Oct. 30 (Bloomberg) -- Oil & Natural Gas Corp., India's biggest explorer, reported an unexpected drop in second-quarter profit after it was forced by the government to sell crude to state-owned refiners at below market rates.

Net income fell to 48 billion rupees ($967 million) in the three months ended Sept. 30 from 51 billion rupees a year ago, the company said today. Earnings were expected to rise to 63.3 billion rupees, according to the median estimate of 13 analysts surveyed by Bloomberg.

While record oil prices lifted profits for global peers Exxon Mobil Corp. and Royal Dutch Shell Plc, Oil & Natural's gains were limited because it had to pay a record subsidy to refiners for selling fuels below cost. Crude's slump this quarter may not eliminate the payments because India caps gasoline and diesel at below global prices to tackle inflation.

``I am in a dilemma when addressing the subsidy to investors,'' Chairman R.S. Sharma told reporters today in New Delhi. ``We have to see this is done away with.''

Subsidy payouts totaled 126.6 billion rupees in the quarter, or the equivalent of $72.70 a barrel, compared with 38 billion rupees, or $22 a barrel, a year ago, Sharma said. That reduced earnings to $46.70 a barrel from $56.20 a barrel a year earlier.

Earnings would have been higher by 70.7 billion rupees had the company not paid the subsidy, Sharma said.

While crude oil prices have fallen 53 percent from a record $147.27 a barrel in July, the company may not benefit because its subsidy payments to refiners are expected to remain high, Goldman Sachs Group Inc. said in an Oct. 14 report. The brokerage reduced the 12-month target price to 760 rupees from 1,000 rupees.

Stock Slumped

Oil & Natural shares rose 0.6 percent to 648.35 rupees in Mumbai trading yesterday. The stock has fallen 48 percent this year, less than the 55 percent slump in the benchmark Sensitive Index. Indian markets were closed today for a public holiday.

The explorer is bidding for fields overseas to make up for dwindling output from aging fields at home. Oil production fell to 6.853 million tons in the second quarter from 7 million tons a year ago, the company said today. Gas output totaled 6.43 billion cubic meters from 6.35 billion cubic meters.

Oil & Natural Gas has said the global credit freeze won't hamper its plans to buy the U.K.'s Imperial Energy Plc. for 1.4 billion pounds ($2.4 billion), its biggest takeover aboard. The company may borrow $1 billion in bridge loan to partly fund the purchase. It had 220 billion rupees in cash on Sept. 30, Finance Director D.K. Sarraf told reporters today.

``The transaction is under process,'' Chairman Sharma said, without providing details.

Spending Plan

The company will spend 196.42 billion rupees on exploration in the year ending March 31, 2009, up from 176.51 billion rupees a year earlier, Sharma said. It aims to spend 208.7 billion rupees in the year to March 31, 2010, he said.

Five oil and gas discoveries were made in the second quarter, Sharma said. Oil output may rise to 26.98 million tons in the year ending March 2010 from an estimated 26.08 million tons this year, he said.

India imports more than three-quarters of its oil needs and is looking to invest in oil projects in Russia, Kazakhstan, Iran and Africa to meet fuel demand for vehicles and electricity.

Exxon, the world's biggest oil company, today reported third-quarter profit rose 58 percent to a record because of record oil prices. Shell, Europe's biggest oil company, said profit gained 22 percent in the third quarter.

To contact the reporter on this story: Subramaniam Sharma in New Delhi at ssharma@bloomberg.net; Pratik Parija in New Delhi at pparija@bloomberg.net.

Last Updated: October 30, 2008 09:37 EDT