Thematic

Union Budget FY14-15

| August 2014

Oil & Gas

Marketing freedom: A win-win for all

Part 2 of 3

Harshad Borawake

(HarshadBorawake@MotilalOswal.com); +91 22 3982 5432

Nitish Rathi

(Nitish.Rathi@MotilalOswal.com); +91 22 3982 5558

July 2014

2

Oil & Gas | Thematic

Marketing freedom: A win-win for all

OMC’s to move into structural investment plays

Page No.

Summary…………………………………………………………………………………..…………………….…………………..

Story in charts…………………………………………………………………………….…………………….…………………

Diesel deregulation - Higher marketing margin = higher profitability………………………………..

Small dose of diesel price hikes - a palatable solution, will kero/LPG follow?

Expect overall under-recovery to reduce by ~50% by FY16E

OMCs profitability on a structural upturn

Working capital reduction to increase EPS by 8-16%

Free market to improve marketing profitability, expect 18-35% EPS upside

3

5-6

7 - 12

Private entry unlikely to dent OMCs volume………………...…………………………………………………...

OMCs seem well prepared v/s previous deregulation period

Fuel retail outlet economics challenging at low volumes

Indian demand potential has room for PSUs and private as well

22,000 new fuel retail stations required in the next five years

Absolute volume loss for OMCs unlikely

Long term winning strategy for fuel retailers

13 - 19

Expect OMC’s could benefit by forward integration………………………………………………….…….....

Pure refining business becoming more challenging…

…..investments inevitable to survive in the new normal

Petchem integration to offer diversification and stability in earnings

Integration into downstream chemical can significantly reduce risks

20 - 22

OMC’s to benefit from diesel deregulation and likely marketing margin increase………….…

Expect OMCs to move from trading plays to structural investment plays

BPCL is our top pick in OMC’s

23 - 24

Annexure 1: Petroleum product price trend in India………………………………………………….….…..

Annexure 2: Petroleum product consumption trend and drivers…………………….…………….….

Annexure 3A: Refineries in India………………………………………………………………………….…….…………

Annexure 3B: Map of refinery locations…………………………………………………………….………………..

Annexure 4: Under-recovery and their sharing……………………………………………………..…….……..

Annexure 5: Petroleum pricing in India…………………………………………………….…….…………………..

Annexure 6: Key recommendations of oil sector expert committees……………….………………..

Annexure 7: OMC’s 1 year forward P/E and P/B charts (15 years)………….…………….……………

Company section

BPCL

HPCL

IOCL

25

26

27

28

30-31

32

33

34

36 - 41

42 - 46

47 - 51

22 August 2014

2

Oil & Gas | Thematic

Oil & Gas

Companies Covered



Pg

36

Marketing freedom: A win-win for all

OMC’s to move into structural investment plays



BPCL

HPCL

IOCL

The diesel reforms of January 2013 partly addressed investor skepticism, shifting the

focus from “whether” to “when”. However, these reforms were only ‘incremental’ and

not ‘big bang’ due to the imminent election cycle.



42

47







Now, with a strong government in place and its growth-focused agenda, we believe

the reform dialogue will shift from “when” to “how much and how soon”.

In a follow-up to our report, “Breaking free...WHEN?”, this is the second in a three-

part series where we cover (1) upstream, (2) downstream and (3) gas chain

companies, and attempt to assess the required and likely changes to achieve full

potential.

Also refer to part 1 of our

“Breaking free” series

released on July 2014

Diesel deregulation = higher marketing margins = higher profitability





Post INR11/ltr hike in the last 19 months, diesel is set to be deregulated in the

coming months, leading to ~50% reduction in gross under recoveries to INR750b

by FY16. And a realistic kero/LPG hike could cut under-recovery by 70%.

We expect 26-51% increase in the OMCs earnings in the medium term led by

a) Diesel reforms leading to deregulation, lower working capital loans

translating into savings in interest costs and,

b) Likely higher marketing margins on auto fuels (INR0.5/ltr higher diesel

marketing margin will increase OMCs’ PBT by INR40b = 24% of FY14 PBT).

Private competition unlikely to dent OMCs profitability







Private companies’ comeback, post diesel deregulation, is unlikely to dent OMCs

volumes in the near-to-medium term due to OMCs scale and pump economics.

Private players can gain market share in the bulk segment, but retail could be

tough, unlike 2004-07, as over the last 10 years, OMCs (a) have addressed

adulteration issues, (b) increased reach and (c) tied up with high volume fleet

operators.

Over the long term, winners in petroleum retail will be players who can (a)

modernize (value/service to customers, non-fuel retail), (b) have scale (reach to

cater fleet operators), (c) have multi-fuel outlets and (d) be efficient

(profitability focus, real-time monitoring).

OMC’s to benefit by forward integration





Investors are advised to refer

through disclosures made at the

end of the Research Report.



In an era of volatile refining margins, apart from marketing business, forward

integration could be an effective value creation route for OMC’s in our view.

Overall RoE’s will improve by (1) utilizing surplus naphtha, (2) cost savings by

shared utilities and infrastructure, and (3) exploitation of potential in

specialty/niche products.

Also, risks would reduce with (1) stable company-level margins, (2) higher

operational flexibility with well integrated hydrocarbon processes, and (3)

control on feedstock supply chain.

3

22 August 2014

Oil & Gas | Thematic

Valuation and view







Ongoing reforms leading to earnings predictability and RoE improvement have

the potential to transform OMCs into a structural investment plays in our view.

Diesel price is set to be market linked in coming months and as anticipated

(Refer report March 2013), in the initial period of diesel reforms OMC’s earnings

are (a) being benefited from lowering of interest and (b) later will be benefited

by likely increase in the diesel margins in our view.

BPCL is our top pick (stable refining margins, E&P upsides, strong balance sheet)

followed by IOCL (diversified earnings, EPS accretive Paradip refinery) and HPCL.

Oil & Gas: Earnings and valuation summary

M Cap CMP TP Var v/s Reco

USDb (INR) (INR) TP (%)

Integrated/Upstream

53.4 998 1,027

3

Neutral

RIL

¹

ONGC

CAIRN

OINL

OMC's

IOC

BPCL²

HPCL

MRPL

GAIL

GSPL

PLNG

IGL

14.5

8.0

2.6

1.8

9.1

0.8

2.2

0.9

362

673

458

63

433

88

177

371

449

795

527

65

410

90

190

342

24

18

15

4

-5

2

8

-8

Buy

Buy

Buy

Neutral

Neutral

Neutral

Neutral

Neutral

EPS (INR)

FY15E FY16E FY17E

81.6

34.3

56.4

61.4

32.6

42.8

42.4

4.2

28.2

8.1

10.3

32.7

89.9

42.7

50.6

71.5

39.5

48.3

50.3

8.0

32.0

9.5

11.1

35.2

112.8

44.8

39.5

74.9

47.2

56.8

57.5

8.6

35.7

10.2

15.2

36.3

P/E (x)

EV/EBITDA (x)

P/B (x)

FY15E FY16E FY17E FY15E FY16E FY17E FY15E FY16E FY17E

12.2

12.5

5.8

9.7

11.1

15.7

10.8

NA

15.3

10.9

17.1

11.3

11.1

10.0

6.4

8.4

9.2

13.9

9.1

7.8

13.5

9.3

15.9

10.5

8.8

9.5

8.2

8.0

7.7

11.9

8.0

7.3

12.1

8.7

11.6

10.2

10.1

5.4

4.1

6.4

8.0

10.6

10.4

10.0

5.4

6.1

9.7

6.0

9.6

4.6

4.1

5.3

6.8

9.6

8.0

5.5

4.7

5.6

8.7

5.2

7.2

4.4

4.1

4.9

5.3

8.4

7.0

4.8

4.9

5.2

6.8

4.7

1.3

1.9

0.9

1.6

1.2

2.3

1.0

1.4

1.8

1.3

2.4

2.5

1.2

1.7

0.9

1.4

1.1

1.1

0.9

1.3

1.7

1.2

2.1

2.1

1.1

1.5

0.8

1.3

1.0

1.0

0.9

1.1

1.5

1.1

1.8

1.8

Dvd

RoE (%)

FY15E FY16E FY17E Yld %

11.5

16.3

17.4

17.0

11.2

15.3

9.4

NA

12.5

13.1

14.5

23.7

11.5

18.2

13.9

18.0

12.6

15.6

10.4

17.2

13.0

13.6

14.0

21.5

13.2

17.0

10.0

17.1

13.5

16.5

11.1

16.2

13.4

13.0

17.0

19.0

1.0

2.3

3.0

4.0

2.8

2.0

2.8

1.3

1.8

1.1

1.1

1.9

60.3

10.1

5.9

427

325

598

486

358

700

14

10

17

Buy

Neutral

Buy

Independent Refiners

Gas Companies

CGD Companies

¹ No. of shares adj. for treasury shares; ²P/B adjusted for E&P valueof INR223/sh; Dividend yield on FY15E basis

Source: MOSL

22 August 2014

4

Oil & Gas | Thematic

Story in charts

Diesel set to be deregulated in the next few months (INR/ltr)

Diesel U/R (INR/ltr)

28

20

12

4

-4

3.8

20.4

14.9

17.1

Diesel Price (Inr/ltr) - RHS

60

14.5

10.5

45

30

1.8 15

0

…leading to ~50% reduction in under-recovery by FY16

2,000

1,500

1,000

500

0

201

400 494

Petrol

Diesel

Kerosene

LPG

Total

1,610

1,381 1,399

1,033

773

461

780

948

750 689

Source: PPAC, MoPNG, MOSL

Source: PPAC, MoPNG, MOSL

We model OMC’s subsidy sharing at 2% (%)

Government

Upstream

SA Refiners

OMC's

-

-

1 2 2 2 2

-

-

-

-

-

10

12 9

-

- 21

-

32

35

40 37

-

48

31 39

42

64 64 64

70 2

33

35

69

-

56 53 60 62 51

49 46

34 34 34

30 29

-

Diesel deregulation set to cut OMC’s debt significantly (INRb)

2,000

1,500

1,000

500

0

HPCL

BPCL

IOCL

Source: Company, MOSL

Source: PPAC, IMF, Shell, Industry, Australia govt., MOSL

Global diesel marketing margin meaningfully above India’s

level (INR/ltr)

7.33

5.42

4.50

2.83

1.41

3.49

3.40

…likely increase in OMC’s marketing margin to increase

earnings significantly (INR/sh)

HPCL

68

63

39

BPCL

76

67

42

IOCL

84

91

52

48

44

31

53

34

0.25

60

58

36

72

45

77

47

India

US

Canada Thailand South Australia

Africa

UK

FY14 adj.

EPS

0.50

0.75

1.00

1.25

1.50

Additional Marketing Margin (INR/ltr)

*gross basis, costs typically ~50%

Source: Company, MOSL *Sensitivity only for diesel

Source: Company, MOSL

22 August 2014

5

Oil & Gas | Thematic

Story in charts

At a domestic GDP growth of 6-9%, expect Indian auto fuel

demand to grow 35-50% in 5 years at a 5-7% CAGR (b ltr)

Petrol + Diesel

(in b litres)

5% CAGR

6% CAGR

7% CAGR

Private competition unlikely to dent OMC volume: Even at

15% market share loss, OMC volume to grow at 2-4% (b ltr)

Worst case OMC volume

Best case private volume (~15% market share)

Total

160

152

143

24

107

23

21

107

122

@5% CAGR

129

136

107

160

150 143

140 136

131 130

124

122

152

143

112 114 118

135

127

120

113

@6% CAGR

FY20

@7% CAGR

FY14

FY15

FY16

FY17

FY18

FY19

FY20

FY14

Source: MOSL *Auto fuel volume growth assumed at ~6%

Source: MOSL

Challenging refining business: Declining GRM/crude ratio (%)

is evident of challenges being faced by pure refining players

25

20

15

10

5

0

Aug-04

Aug-06

Aug-08

Aug-10

Aug-12

Aug-14

Integrated players across globe realize higher average RoCE

(%)

15

12

9

6

3

0

2005 2006 2007 2008 2009 2010 2011 2012 2013

Petchem

Refining

Integrated

GRM/Brent crude price (%)

Source: Bloomberg, Reuters, MOSL

Source: Bloomberg, MOSL

Segmental EBITDA break-up (%): HPCL has leverage to

reforms while IOCL earnings are well diversified

Higher marketing margins can significantly drive earnings and

fair value of OMC’s

FY16 E EPS

Fair value

67

55

-

6

39

45

9

29

17

Marketing

Petchem

Pipelines

Refining

-

18

15

HPCL

BPCL

IOCL

Source: MOSL

Source: MOSL

22 August 2014

6

Oil & Gas | Thematic

Diesel deregulation = higher marketing margins

OMC’s profitability set to increase



Post INR10/ltr hike in the last 20 months, diesel is set to be deregulated in the coming

months, leading to ~50% reduction in gross under-recovery to INR750b by FY16. And a

realistic kero/LPG hike could cut under-recovery by 70%.



We expect 26-51% increase in the OMCs earnings in the medium term led by: a)

Diesel reforms leading to deregulation, lower working capital loans translating into

savings in interest costs and, b) Likely higher marketing margins on auto fuels

(INR0.5/ltr higher diesel marketing margin will increase OMCs’ PBT by INR40b = 24%

of FY14 PBT).

Small dose of diesel price hikes - a palatable solution









Retail petroleum prices for controlled products (Diesel, Gasoline, Kerosene and

LPG) in India historically witnessed ad-hoc increases and that too with a lag,

leading to significant under-recovery for the oil marketing companies.

After deregulating Petrol (gasoline) in June 2010 and with continued high

subsidy payouts, the Government was forced to undertake diesel reforms.

The decision to increase diesel prices in small doses of INR0.5/ltr per month was

the most palatable decision and witnessed very little resistance across the

populace and political parties.

Now, after 21 months of monthly price hikes, diesel is set to be market-linked in

the next few months.

Retail petroleum product price hikes lagged international price trends, resulting in high under-recovery

Gasoline price (YoY %)

Diesel price (YoY %)

Brent price in INR (YoY %)

Under recoveries (INRb)

1,381

1,033

201

6

(2)

FY04

FY05

FY06

12 21 64

400

15 16 25

(1) (1)

FY07

FY08

494

3

773

461

17 15 51

(11) (3) (40)

FY09

FY10

FY11

FY12

780

1,610

1,399

93

1

6 5 35

23 6 43

12 8 20

4 19

(6)

FY13

6 14 8

FY14

Source: IOC, MoPNG, PPAC, MOSL

Will LPG/kero follow?







After a market-linked pricing of diesel, we expect the Government to take up

LPG and kerosene reforms.

PDS kerosene has been an important fuel for the economically weaker sections

in rural India. (its price has been at ~INR10/ltr since 2002). Hence, we expect the

Government to first take up LPG price deregulation, which could later be

followed by kerosene in the longer term.

The initial thrust should be on widening the base for direct benefit transfer

scheme, followed by removal of dual pricing in LPG and kerosene.

22 August 2014

7

Oil & Gas | Thematic



Substantial quantities (~35%, translates into USD3b black market) of kerosene

are supposedly diverted for adulteration with diesel due to the large pricing

difference between diesel and kerosene. Elimination of dual pricing in kerosene

by adopting direct subsidy transfer to the genuine consumers will eliminate the

scope for adulteration.

Fast rollout of PNG through CGD in cities, and akin to diesel,

small price hikes should help to cut LPG subsidies



Domestic LPG price in India has been increased at 5%

CAGR in the last 10 years v/s 11% CAGR of international

crude prices.



Rural households belonging to the four poorest deciles use

less than 6 cylinders per year, while households belonging

to the poorest decile of urban consumers use 8 cylinders.



As per NSSO survey, households have the flexibility to

absorb certain additional costs on LPG by adjusting the

expenditure on discretionary items.



The Kirit Parikh committee, after studying the household

expenditure pattern, had recommended an immediate

price hike of INR100/cyl to be followed by periodic

revision, based on the paying capacity as reflected in the

per capita income.

Kerosene deregulation could take time, but dual pricing

should be eliminated in the interim



PDS kerosene is primarily used for lighting purpose in the

absence of electricity and its allocation has been on the

decline (-5% consumption CAGR in last five years) as more

and more households are connected to electricity grid.



The Kirit Parikh Committee had argued that the rural

household in the poorest decile spends ~2% of monthly

expenditure on kerosene. This is equivalent to 13% of its

discretionary spend and hence there is scope to increase

PDS kerosene prices.



A case in point is the pilot project at Kotkasim tehsil of

Rajasthan's Alwar district, where the shift to direct benefit

transfer reduced the kerosene consumption substantially

as it curbed leakages of kerosene to the black market.



As per NSSO survey, most of the households use ~3.5 litres

per month and allocation of 5 litres per household per

month should be adequate.



The Kirit Parikh committee in its February 2010

recommendations had proposed an immediate hike of

66% in Kerosene to INR15/ltr and yearly revision in-line

with the growth in per capita agricultural GDP at nominal

prices.

Expect overall under-recovery to reduce by ~50% by FY16E









Significant volume growth (6.3% CAGR in the last 10 years) coupled with

increasing under-recovery (peaked at ~INR21/ltr in 1QFY09 and ~INR17/ltr in

Aug-12) led to increase of diesel share in the overall under-recovery to 45-60%,

thereby making the reforms critical.

Led by monthly price hikes of INR0.5/ltr since Jan-13, diesel under-recovery now

stands at INR1.8/ltr, and is set to be market-linked in the next few months (sans

any sharp increase in oil price of INR/USD depreciation).

We estimate the overall under-recovery to reduce by 46% by FY16E to INR750b

from INR1,399b in FY14.

We estimate that if the government increases domestic LPG and PDS kerosene

prices similar to diesel (Kero: INR1/ltr per month, LPG: INR50/cylinder per

quarter), the FY16 under recoveries could be lower by 70% to INR440b v/s

INR1,399b in FY14.

22 August 2014

8

Oil & Gas | Thematic

Share of diesel under-recovery was almost 60% in recent years (INRb)

Petrol

Diesel

38%

46%

Kerosene

51%

20%

773

494

400

201

107

102

179

84

144

188

126

2295

FY05

FY06

FY07

156

191

353

FY08

1,033

176

282

523

FY09

461

143

174

93

FY10

780

205

200

348

FY11

LPG

45%

1,381

284

278

819

FY12

1,610

399

296

915

FY13

Total

59%

Diesel share

57%

45%

1,399

465

306

628

FY14

32%

11%

Source: PPAC, MoPNG, MOSL

Diesel set to be deregulated in the next few months (INR/ltr)…

28

20

12

4

-4

3.8

20.4

14.9

Diesel U/R (INR/ltr)

17.1

Diesel Price (Inr/ltr) - RHS

60

45

10.5

30

1.8 15

0

14.5

Source: PPAC, MoPNG, MOSL

…leading to ~50% reduction in under-recovery by FY16 (INRb)

Petrol

Diesel

Kerosene

1,381

1,033

773

201

84

95

2

22

FY05

400

102

144

126

27

FY06

494

107

179

188

20

FY07

156

191

353

73

FY08

176

282

523

52

FY09

780

461

143

174

93

52

FY10

205

200

348

27

FY11

284

278

819

-

FY12

FY13

399

296

915

465

306

628

-

948

474

290

184

-

498

252

-

470

220

-

750

689

LPG

1,610

Total

1,399

FY14 FY15E FY16E FY17E

Source: PPAC, MoPMG, MOSL

OMCs profitability on a structural upturn





High under-recovery coupled with delayed subsidy payments from the

Government had resulted in significantly high working capital related debt for

OMCs (HPCL, BPCL and IOCL).

The combined debt of OMCs had increased at 22% CAGR in the last 10 years and

interest cost increased at a CAGR of 27%.

22 August 2014

9

Oil & Gas | Thematic



Over the last few years, Government subsidy receivables formed 30-40% of the

OMCs debt and with the diesel deregulation, this will reduce to a minimal level,

leading to reduction in debt and interest cost.

Interest cost continued to remain high (INR b)

INR billion

1.4

1.5 1.5

87

42

26

17

6

3

15

17

27

33

24

21

38

17

11

9

30

12

9

23

17

25

18

51

HPCL

BPCL

IOCL

Total

99

71

59

114

94

OMCs debt peaked in FY14 to INR1.5t (INR t)

INR trillion

HPCL

BPCL

IOCL

Total

0.9 1.0

0.7

0.5 0.5

1.1

0.9

0.8 0.8

59

0.6

0.5 0.5

0.4

0.3 0.2

0.3 0.3 0.3

0.2 0.2

0.3

0.2 0.3 0.3

0.3

0.2

0.2 0.2 0.1 0.1

0.3 0.3

0.1

0.1 0.1 0.0 0.1 0.1 0.1 0.2 0.2 0.2 0.3 0.3

0.0 0.0 0.0 0.0 0.1

9

11

9 5

8

2 5 1 3 12

18

17

13

7

5

3

4 8

2

20

15

Source: Company, MOSL

Source: Company, MOSL

Delayed Government compensation led to significant increase in working capital-led debt (INR b)

INR b

Receivables from government

29%

39%

22%

9%

298

325

319

11%

19%

Other debt

30%

26%

Gross debt

29%

13%

473

16%

495

Receivable a % of total

26%

800

28%

840

23%

885

9%

14%

18%

19%

578

228

213

250

242

267

252

302

329

333

FY09 FY10 FY11 FY12 FY13 FY14

HPCL

FY09 FY10 FY11 FY12 FY13 FY14

BPCL

FY09 FY10 FY11 FY12 FY13 FY14

IOCL

Source: Company, MOSL

Working capital reduction to increase EPS by 8-16%







While OMCs received the upstream subsidy through discounts, Government

compensation was delayed. Hence, OMCs had to fund the under-recovery till

the compensation was received from the Government.

During the last 12 months diesel under recoveries have come down significantly

leading to meaningful reduction in the OMC’s working capital requirement.

We estimate OMCs debt to reduce by 15-25% in the next one year, leading to 8-

16% EPS benefit, with HPCL at 16%, followed by BPCL at 9% and IOCL at 8%.

22 August 2014

10

Oil & Gas | Thematic

Diesel deregulation to reduce interest cost by 15-25%, leading to 8-16% increase in OMCs

earnings (INR b)

INR Billion

HPCL

BPCL

IOCL

Annual diesel sales (b ltrs)

16

20

40

FY14 avg. loss (INR/ltr)

8.4

8.4

8.4

Annual Diesel loss (INRb)

134

171

337

Daily Diesel loss - A

0.4

0.5

0.9

~48% Upstream Subsidy - B

0.2

0.2

0.4

Daily additional working capital = A - B

0.2

0.2

0.5

Cash subsidy delay (# of days)

200

200

200

Reduction in Debt

(38)

(49)

(96)

Interest rate on WC loans (%)

9.5%

9.5%

9.5%

Interest savings / PBT addition

4

5

9

Tax rate (%)

34%

34%

34%

Increase in PAT

2.4

3.0

6.0

# of shares

339

723

2428

Increase/ Decrease in EPS

7.0

4.2

2.5

Current FY14 Adj. EPS

44.2

48.5

30.9

EPS upside

16%

9%

8%

FY14 interest (INRb)

15

20

59

Savings as a % of FY14 interest

24

23

15

* FY14 EPS adjusted for forex change, inventory change and other exceptional

Source: Company, MOSL

Free market to improve marketing profitability, expect 18-35% EPS upside









The marketing margin component for OMCs’ marketing sales was fixed by the

Government in 2006 and despite the cost increases of 8-10%, OMCs got only

~4% of annual escalation. This led to a severe reduction in the marketing

division’s profitability.

Post the deregulation, we expect OMCs’ marketing division profitability to

increase meaningfully as we expect they will be able to charge higher marketing

margins.

Global comparison shows that the current marketing margin in diesel in India at

~INR1.4/ltr is way below the global averages.

HPCL being the highest leveraged to marketing volumes (standalone

marketing/refining ratio of 2x), we estimate an EPS increase of INR15.5/sh for

INR0.5/ltr increase in the diesel marketing margins, followed by BPCL and IOCL.

7.3

5.4

4.5

2.8

1.4

3.5

3.4

Global diesel marketing margin meaningfully above India’s level (INR/ltr)

India

US

Canada

Thailand

South

Africa

Australia

UK

*marketing margin includes costs. Costs in India are at ~50%

Source: PPAC, IMF, Shell, Industry, Australia govt., MOSL

22 August 2014

11

Oil & Gas | Thematic

INR0.5/ltr increase in marketing margin will upgrade OMCs EPS by 18-35%

INR Billion

Diesel Volumes (mmt)

Diesel Volumes (b ltrs)

Addl. mktg margin (INR/ltr)

Additional revenues

Addition to PBT

Tax rate (%)

Increase in net profit

# of shares

Increase/ Decrease in EPS

Current FY14 Adj. EPS

EPS upside

HPCL

13.1

16

0.50

8

8

34

5

339

15.5

44.2

35

BPCL

IOCL

16.8

33.1

20

40

0.50

0.50

10

20

10

20

34

34

7

13

723

2428

9.3

5.4

48.5

30.9

19

18

Source: Company, MOSL

EPS sensitivity to increase in marketing margin (INR/sh)

HPCL

68

63

39

BPCL

76

67

42

IOCL

84

91

High marketing/refining ratio leads to highest EPS sensitivity

in HPCL to marketing margin change

HPCL

BPCL

IOCL

89%

107%

52

48

44

31

FY14 adj.

EPS

53

34

0.25

60

58

36

72

45

77

47

36%

18%

10%

FY14 adj.

EPS

9%

0.25

19%

18%

71%

53%

39%

29%

27%

36%

48%

45%

58%

54%

0.50

0.75

1.00

1.25

1.50

Additional Marketing Margin (INR/ltr)

1.00

1.25

1.50

0.50

0.75

Additional Marketing Margin (INR/ltr)

Source: Company, MOSL

Source: Company, MOSL

22 August 2014

12

Oil & Gas | Thematic

Private entry unlikely to dent OMCs volume

Domestic volume growth to provide enough opportunity for all players





Private companies’ comeback, post diesel deregulation, is unlikely to dent OMCs

volumes in the near-to-medium term due to OMCs scale and pump economics.

Private players can gain market share in the bulk segment, but retail could be tough,

unlike 2004-07, as over the last 10 years, OMCs (a) have addressed quality perception

issues, (b) increased reach and (c) tied up with high volume fleet operators.



Over the long term, winners in the petroleum retail will be players who can (a)

modernize (value/service to customers, non-fuel retail), (b) have scale (reach to cater

fleet operators), (c) operate multi-fuel outlets and (d) be efficient (profitability focus,

real-time monitoring).

OMCs seem well prepared v/s previous deregulation period









We do not expect the re-entry of private players into the fuel retailing business

to meaningfully dent OMCs market share in the near to medium term. The long

term impact would be driven by differentiated strategies adopted by these

companies in the medium term.

In the previous period of brief deregulation (FY04-07), private players’ market

share had reached ~5% in gasoline and ~10% in diesel.

However, this time around, we do not expect the journey to be smooth for

private players, given that over the last decade, OMCs have been:

a)

Improving Purity Perception:

GPS tracker, surprise checks at dealer outlets,

tamper proofing, branding;

b)

Extending Reach:

Doubled retailed outlets at 9% CAGR to >49,000 in the last

decade;

c)

Customer engagement:

Loyalty cards, prepaid cards for transporters, and

d)

Automation:

Real-time tracking, superior inventory management etc.

Further, challenging retail fuel pump economics will be a major issue for private

player expansion.

OMCs have automated 100% of high volume (>200KLPM) retail outlets

Converted

35%

12,503

8,103

4,400

BPCL

Yet-to-convert

100%

16%

12,869

10,760

2,109

HPCL

25%

23,993

17,916

6,077

IOCL

HPCL

BPCL

2,108

3,945

5,877

-

IOCL

7,000

7,000

HPCL

9,730

565

9,165

BPCL

VMS on Trucks

100%

Total

100%

Automated /TPC as a % of total

100%

94%

80%

18,505

3,710

14,795

IOCL

Automation (full network)

Automation (>200KLPB)

Source: Company, MOSL

22 August 2014

13

Oil & Gas | Thematic

Earlier typical rural fuel pumps

OMCs have come a long way now:

Latest, highway fuel pumps also focus on non-fuel retailing

Source: Industry, MOSL

Source: Industry, MOSL

Key retail fuel brands in India

HPCL

BPCL

IOCL

Shell

Essar

RIL

Source: Company, MOSL

22 August 2014

14

Oil & Gas | Thematic

Fuel retail outlet economics challenging at low volumes







At an all-India level, average monthly fuel volume stood at ~179KLPM in FY14

and we estimate CRoCI of ~17% at these volumes.

We note that the retail fuel economics will vary widely depending on location

and volumes and land price will play a major role in pace of expansion for new

outlets.

As the calculation suggests, it is imperative to have higher throughput at the fuel

pump to make decent returns.

Excluding land costs, retail fuel pump economics get into not-so-attractive zone at lower volumes

in INR '000

Volumes (KLPM)

Annual volumes ('000 Litres)

Diesel dealer margin (INR/ltr)

Petrol diesel margin (INR/ltr)

Average Dealer Margin (INR/ltr)

Annual dealer revenues

Employee Cost

S,G&A

EBITDA

EBITDA (INR/ltr)

Depreciation (@ 5%)

Interest on WC (@ 11%)

PBT

Income tax (@ 30%)

PAT

PAT (INR/ltr)

CRoCI

Investment

*Cash return on cash invested

Case 1

100

1,200

1.2

2.0

1.4

1,716

720

401

595

0.50

225

95

275

82

192

0.16

9.3%

4,500

Case 2

125

1,500

1.2

2.0

1.4

2,145

900

444

801

0.53

225

119

456

137

319

0.21

12.1%

4,500

Case 3

150

1,800

1.2

2.0

1.4

2,574

1,080

508

986

0.55

225

143

618

185

433

0.24

14.6%

4,500

Case 4

175

2,100

1.2

2.0

1.4

3,003

1,260

563

1,180

0.56

225

167

788

236

551

0.26

17.3%

4,500

Case 5

200

2,400

1.2

2.0

1.4

3,432

1,440

644

1,348

0.56

225

191

932

280

653

0.27

19.5%

4,500

Comments

Last revised by INR0.1/ltr in Dec-13

Last revised by INR0.21/ltr in Dec-13

Petrol @1.99: Diesel @1.19 in ratio of

30: 70

Annual revenues to the retail outlet

Would vary between Highway and City

locations

Electricity, fuel shrinkage

Assumed inventory days at 4

Investment could vary between INR30-

60 lakh; excludes land cost

Source: Industry, MOSL

Indian demand potential has room for PSUs and private as well





Domestic diesel demand increased at 8% CAGR during FY08-13 period led by

economic growth, before remaining flat in FY14 led by (a) longest period of

continuous price increases effected by the Government and (b) shift-back to

alternate fuels like FO, which despite low quality had become cheaper than

diesel.

Over the next five year period, we estimate domestic auto fuel demand to grow

by 35-50% at a CAGR range of 5-7%.

22 August 2014

15

Oil & Gas | Thematic

Indian auto fuel demand has increased at 7% CAGR, with petrol at 8% and diesel at 6%

Diesel sales (b litres)

Gasoline sales (b litres)

20

21

22

24

9

46

10

44

11

44

11

45

12

48

12

49

13

52

15

16

18

58

63

68

73

78

84

83

FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14

Source: MoPNG, Industry, MOSL

At a domestic GDP growth of 6-9%, expect Indian auto fuel demand to grow 35-50% in the

next 5 years at a 5-7% CAGR (b ltr)

Petrol +

Diesel

(in b litres)

112

107

114

5% CAGR

6% CAGR

131

7% CAGR

130

140

136

150

143

152

160

118

122

124

113

120

127

135

143

FY14

FY15

FY16

FY17

FY18

FY19

FY20

Source: MOSL

22,000 new fuel retail stations required in the next five years





The continuous outlet growth by OMCs over the last decade brought down the

average volume per outlet from 241KLPM (kilo litre per month) to 170KLPM in

FY04.

At an average throughput of 170KLPM and at 5% CAGR of demand growth, we

estimate that additional 22,000 new outlets will be required by FY20.

Estimate requirement of 22,000 new retail fuel outlets by FY20

241 241

Outlets (No.)

214

194

Throughput (KLPM)

189 185 190 185

170 170 170 170 170 170 170

168 162 164 180

*Auto fuel volume growth assumed at ~6%

Source: MOSL

22 August 2014

16

Oil & Gas | Thematic

Highlighted states would see a significant outlet addition in the coming decade

6,500

5,200

UP

AP

TN

3,900

Punjab

Karnataka

Rajasthan

Haryana

Maharashtra

2,600

WB

1,300

Bihar

MP

Kerala

Gujarat

0

100

Jharkhand Odisha

Chhattisgarh

Goa

Uttarakhand Pondicherry

J&K

Delhi

Assam

Meghalaya

Chandigarh

HP

Volume (KLPM) - Logarithmic scale

400

Source: MoPNG, PPAC, MOSL

Absolute volume loss for OMCs unlikely



Now, in the worst case scenario, even if we assume a 15% market share loss on

a full volume in FY20 to private players, OMCs will still have a volume CAGR of 2-

4%.

Low market share loss was seen in gasoline (largely urban

Private players opened outlets in highways, impacting diesel

fuel) as OMCs were well entrenched in large cities and towns market share of OMCs

Gasoline

-

25

32

0

25

31

IOCL

1

25

30

BPCL

5

24

29

HPCL

5

24

28

Private

5

24

28

1

25

29

Diesel

-

21

24

IOCL

0

20

24

4

19

23

BPCL

10

18

21

HPCL

6

18

23

Private

3

19

24

1

20

24

44

44

45

43

43

43

45

55

55

54

51

53

53

54

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY03

FY04

FY05

FY06

FY07

FY08

FY09

Source: MoPNG, Industry, MOSL

Source: MoPNG, Industry, MOSL

Even at 15% market share loss, OMC volume will grow at 2-4% through FY20 (b litres)

Worst case OMC volume

107

107

Best cas private volume (~15% market share)

143

21

122

@5% CAGR

FY14

152

23

129

136

160

24

Total

@6% CAGR

FY20

@7% CAGR

Source: MOSL

22 August 2014

17

Oil & Gas | Thematic

Long term winning strategy for fuel retailers





Indian domestic fuel retail business has come a long way from a traditional pure

fuel dispensing station to a multiservice model creating a cross selling

opportunity.

While the underlying growth drivers for the fuel retail industry will continue to

be demand growth led by new vehicle addition and miles travelled, winners in

the business will be in a free market driven by multiple factors and not presence

alone, which is the current case.

Likely evolution of downstream fuel retailing business

Rise of Hyper markets

Focus on service/non-

fuel

Focus on efficiency /

reach

- Increased

competition with

entry of new players.

- Profitability focus

through elimination

of low profit outlets

and improve internal

efficiencies.

- Modernization of

outlets to give more

value and service to

the consumer

- Innovative schemes

to promote

customer loyalty

- Focus on non-fuel

retailing leading to

multiple retail outlet

formats.

- Focus on branding

as fuel sales could

shift to

hypermarket model

which will have

multi brand fuels

- Focus on multi fuel

outlets

- Dynamic real-time

pricing to improve

profitability

Source: Industry, MOSL



Some of the new themes which will drive the market share for various fuel

retailers will be:

a)

Outlet modernization and branding:

value/service to customers through

proactive interaction, non-fuel retail business, brand development.

b)

Scale:

control on supply chain, presence at strategic locations and nation-

wide reach to cater fleet operators.

c)

Multi-fuel selling capability:

Ability to supply petrol, diesel, CNG, LNG (not

yet in India) and electric charging (longer term) and,

d)

Efficiency:

Profitability focus, real-time monitoring for inventory

management, dynamic pricing.

22 August 2014

18

Oil & Gas | Thematic

Expect multiple retail formats to emerge in coming years

Source: Industry, MOSL

22 August 2014

19

Oil & Gas | Thematic

Expect OMC’s to benefit by forward integration





In an era of volatile refining margins, apart from marketing business, forward

integration could be an effective value creation route for OMC’s in our view.

Overall RoE’s will improve by (1) utilizing surplus naphtha, (2) cost savings by shared

utilities and infrastructure, and (3) exploitation of potential in specialty/niche

products.



Also, risks would reduce with (1) stable company-level margins, (2) higher operational

flexibility with well integrated hydrocarbon processes, and (3) control on feedstock

supply chain.

Pure refining business becoming more challenging...







Over the last decade, refining business has become more challenging with

volatile/low GRM and high energy costs.

Higher

global refining complexity

and scale has enabled heavier crude

consumption, increased distillate yields and reduced refining costs, leading to

narrowing of

light-heavy crude spreads

and

declining GRM/crude cost ratio.

Over last five years, crude cost has increased by USD30 / bbl, while operating

cost are increasing @ 8-10% leading to USD3-4/bbl impact on GRM.

…investments inevitable to survive in the new normal



While the short-term opportunities include optimization of multiple CDU’s and

other processes along with the crude mix, long-term opportunities for refining

companies are:

1. Up-gradation of scale for

2. Lowering of energy cost,

3. higher complexity, with focus shift from reforming and cracking to coking, to

destruct heavier products (FO and coke),

4. investments to produce low sulphur/cleaner fuels, and

5. deep integration of refining with downstream petchem businesses, utilizing

naphtha and gaining flexibility.

Declining GRM/crude ratio (%) is evident of challenges being faced by pure refining players

25

20

15

10

5

0

Aug-04

Aug-06

Aug-08

Aug-10

Aug-12

Aug-14

GRM/Brent crude price (%)

Source: Bloomberg, Reuters, MOSL

22 August 2014

20

Oil & Gas | Thematic

Refiners globally shifting focus towards (1) higher complexity, (2) larger scale, and (3) vertical integration

North America

Europe



Higher utilization led by low



Dieselization has led

cost WTI

to imbalance target



Gearing refineries to process

product mix (long

heavier Canadian oil sand

gasoline, short

diesel)

crudes



Targeting to increase scale



Low capacity

utilization leading to

uneconomical

operations

Middle East



Production exports being

shifted to local refining and

downstream products



Cheaper raw material and

energy costs are the key

drivers

Asia Pacific



Shifting to larger scale and

increasing complexity

Source: MOSL

Petchem integration to offer diversification and stability in earnings







While, naphtha spread over crude has remained negative and volatile, value

added petrochemical manufacturing through naphtha shall improve

profitability.

We expect significant cost reduction through (1) shared utilities, infrastructure

and services, (2) reliable feedstock availability and lower transportation costs,

and (3) energy savings in integrated hydrocarbon processes.

Expect higher margin realizations and better yield patterns, led by diversification

across the value chain and exploitation of higher margin plastics, and niche

products.

Integrated players across globe realize higher average RoCE (%)

15

12

9

6

3

0

2005

2006

2007

2008

2009

2010

2011

2012

2013

Petchem

Refining

Integrated

Source: Bloomberg, MOSL

Integration into downstream chemical can significantly reduce risks







While, globally competitive refining has led to pressure on its margins,

integration into petchem shall provide stability to the margins realized.

Expect risk reduction led by improved flexibility of operation among products

and processes, adjusting to the changing markets.

Expect minimal or lower dependence for feedstocks and product supply

markets.

22 August 2014

21

Oil & Gas | Thematic

5 year RoCE average (%): Integrated players show better returns as against pure petchem and refining companies

50

40

30

20

10

0

-10

Petchem Companies

5-year average pre-tax RoCE (%)

Refining & Marketing companies

Integrated Companies

Source: Company, MOSL

5 year RoA average (%): Integrated players show better returns as against pure petchem and refining companies

14

10

6

2

-2

Petchem Companies

5-year avg. RoA (%)

Refining & Marketing compaies

Integrated companies

Source: Company, MOSL

22 August 2014

22

Oil & Gas | Thematic

OMC’s to benefit from diesel deregulation and

likely marketing margin increase

BPCL is our top pick in OMC’s





Ongoing reforms leading to earnings predictability and RoE improvement have the

potential to transform OMCs into a structural investment plays in our view.

Diesel price is set to be market linked in coming months and as anticipated (Refer

report March 2013), in the initial period of diesel reforms OMC’s earnings are (a) being

benefited from lowering of interest and (b) later will be benefited by likely increase in

the diesel margins in our view.



BPCL is our top pick (stable refining margins, E&P upsides, strong balance sheet)

followed by IOCL (diversified earnings, EPS accretive Paradip refinery) and HPCL.

Expect OMCs to move from trading plays to structural investment plays







Significant unpredictability in the earnings of OMCs was preventing investors

from take a long term view and thereby making them a trading play.

Ongoing reforms have the potential to transform OMCs to a structural

investment play in our view, for the following reasons:

a) Earnings predictability will improve and normalization of earnings will be a

key catalyst



Diesel deregulation to lower overall under-recovery significantly and subsidy

sharing is likely to be rationalized



Large savings in interest cost with freeing up of working capital debt

b) RoEs likely to move up from single digit to double digits

c) Inherent business triggers to increase profitability



A INR0.5/ltr increase in diesel marketing margin will increase OMCs PBT by

INR40b (@80n liters of India diesel consumption), which equals 24% of

combined OMCs PBT in FY14.

BPCL is our top pick in OMCs due to its relatively strong balance sheet,

operational upsides through capacity additions/complexity improvement and

E&P upside potential (key differentiator vis-à-vis HPCL and IOCL).

FY16 E EPS

Fair value

980

1,073

449

497

544

592

Earnings and fair value show high sensitivity to diesel marketing margins (INR/sh)

527

649

771

893

96.8

795

888

50.3

65.8

81.3

48.3

57.6

66.8

76.1

39.5

44.9

50.4

55.8

Base case

MM

MM

MM

@0.5/ltr @1.0/ltr @1.5/ltr

HPCL

Base case

MM

MM

MM

@0.5/ltr @1.0/ltr @1.5/ltr

BPCL

Base case

MM

MM

MM

@0.5/ltr @1.0/ltr @1.5/ltr

IOCL

*fair value sensitivity based on implied P/E on our target price post investments

Source: MOSL

22 August 2014

23

Oil & Gas | Thematic

We expect that OMC’s RoE’s which had fallen to single digit are now likely to improve to a

healthy double digit range (%)

25

20

15

10

5

0

FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17

HPCL

BPCL (Cons)

IOCL (Cons)

Source: Company, MOSL

HPCL has highest sensitivity to marketing margins given high marketing to refining ratio (x)

HPCL

2.2

1.9

1.6

1.3

1.0

FY09

FY10

FY11

FY12

FY13

FY14

2.0

BPCL

IOCL

HPCL (incl. JV share)

BPCL (incl. JV share)

1.55

1.5

1.4

1.29

Source: Company, MOSL

Segmental EBITDA break-up (%): IOCL has well diversified earnings with large pipeline and

petchem contribution

67

55

45

Marketing

9

29

Petrochemicals

Pipelines

Refining

-

6

-

18

15

HPCL

BPCL

39

17

IOCL

Source: Company, MOSL

22 August 2014

24

Oil & Gas | Thematic

Annexure 1: Petroleum product price trend in India

Diesel price trend in India

68

54

40

26

12

Aug-04

Aug-06

Aug-08

Aug-10

Aug-12

Diesel (INR/ltr)

Chg (%) - RHS

20%

10%

0%

-10%

-20%

Aug-14

Petrol price trend in India

Petrol (INR/ltr)

84

67

50

33

16

Aug-04

Aug-06

Aug-08

Aug-10

Aug-12

Chg (%) - RHS

20%

10%

0%

-10%

-20%

Aug-14

Source: MOSL, Company

Source: MOSL, Company

Kerosene remained regulated in the past decade (INR/ltr)

20

15

10

5

0

Aug-04

Aug-06

Aug-08

Aug-10

Aug-12

Kerosene (INR/ltr)

Chg (%) - RHS

30%

20%

10%

0%

-10%

Aug-14

LPG price trend in India (INR/cyl)

500

425

350

275

200

Aug-04

Aug-06

Aug-08

Aug-10

Aug-12

LPG (INR/Cyl)

Chg (%) - RHS

20%

10%

0%

-10%

-20%

Aug-14

Source: MOSL, Company

Source: MOSL, Company

Petrol-diesel price differential declining as diesel gets deregulated

Retail prices (INR/ltr)

90

70

50

30

10

Petrol

Diesel

Price Difference - RHS

36

28

20

12

4

Source: Company, MOSL

22 August 2014

25

Oil & Gas | Thematic

Annexure 2: Petroleum product consumption trend and drivers

Auto and domestic fuel growth (%):

20%

13%

5%

-3%

-10%

FY02

FY04

FY06

FY08

FY10

FY12

FY14

Total (YoY %)

MS

HSD

LPG

SKO

26%

12%

-2%

-16%

-30%

FY02

FY04

FY06

FY08

FY10

FY12

FY14

Industrial fuel/feedstock growth (%):

Total (YoY %)

FO

Naptha

Source: MOSL, Industry

Source: MOSL, Industry

Diesel demand break-up: Transport sector accounts for 70%

of India’s diesel demand (%)

Cars/UVs -

Private

13.2%

Mobile

tower

1.5%

Others

5.0%

Gensets

10.5%

HCV/LCV

28.3%

Cars/UVs -

Comm.

8.9%

Buses

9.6%

3-wheelers

6.4%

Railways

3.2%

Agriculture

13.0%

Aviation/shi

pping

0.5%

Petrol demand break-up: Two-wheelers dominate petrol

demand, with 61% share (%)

3-wheelers

2.3%

SUVs

1.5%

Others

0.4%

2-wheelers

61.4%

Cars

34.3%

Source: MOSL, PPAC

Source: MOSL, PPAC

HCV/LCV sales drive diesel sales with a lag

HCV/LCV Sales('000)

300

225

150

75

0

Diesel Sales (kbpd) - RHS

1,800

1,350

900

450

0

Strong correlation of two-wheeler and petrol sales

2-wheeler Sales ('000)

4,000

3,000

2,000

1,000

0

Petrol sales (kbpd) - RHS

440

330

220

110

0

Source: Industry, SIAM, PPAC, MOSL

Source: Industry, SIAM, PPAC, MOSL

22 August 2014

26

Oil & Gas | Thematic

Annexure 3A: Refineries in India

Company / Location

Year

Capacity

Comments

(mmt) (kbpd)

0.7

1.0

13.7

13

20

274











Barauni, Bihar

Haldia, West Bengal

July-1975

Jan-1975

6.0

7.5

120

150





















Visakh, Andhra Pradesh

1957

8.3

166





































Reliance Industries Ltd (RIL)

Jamnagar, Gujarat

Jul-1999

Jamnagar (SEZ), Gujarat

Dec-2008

Essar Oil (Vadinar), Gujarat

Nov-2006

Total

33.0

29.0

20.0

217.1

660

580





Established by Assam Oil Co. and was later taken over by IOCL in 1981.

Capacity Change (mmtpa): 0.5 (1901), 0.65 (1996) and currently at 0.7.

First public sector refinery set up (~INR 173m) in Romanian

collaboration.

Built with Soviet collaboration (INR260m); to process crude from

Ankleshwar, Kalol and Nawagam in Gujarat.

Capacity (mmtpa): 2 (1965), 4.3 (1967), 7.3 (1978), 9.5 (1989), 12.5

(1999) and now at 13.7mmtpa.

Built in collaboration with the Soviet Union at a cost of INR494m.

Capacity mmtpa): 3.3 (1969), 4.2 (2000), 6.0 (2002) and now at 6.0.

In collaboration with France (fuel products) and Romania (Lube oil base).

Capacity (mmtpa): 2.5 (1975), 3.2 (1988), 3.4 (1996), 4.4 (1997), 5.8

(1999) and 7.5 (2010)

Cost of INR2.5b; Capacity (mmtpa): 6 (1982), 7.5 (1989) and now at 8.

Cost ~INR39b; Cap. (mmtpa): 6 (1998), 12 (2006), 15 (2010) & now at 15.

Capacity Chg (mmtpa): 1 (1979), 1.35 (1987), 2.35 (1995) and now at 2.4.

First owned by Standard Vacuum (StanVac); renamed ESSO India in

1962

In 1969 Lube India formed to manufacture LOBS; in 1974 ESSO and Lube

India nationalized and merged to form HPCL

Capacity (mmtpa): 1.25 (1952), 2.5 (1969), 3.5 (1983), 5.5 (1985), 6.5

(2009) and now at 6.5.

First oil Refinery on the East Coast, commissioned by Caltex Oil

Taken over by the Government of India in 1976 and was consequently

amalgamated with HPCL in 1978.

Cap (mmtpa): 0.68 (1957), 4.5 (1985), 7.5 (1999), 8.3 (2010); now at 8.3.

A JV between HPCL and Mittal Energy Ltd. located in Bathinda, Punjab

First owned by Burmah Shell Refineries Ltd.; later acquired by Govt and

transferred to BPCL in 1976.

Capacity (mmtpa): 2.2 (1955), 6 (1985), 12 (2005) and now at 12.

Set up under agreement between Govt. of India, Philips Petroleum Co. of

USA and Duncan Brothers of Calcutta.

BPCL acquired Govt's stake in 2001 and amalgamated with BPCL in 2006

Cap (mmtpa): 2.5 (1963), 3.3 (1973), 7.5 (1994), 9.5 (2010) & now at 9.5.

Set up by Bharat Oman Refineries Limited (BORL), a JV of BPCL and

Oman Oil Corp Ltd (OOCL) at a cost of INR122b.

Setup to fulfill the commitment by govt. under " Assam Accord" of 1985

Shareholders: BPCL (61.65%), OINL (26%) and Govt of Assam (12.35%).

JV of Govt. (74%), AMOCO (13%) & National Iranian Oil Co. (NIOC – 13%)

IOCL acquired govt stake in FY01; Cap.(mmtpa): 2.5 (1965) & now at

10.5.

Capacity (mmtpa): 0.5 (1993) and currently at 1mmtpa.

Built at an approved cost of INR270m.

Set up as a JV of HPCL and A V Birla Group; In 2003 ONGC acquired Birla

stake and infused equity making MRPL a majority held ONGC subsidiary.

Capacity change (mmtpa): 3.7 (1996), 11.8 and currently at 15mmtpa.

Is the World’s largest grassroots Refinery.

Amalgamation Reliance Petroleum Ltd with RIL in 2009.

Capacity (mmtpa): 10.5 (2006), 14 (2009) and now at 20mmtpa.

Indian Oil Corporation (IOC)

Digboi, Assam

1901

Guwahati, Assam

Koyali, Gujarat

Jan-1962

Oct-1965

Mathura, UP

Panipat, Haryana

Bongaigaon, Assam

Jan-1982

1998

Feb-1974

8.0

15.0

2.4

6.5

160

300

47

130

Hindustan Petroleum Corporation Ltd (HPCL)

Mumbai,

1952

Maharashtra

HPCL - Mittal JV, Bhatinda

Apr-2012

9.0

12.0

180

240

Bharat Petroleum Corporation Ltd (BPCL)

Mumbai

Jan-1955

Maharashtra

Kochi, Kerala

Apr-1963

9.5

190

BPCL- OOCL JV; Bina, MP

Numaligarh, Assam

May-2011

Oct-2000

6.0

3.0

120

60

Chennai Petroleum Corporation Ltd (CPCL)

Manali, Tamilnadu

1967

10.5

210

Narimanam, Tamilnadu

ONGC; Tatipaka, AP

MRPL;

Mangalore, Karnataka

1993

Sep-2001

Mar-1996

1.0

0.1

15.0

20

1

300

400



4,341

22 August 2014

27

Oil & Gas | Thematic

Annexure 3B: Map of refinery locations

Source: MOSL

22 August 2014

28

Oil & Gas | Thematic

Annexure 4: Under-recovery and their sharing

Under-recovery: Our FY16 subsidy estimate assumes Brent at USD105/bbl

Marketing

Losses

LPG

INR493/cyl

INR531b

Kerosene

INR31.2/ltr

INR244b

MS

nil

nil

Diesel

nil

nil

HPCL (~24%): INR181b

BPCL (~23%): INR170b

IOC (~53%): INR399b

Gross under-recovery:

INR751b

64%

Upstream

INR480b

Subsidy

Sharing

ONGC (84.4%): INR405b

34%

Oil bonds

INR255b

HPCL: INR61b

BPCL: INR58b

IOC: INR135b

2%

OMCs

INR15b

HPCL: nil

BPCL: nil

IOC: nil

GAIL (2.4%): INR11b

OIL (13.2%): INR11b

Source: MOSL

Under-recovery: We model upstream sharing at INR588/480b for FY15E/16E

(INR b)

FY06

Fx Rate (INR/USD)

44.3

Brent (USD/bbl)

58

Product Sales (mmt)

64

Product-wise Gross under-recovery (INR b)

Petrol

27

Diesel

126

Kerosene

144

LPG

102

Total

400

Sharing of Gross under-recovery (INR b)

Government

115

Upstream

140

OMC's

138

Total

400

Sharing of Gross under-recovery (%)

Government

29

Upstream

35

OMC's

35

Total

100

Sharing within Upstream Sharing (INR b)

ONGC

120

OIL

10

GAIL

11

Total

140

Sharing within Upstream Sharing (%)

ONGC

85

OIL

7

GAIL

8

Total

100

FY07

45.2

64

69

20

188

179

107

494

241

205

48

494

49

42

10

100

170

20

15

205

83

10

7

100

FY08

40.3

82

76

73

353

191

156

773

353

257

163

773

46

33

21

100

220

23

14

257

86

9

5

100

FY09

46.0

85

83

52

523

282

176

1,033

713

329

(9)

1033

69

32

(1)

100

282

30

18

329

86

9

5

100

FY10

47.5

70

91

52

93

174

143

461

260

145

56

461

56

31

12

100

116

15

13

144

80

11

9

100

FY11

45.6

86

96

27

348

200

205

780

410

303

67

780

53

39

9

100

249

33

21

303

82

11

7

100

FY12

47.9

114

100

0

812

278

284

1,385

829

552

0

1,385

60

40

0

100

445

74

32

550

81

13

6

100

FY13

54.5

111

104

0

915

296

399

1,610

1,000

600

10

1,610

62

37

1

100

494

79

27

600

82

13

4

100

FY14 FY15E FY16E FY17E

60.6

59.0

58.0

58.0

108

108

105

100

98

111

117

122

0

628

306

465

1,399

707

671

21

1,399

51

48

2

100

564

88

19

671

84

13

3

100

0

186

275

457

918

312

588

18

918

34

64

2

100

496

78

14

588

84

13

2

100

0

0

244

597

750

255

480

15

750

34

64

2

100

405

63

11

480

0

0

210

481

691

235

443

14

691

34

64

2

100

374

58

11

443

84

84

13

13

2

2

100

100

Source: MOSL

22 August 2014

29

Oil & Gas | Thematic

Under-recovery: sensitivity analysis

For every USD1/bbl variation in oil price:



Gross under-recovery (U/R) changes by INR41b.



Diesel U/R changes by INR27b (~65% of gross change).



Kerosene U/R changes by INR3b (~8% of gross change); LPG U/R changes by

INR11b (~27% of gross change).

Every INR1/USD variation in exchange rate changes U/R by INR98b (oil at USD110-

120/bbl). Impact of INR1/ltr price hike on U/R: Diesel – INR81b; Kero – INR12b, and

LPG hike of INR25/cyl – INR24b.

Under-recovery: sensitivity analysis

Gross Under recoveries (INRb)

Brent (USD/bbl)

90

56

510

58

547

60

583

62

710

64

871

Diesel (INRb)

Brent (USD/bbl)

56

58

60

62

64

66

Kerosene (INRb)

Brent (USD/bbl)

56

58

60

62

64

66

LPG (INRb)

Brent (USD/bbl)

56

58

60

62

64

66

90

0

0

0

90

214

338

90

188

199

210

220

231

242

90

322

348

374

400

426

451

100

641

683

787

964

1,142

100

0

0

63

199

335

470

100

217

229

241

253

265

277

100

424

454

483

513

543

572

105

707

750

906

1,092

1,278

105

0

0

112

253

395

537

105

231

244

256

269

281

294

105

475

507

538

570

601

633

110

811

870

1,064

1,258

1,452

110

38

51

199

346

494

642

110

246

259

272

285

298

311

110

526

560

593

626

660

693

115

1,007

1,111

1,313

1,515

1,718

115

169

224

378

531

685

839

115

260

274

287

301

315

328

115

577

613

648

683

718

753

120

1,203

1,352

1,562

1,773

1,984

120

299

397

557

716

876

1,035

120

275

289

303

317

331

345

120

629

666

703

740

777

814

Gross U/R without Diesel (INRb)

90

100

105

510

641

707

547

683

750

583

724

794

620

766

838

657

807

882

Diesel (INR/ltr)

90

100

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

1.4

0.0

3.1

Kerosene (INR/ltr)

90

100

24.2

27.9

25.6

29.4

27.0

30.9

28.3

32.3

29.7

33.8

31.1

35.3

LPG (INR/cylinder)

90

100

322

417

346

444

369

471

393

498

416

525

440

552

105

0.0

0.0

0.3

2.0

3.7

5.5

105

29.7

31.2

32.8

34.4

35.9

37.5

105

464

493

522

550

579

608

110

772

818

865

911

958

110

0.0

0.6

2.4

4.2

6.0

7.8

110

31.5

33.1

34.7

36.4

38.0

39.6

110

512

542

572

603

633

663

115

838

886

935

984

1,033

115

0.8

2.7

4.6

6.5

8.4

10.2

115

33.3

35.0

36.7

38.4

40.1

41.8

115

559

591

623

655

687

719

120

903

954

1,006

1,057

1,108

120

2.9

4.8

6.8

8.7

10.7

12.6

120

35.1

36.9

38.6

40.4

42.1

43.9

120

607

640

674

708

741

775

Source: MOSL

22 August 2014

30

Oil & Gas | Thematic

Annexure 5: Petroleum pricing in India

Era

Period

Till 1939

Details



Burmah - Shell, London office computed/advised on prices.



Retail selling price in India was worked out after adding railway freight, local taxes

etc.

1939-1948

Market determined



Burmah - Shell, Stanvac, Caltex and BOC operated a price pool for Kerosene and

Petrol.



For HSD, daily prices were fixed by individual oil companies.

1948-1958

Value Stock Accounting



Under VSA agreement, a cost plus formula with import parity price linked to

(VSA): First regulation

‘Abadan’ Iran plus freight to India, insurance, ocean loss, import duty and other

attempt - Fore-runner to levies/charges)

oil pool mechanism



Burmah - Shell, maintained VSA for each product. Collections at provisional basic

selling price were set off against actual costs. Surplus/deficit were either

ploughed back/recouped from by adjusting selling price.

1958-1961

Ad-hoc arrangement

1961-1965

Oil Price Enquiry

Committee (OPEC)

1966-1970



K.R. Damle committee

found out that sales to other countries were at a

significant discount, hence proposed the linkage of Prices to lowest prices at

Abadan, Iran less discounts.

Working Group on Oil



Talukdar committee

recommended no major change, but asked for higher

Prices (WGOP) Formula

discount

on

FOB

basis.

Effective September 1967, prices were linked to posted prices at ‘Bandar

Mahshahr’ in Iran.

Oil Prices Committee



Shantilal Shah committee

concluded that Import parity pricing was not correct,

but due to lack of cost data and govt. commitment to oil companies it is adopting

(OPC)

import

parity

pricing.

Also, inland refineries were also made pricing points to compensate from

additional freight cost

After 1973 Oil Crisis,



OPC under K. S. Krishnaswamy recommended shift from import parity to “cost

plus basis” (APM).

govt. formed Oil Prices

Committee (OPC) and



In 1984, OCRC, under J. S. Iyer changed compensation basis from a flat rate on CE

to 12% post tax RONW and weighted cost of borrowings; Applicable till March 31,

later in 1984 Oil Cost

Review Committee

1998.

(OCRC)

a) Upstream: Crude FOB = Normative opex + 15% post-tax RoCE + levies like

royalty and cess;

b) Refining: Ex-refinery price = Cost of crude + normative opex + 12% post-tax

RONW;

c) Price to Consumers = Marketing Margin (MM) + Ex. refinery price +

Surcharges + other duties/taxes; MM = Normative opex, and a 12% post-tax

RONW.



Oil Pool Accounts maintained by Oil Co-ordination Committee (OCC): Crude Oil

Price Equalisation (COPE) Account, Cost and Freight (C&F) Account, Product Price

Adjustment (PPA) Account



Lubricants decontrolled in 1993

Import Parity Pricing



In November 1997, government notified phased dismantling of APM with full

dismantling by April 2002.



From April 1, 1998, moved to adjusted import parity pricing for MS, HSD, SKO, ATF

and LPG



De-regulated Naphtha, FO/LSHS, and Bitumen from April 1998 and ATF from April

2001.



In Oct 2003, MOP&NG approved a sharing of OMCs losses on PDS kero/dom. LPG

by upstream companies.

Trade Parity Pricing



Rangarajan committee recommendation implemented from June 2006 to move to

trade parity pricing (with weight of 80 % Import Parity Pricing and 20 % Export

Parity Pricing)



Petrol deregulated in June 2010.



In June 2013, allowed INR0.5/ltr monthly price hikes in diesel, set to be

deregulated in next few months. Bulk consumers to pay market linked price



Limited LPG cylinders to 12/household/yr, and shift to direct benefit transfer

(DBT) in LPG and PDS Kerosene

Pricing mechanism

Market determined

Till 1974

Market

Determined

Pricing

(MNC's were

actively doing

business in India

1970-1975

1975-1998

APM Era: 1975-

1998

(A cost-plus

pricing system for

producers,

together with

cross-

subsidization

scheme for end-

users )

1998-2006

Post APM Era

2006

2010-till

date

On-going reforms

22 August 2014

31

Oil & Gas | Thematic

Annexure 6: Key recommendations of oil sector expert committees

Recomm-

endations

on

Rangarajan

Committee

(Feb-06)

Pricing methodology for

Petroleum products



Chaturvedi

Committee

(2008)





Pricing of Petroleum

products should be

on trade parity

pricing (TPP) -

weighted avg of

import (IPP) and

export (EPP) parity

price in 80:20 ratio.

Pricing of petroleum

products should be

EPP, as the IPP prices

are higher than the

International/FOB

prices.

Shift retail prices

from incl. of state

taxes to before state

tax prices (to avoid

inter-state tax

differences.

Petrol and diesel

pricing and

subsidy



OMC's should

be allowed to

fix retail prices

of petrol and

diesel, subject

to ceiling.

Kerosene pricing

and subsidy



LPG pricing and

subsidy



Subsidy sharing

recommendations



Subsidy in

kerosene to be

given only to

BPL families.

Increase LPG

price by

INR75/cyl,

and gradually

deregulate

LPG.



Subsidies from ONGC, OINL

and GAIL should be

discontinued

OIDB cess collected from

ONGC/OINL to be increased

from INR1,800/MT to

INR4,800/MT.





Diesel prices to

be adjusted in

24 months by

small gradual

price hikes.

Petrol and

diesel prices to

be deregulated

by March

2009.



Restrict

subsidized

kerosene supply

only to BPL

families

through issuing

smart cards.



Subsidy on

LPG to be

phased out in

three years.

Kirit Parikh

Committee

(Feb-10)







Kirit Parikh

Committee

(Oct-13)



Deregulate

Petrol &

diesel

Well-off

people use

vehicles,

hence no

need for

subsidy.

Impact on

agriculture

can be

compensated

by higher

MSP.

Petrol prices

to be

adjusted by

March 2009.



Increase

kerosene

price by

INR6/ltr and

revise it in

steps with

growth in per

capita

agricultural

GDP at

nominal

prices.



LPG price

increase by

at least

INR100/cyl

and to

revise

based on

increase in

per capita

income

Retail prices to be brought in-

line with market, under-

recoveries should be financed

temporarily through special oil

tax:

1. 100% tax on realization

above USD75/bbl for

ONGC/OINL; 40% tax for

private players/JVs prior to

NELP.

2. Cut-off price of USD75/bbl

be reviewed periodically in

view of investment needs of

E&P companies.

3. Subsidy contribution from

GAIL to be fixed at INR5b.



ONGC and OINL subsidy on

slab-based taxes at different

oil prices



ONGC's formula: Tax nil till

USD60/bbl; incremental tax-

slabs of 20/40/60/80% on

incremental revenue for

USD60-70-80-90/bbl crude

price respectively.



Rest to be shared by GoI.





Increase

kerosene

price by

INR6/ltr and

revise it in

steps with

growth in per

capita

agricultural

GDP at

nominal

prices.



LPG price

increase by

at least

INR100/cyl

and to

revise

based on

increase in

per capita

income.







Subsidy to be shared by

ONGC and OINL to bear tax

on slab-based on rates at

different crude oil prices

ONGC's formula): Nil tax till

USD60/bbl crude;

incremental tax-slabs of

20/40/60/80% on

incremental revenue for

USD60-70-80-90/bbl crude

price respectively.

Rest to be shared by GoI.

Source: MoPNG, PPAC, MOSL

*TPP - Trade Parity Price;

EPP

- Export Parity Price;

IPP

- Import Parity Price;

OIDB

- Oil Industry Development Board

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Oil & Gas | Thematic

Annexure 7: OMC’s 1 year forward P/E and P/B charts (15 years)

BPCL: 1 year forward P/E (x) chart

32

24

16

12.6

8

0

10.3

13.4

14.9

P/E (x)

5 Yrs Avg(x)

15 Yrs Avg(x)

10 Yrs Avg(x)

BPCL: 1 year forward P/B (x) chart

P/B (x)

5 Yrs Avg(x)

Adj. P/BV (excl. E&P)

15 Yrs Avg(x)

10 Yrs Avg(x)

2.2

1.3

1.4

1.3

2.6

2.0

1.4

0.8

0.2

Source: Company, MOSL

Source: Company, MOSL

HPCL: 1 year forward P/E (x) chart

30

23

16

9.2

9

2

9.4

P/E (x)

5 Yrs Avg(x)

15 Yrs Avg(x)

10 Yrs Avg(x)

HPCL: 1 year forward P/B (x) chart

2.2

1.7

1.2

10.0

0.7

0.2

1.0

0.8

0.9

1.0

P/B (x)

5 Yrs Avg(x)

15 Yrs Avg(x)

10 Yrs Avg(x)

10.9

Source: Company, MOSL

Source: Company, MOSL

IOCL: 1 year forward P/E (x) chart

28

21

14

7

0

9.9

8.2

P/E (x)

5 Yrs Avg(x)

15 Yrs Avg(x)

10 Yrs Avg(x)

IOCL: 1 year forward P/B (x) chart

2.8

2.2

1.5

P/B (x)

5 Yrs Avg(x)

1.3

1.2

1.1

1.2

15 Yrs Avg(x)

10 Yrs Avg(x)

9.9

10.2

0.9

0.2

Source: Company, MOSL

Source: Company, MOSL

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