Friday, September 23, 2005

HPCL and BPCL - a long dated call option?

Investors in oil over the last year have had a great bull run worldwide. There has been no such luck for investors in HPCL, BPCL and the other public sector oil companies in India. With the government not allowing the retail prices of oil to rise to levels commensurate with the worldwide prices of oil, it is these oil marketing companies that have been taking all the hit between the price they pay to buy oil and the price at which they sell it to retail consumers.

So how much are HPCL and BPCL worth? I think that at some point over the next year, Indian retail oil prices will slowly catch up with global oil prices. And if global oil prices slip down below the retail price point - which they will, because current prices of $68 per barrel are not substainable (see below) - then the government will not reduce the retail oil prices. They will let both HPCL and BPCL get whole on the losses. And their stock prices will shoot up at that time. One should recall that it is dividends from these companies that had helped the central government keep its finances in shape in the last few years - and so the losses at these companies are very painful for the budget.

In the meantime, how low can HPCL and BPCL go? Clearly there is a value to the assets - the companies own oil refineries and petroleum distribution points across the country. I dont know what the value of these assets is - but it looks increasingly that this is as bad as it can get for both these companies. HPCL has consistently found support around Rs 285-Rs 290 levels. I think that the risk-reward in both these stocks is skewed heavily towards upside. But it might take a long time for this to play out - one year, maybe two - and so you have a long-dated call option will these stocks.

What is the story with oil? I had written earlier on how low interest rates in the US are continuing to fuel the housing boom and the consumer demand which is keeping oil demand high, and also the role China is playing by keeping its currency pegged to the dollar: One should remember that the oil price increase this time is different from the 1970's: then it was a supply side shock with a cartel of Middle East countries suddenly raising prices. This time it is demand driven, and there are some indications that at $3/gallon of gasoline, even the crazy US consumers start feeling the pinch. If Hurricane Rita takes out the oil refining capacity in Texas, and gasoline shoots up to $4/gallon, we won't have a merry Thanksgiving and Christmas in the US. Demand of oil will go down as economy hits a soft patch, and so will the prices.

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