Nov. 1 (Bloomberg) -- Oil & Natural Gas Corp., India’s most-profitable company, is at risk of incurring a loss at its crude oil business for the first time as subsidy payments and production expenses rise.
The cost of producing crude oil has increased 5 percent, while buyers are paying 4 percent less for the product, squeezing margins, according to Chairman Sudhir Vasudeva. ONGC may give 137 billion rupees ($2.2 billion) as discounts on its crude oil sales to government-run refiners including Indian Oil Corp. for the three months through Sept. 30, Vasudeva said. That’s 11 percent higher than a year earlier.
“The narrowing margins at some point is going to affect our growth, our capex, and our business,” Vasudeva, 59, said by phone from New Delhi. “It’s difficult to sustain, difficult to plan for the future.”
Pretax margins at ONGC, which is responsible for bolstering India’s energy supplies, have already narrowed to a four-year low as it gives away half of its profit to finance fuel discounts mandated by the government. The erosion in earnings is threatening to derail its plan to spend 11 trillion rupees by 2030 to raise output that is crucial to shrinking the nation’s record current-account deficit.
“If this rate of high subsidy payout continues, the company will soon have to use its cash reserves for its capex and operating expenses,” said Neelabh Sharma, analyst at BOB Capital Markets. “If that becomes reality, it will be a dreadful situation.”
Prime Minister Manmohan Singh’s government caps prices of kerosene, diesel and cooking gas in a country where the World Bank says about 820 million people live on less than $2 a day. The subsidy burden is shared by the government and state-run explorers as Singh struggles to rein in the second-fastest inflation among the Group of 20 nations.
ONGC has gained 8.5 percent this year compared with a 9.1 percent rise in the benchmark S&P BSE Sensex index. The shares fell as much as 1.3 percent to 290 rupees and traded at 290.45 rupees as of 9:16 a.m. in Mumbai.
ONGC sold crude at $47.85 a barrel in the year ended March 31, less than the $54.72 in the previous year, according to a Sept. 25 presentation on its website. This left the explorer with a pretax margin at $7.75 a barrel, the lowest in at least decade.
The narrowing margin means oil accounted for 25 percent of the explorer’s pretax profit in the year compared with about 55 percent of sales, Finance Director Aloke Kumar Banerjee said in a Oct. 30 interview. The remainder of the profit was from the sale of natural gas and products including naphtha and liquefied petroleum gas.
The company will benefit from higher gas prices starting April 1 next year. The government in June allowed producers to set prices as a weighted average of rates in the U.S., U.K. and import costs of Japan and India. This will almost double local prices from the current $4.2 per million British thermal units.
“The higher prices will make the gas business more and more relevant for ONGC,” said Gagan Dixit, a Mumbai-based analyst with Quant Broking Pvt., who has a buy rating on ONGC. “Anything above the current price will make a lot of smaller and deepwater discoveries viable to produce from.”
ONGC sells its gas in dollars. The rupee’s 10.6 percent decline this year helps it increase earnings when converted to rupees.
India has spent $71.9 billion to import crude oil in the six months to September, according to oil ministry data. That’s 31 percent of the nation’s total imports in the period. It’s oil purchase bill climbed to a record $144 billion in the year ended March 31.
The nation’s current account deficit rose to $21.8 billion in the three months ended June 30 from $18.1 billion in the preceding quarter after a record $31.9 billion in the previous three months.
ONGC’s pretax margins, or profit before tax as a percentage of sales, fell to 36.8 percent in the year ended March 31, the lowest in four years. The measure for Cairn India Ltd., producer of crude from the nation’s biggest field on land, was 74.5 percent.
Adding to the lower margins is ONGC’s declining oil production. Output at its fields and that of its partners dropped 3 percent to 26.12 million metric tons (522,400 barrels a day) in the year ended March 31. Over 80 percent of the explorer’s current output comes from fields that are more than three decades old.
The explorer plans to spend 350 billion rupees in the year ending March 31, Banerjee said. The company may have to use about 50 billion rupees of its 132 billion rupees cash balance to fund the expenditure, he said. Cash from operations dropped to a three-low of 362 billion rupees in the last financial year, according to data compiled by Bloomberg.
“In case existing subsidy regime continues, ONGC may become cash surplus to cash deficit very soon,” the company said in a Sept. 25 presentation on its website. “It will constrain ONGC’s future investments in exploration and production.”