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The energy sector: A SWOT analysis

September 18, 2004 07:15 IST

The energy sector has witnessed mixed news during the current fiscal so far. While crude prices firmed up in the global market, the government's freeze on prices of petro-products affected margins of oil companies in 1QFY05.

However, the government took a series of steps starting mid-June including excise duty reduction and price increases. This was followed by another series of duty cuts (this time excise as well as custom duties).

Given this backdrop, we feel that there is a compelling reason for a SWOT analysis on the oil sector at the current juncture.

Strengths

Consumption growth
(MMT)FY01FY02FY03FY04
Diesel3836.536.637.3
(%) change-3.9%0.3%1.9%
Petrol6.677.67.9
(%) change6.1%8.6%3.9%
LPG77.78.49.3
(%) change10.0%9.1%10.7%

  • Developing economy: Historically, demand for petroleum products has traced the economic growth of the country. With GDP expected to grow at near 7% in the long-term, the energy sector would benefit from the same, going forward.

    To put things in perspective, diesel sales grew by nearly 12% (which constitutes 40% of the entire petro-products basket), petrol sales by 9% and a double-digit growth in LPG (liquefied petroleum gas) in 1QFY05. While this rate is not likely to sustain, we expect the industry to witness a 4% growth in the entire product basket in FY05 and beyond.

  • Government decisions: The recent price increases and also the decision to allow oil companies to increase prices within a band of 10% augurs well for the industry.

    This step is likely to reduce government interference and provide some autonomy to oil companies when it comes to increasing petrol and diesel prices in order to protect margins. Further, the duty cuts are also likely to result in reduced under-recoveries by way of subsidies on LPG and kerosene.

    Customs duties
    Excise dutyold (%)new (%)
    Petrol2623
    Diesel118
    Kerosene1612
    Excise duties…
    Customs dutyold (%)new (%)
    crude oil1010
    petrol2015
    diesel2015
    LPG105
    Kerosene105

      Weakness:

      • Crude prices: Nearly 70% of India's crude requirements are fulfilled by imports and this figure is likely to increase going forward. Crude prices have breached the $45 barrier again and are likely to remain at around $40 per barrel range.

        As per IEA, India is one of the most inefficient countries among developing nations as far as energy usage is concerned. Such high crude prices are likely to impact margins of oil marketing companies. Given the political implications, retail prices may continue to lag the rise in input cost.

      • Lack of freedom: Although the government has decided to provide autonomy to oil companies to increase petrol and diesel prices within a 10% band, other products such as LPG and kerosene continue to remain under the government controlled price mechanism.

        As per the current estimates, the subsidies on LPG amount to Rs 90 per cylinder after factoring in duty cuts and that on kerosene is over Rs 6 per litre.

        While the government has managed to reduce its share in subsidies, select oil companies are being forced to absorb the losses.

        Government: Hands-off
        YearSubsidies
        (Rs)LPG/cylinderKerosene/litre
        2002-0367.752.45
        2003-0445.171.63
        2004-0522.850.81

      Opportunities:

      • Equity Oil: Major oil marketing companies are now venturing into upstream exploration and production activities so as to secure crude supply.

        To put things in perspective, IOC and OIL India are likely to jointly bid for oil fields aboard. At the same time, ONGC's wholly owned subsidiary, ONGC Videsh (OVL) has acquired stakes in over 9 countries in its quest to attain the 20 MMT (million metric tonnes) by 2020. This backward integration is an opportunity for IOC to secure at least 25% of its crude oil requirements for the refineries.

        Supply as a (%)
        age of allocation
        Supply
        Power52.0%
        Fertilizer65.0%
        Others*51.0%

      • Natural Gas: Natural gas has the potential to be the fuel of the future with demand outpacing supply by more than two times. Such high scarcity of natural gas provides a big opportunity for oil companies. The below mentioned table indicates the allocation to the various core sectors and the shortage faced by them, thereby giving an idea of the potential for growth.

        Although Petronet LNG has now started importing natural gas, the future holds promise as Reliance Industries' Krishna Godavari Basin goes into commercial production in FY06 and Shell commences its terminal at Hazira. More exploration activities are in the pipeline and this could reduce the country's dependence on crude in the long term.

      Threats:

      • Competition: Until FY04, oil-marketing companies had complete control over the downstream marketing business while private sector players were restricted to only refining.

        However, with entry of private players such as Reliance, Essar Oil and Shell (in the waiting), the sector is likely to witness increased competition going forward. The oil PSUs had hitherto developed a fortnightly pricing mechanism, which is likely to discontinue.

        The price of petrol and diesel is artificially kept high so as to cross-subsidize LPG and kerosene. Since private players will not be bound to provide for these subsidies, PSU marketing players are likely to suffer from lower throughput per outlet.

      • Continuing government interference: During the first six months of the current fiscal year, the oil marketing companies were refrained from increasing product prices due to political reasons.

        This affected margins of downstream players. Going forward, if the government interference continues, oil-marketing companies will be at a disadvantage.

      Although we believe the industry is likely to witness increased competition, the initial retail rush by private sector players has slowed down. PSU marketing companies have already stepped up their expansion plans and to that extent, have created significant entry barriers for private players.

      Although throughput per outlet (sales per outlet) is likely to decline in the future, we believe that any substantial entry of the private players would indirectly benefit the PSUs, as the government's pricing policy will not hold much water and the market forces would determine pricing.

      Equitymaster.com is one of India's premier finance portals. The web site offers a user-friendly portfolio tracker, a weekly buy/sell recommendation service and research reports on India's top companies.



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      Number of User Comments: 2




      Sub: Not satisfied

      I don't agree what vipul says, actually it has followed the rule of SWOT, and the work done by the person should be appreciated.


      Posted by preeti





      Sub: SWOT

      A poorly done SWOT analysis not even following the basic SWOT rules. Expected better one from indian research firm. A good attempt though. regards, Vipul ...


      Posted by vipul




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