) through a proposal in the budget, or a roadmap to achieve this might be announced. Alternatively, a more transparent mechanism of subsidy sharing by different stake holders โ the government, upstream refiners and OMCs โ could be outlined.
3. Customs duty on crude oil and petro-product might be restored to pre-Jun โ08 levels. The customs duty on crude oil was reduced to 0 per cent from 2.5 per cent in June 2008 to give relief to the OMCs and end-users as crude prices reached levels of US$100 a barrel. Given that customs duty on crude was a huge source of revenue for the government, it might be brought back. Also, in order to continue the duty protection to the refiners, the duty on petro-products (auto-fuels) might be raised from 2.5 per cent to 7.5 per cent (pre-Jun โ08 levels).
4. The government might give โinfrastructure statusโ to different segments of Oil & Gas. The extension of infrastructure status could help companies avail of a ten-year income-tax holiday. This might include infrastructure status to
* Oil and gas exploration
* Cross-country pipelines for crude, gas and petroleum products
* LNG import and re-gasification projects
* Crude and product import facilities
5. The government might give โdeclared goodsโ status to natural gas. This could end the use of different sales taxes applicable on natural gas in various states and reset them to a uniform 4 per cent.
6. The cess on auto-fuels for road development might be increased by Re1/litre. The National Highways Authority of India, the main agency implementing/co-ordinating projects to build and improve highways, has suggested raising the road cess on motor fuels by Re1 a litre to mop up resources.
Impact on the sector
* Extension of income tax holiday on gas production - Positive. This would bring in the much-needed fiscal stability in the NELP regime, which was eroded last year as natural gas was excluded from the definition of โmineral oilโ. The tax holiday being extended even to firms finding natural gas during exploration would help obtain a good response to future rounds of NELP auctions.
* De-regulation of petro product prices (partial/ complete) and transparency in subsidy sharing - Positive. This would help remove uncertainty in the sector โ especially for public sector units. Even private sector oil-marketing companies would benefit through a longterm call on the sector as more transparency or de-regulation is ushered in.
* Increase in duties on crude and petro-products - Negative to Neutral. If accompanied by a consequent increase in retail prices of the auto-fuels, this would be neutral for the OMCs. In case retail prices are not allowed to be increased proportionately, OMCs could suffer in the form of higher under-recoveries on retail sales. If the government only increases customs duty on crude but not on petro-products, refiners selling in India or the refining division of companies could suffer as duty protection is lifted.
* Extension of โinfrastructure statusโ to avail of a ten-year tax holiday - Neutral to Positive. While this could be a feel-good factor for the oil and gas sector and would be favorable to end-consumers, we believe only small gains would accrue to those in the gas transmission business where returns would be overseen by the
regulator. Thus any input cost or operational cost reduction would pass to end-consumers. Also, most of the production-sharing contracts for fresh NELP finds have an in-built seven-year tax holiday. Thus, incremental benefit to the E&P sector would be small. The infrastructure status could be beneficial to companies implementing new cross-country pipelines for crude and petroleum products and those putting in new crude and product import facilities (basically refiners).
* Extension of โdeclared goodsโ status to natural gas - Positive. No impact on the companies in the sector, though it could bring down the cost of natural gas to end-consumers. It could help city gas - distribution companies increase volumes as natural gas becomes more competitive to auto-fuels.
* Cess on auto-fuels for road development - Negative to Neutral. No impact on oil-marketing companies as long as the government passes on the higher cess to end-consumers by raising retail prices of auto-fuels to that extent. If the retail prices are not raised proportionately the higher cess might have to be absorbed by the OMCs, raising under-recoveries.
Companies impacted
* Extension of income tax holiday on gas production - To benefit RIL - our valuation for RILโs D6 gas block incorporates the seven-year tax holiday being applicable to earnings from the fields. Other companies that might benefit are ONGC and GSPC, which would start producing gas from the NELP blocks in the next few years.
* De-regulation of petro-product prices (partial/ complete) and transparency in subsidy sharing โ The move would be beneficial to PSUs like ONGC, GAIL, IOC, BPCL and HPCL. The extent of deregulation or transparency would be the chief matter to watch out for.
* Increase in duties on crude and petro-products โ OMCs might be negatively impacted if the higher duties are not passed on to endconsumers through retail price hikes of auto fuels. Refiners (including independent refiners like CPCL, MRPL) could be negatively impacted if only the duties on crude oil are increased/restored while the duties on petro-products are left untouched and thus the duty protection available to refiners is taken away. In such a case, while the marketing division of OMCs might not lose, refining margins would suffer.
* Extension of โinfrastructure statusโ to avail of a ten-year tax holiday - Refiners impacted positively, E&P marginally. Infrastructure status would help the refiners โ RIL, Essar Oil, IOC, BPCL and HPCL positively โ while the others in the E&P domain only benefit to the extent of the seven-year tax holiday being extended to ten years.
Utilities โ gas transmitters GAIL, GSPL and LNG players like Petronet LNG โ might not benefit as the benefit from the income-tax holiday might have to be passed on to end-consumers.
* Extension of โdeclared goodsโ status to natural gas โ Gas distribution companies benefit โ IGL, GGL may benefit as fuel conversion turns more economical. Though the real benefit might arise only when more gas is allotted to the gas distribution companies.
* Cess on auto-fuels for road development - IOC, BPCL and HPCL might be negatively impacted if the higher cess is not passed on to end consumers.
(The report has been prepared by Vishwas Katela and Sriram Ramesh of Anand Rathi Securities).