Oil Marketing Companies Fear Rating Downgrade

Posted on October 9, 2012 in Business and Economy

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By Naman Sanghvi:

Link to Original Article

Original Article

Oil marketing companies (OMCs) fear a rating downgrade, as borrowings of the government-owned entities remain well above Rs 1 lakh crore and a fuel price rise is pending.

A cut in ratings could raise their borrowing costs, especially for foreign funds.

On June 1, Fitch Ratings had lowered the rating outlook of Indian Oil Corporation, long with those of other government-controlled companies. This followed the lowering of India’s rating for long-term foreign and local currency (issuer default ratings) from stable to negative.

A senior executive in an oil company told Business Standard, “We fear if petroleum prices are not increased, ratings may turn negative.”

Non-revision in the prices of diesel, liquefied petroleum gas and kerosene for more than a year led to OMCs resorting to heavy borrowings, which rose 23 per cent to Rs 1,57,617 crore at the end of the quarter ended June, compared with Rs 1,28,272 crore at the end of the previous quarter.

Indian Oil has a foreign currency loan portfolio of about $7.5 billion. “We continue to borrow from the international market and interest rates have not changed due to the outlook downgrade. The positive thing is the credit rating has not been downgraded. But if the government does not compensate us fully, there may be problems on that front, too,” said P K Goyal, director (finance), Indian Oil.

The government’s balance sheet is also stressed, owing to a mounting subsidy bill. Petroleum subsidy accounted for about 30 per cent of the subsidy bill of Rs 2,16,297 crore in 2011-12. “If the price increase does not happen, the government will have to give higher budgetary support,” said Abhinav Goel, senior director, Fitch Ratings.

However, that these companies are government-owned is comforting for rating agencies and lenders. “We believe the government is using the pricing of petroleum products as a tool to push its socio-economic goals. OMCs are, therefore, strategically important for the government,” said Goel. The government would support these companies through subsidy and discounts from upstream companies.

However, many say the government-ownership tag could also lead to hurdles.

A lot depends on market conditions. But even at the peak of economic slowdown in 2008, Indian Oil was able to raise money, though private companies were unable to secure funds. The country’s largest petroleum marketer is funded by banks in various regions, including the US, the UK, Norway, the Netherlands, Germany, France, Mauritius, South Africa, West Asia, Japan, Taiwan, Singapore and Australia.

Explanation


Oil Marketing Companies are companies like Indian Oil that are involved in the business of distributing oil to the Indian market through combination of different business lines including importing, procuring, etc. OMC’s buy oil and then sell oil for private/ public consumption through different mechanisms. Now for day to day operations and long-term growth, OMC’s like all companies raise money through various financing mechanisms — one of which is borrowing money from international and domestic lenders.

Now a bunch of concepts are intertwined here. Having borrowed money, OMC’s owe this amount along with agreed interest to the lender; and the outstanding amount now is well over 100,000 Cr. Typically in the current government regime oil is subsidized by the government. i.e.- the government pays partly for the oil as it is too expensive for the end-user. To protect the financial interest of the common man the government has to take this step and subsidize a commodity. Typically the government is directing profits from its various enterprises into providing this subsidy in the interest of the end-consumer.
So the OMC sells oil in the market at a lesser rate with the balance amount paid by the government through subsidy mechanism. A lesser price makes oil and related products affordable for consumption and keeps the economy running. Governments increase the price of fuel, when they can no longer afford subsidizing it- when subsidizing becomes too expensive for the government to bear, it is compelled to raise the tariff and pass on some part of the cost to the end-consumer.

Every time the amount of subsidy increases beyond a limit, the government has to increase the price of fuel thus passing on the cost partially to consumers to recover costs. These prices are mainly market driven and can happen because of multiple reasons like increase in Global crude prices or sudden excessive domestic demand.

Every government functions like a company where it has its own cash flows and market outlooks- a continued staggering loss on account of providing subsidies may have multiple damaging effects like – the government defaulting on its payment obligations, unnecessary inflationary promoting measures, negative perception of investors and banks, etc. These effects might have cascading effects which can further hurt the country’s economy. Though raising prices of essentials like electricity and oil is seen as detrimental in terms of public welfare, is sometimes a necessary step to control the economy.

When the government doesn’t pass on the cost to the consumer, it is essentially increasing the amount of subsidy paid to the OMC. If the subsidy is not paid out to an OMC on time, the OMC will further not be able to pay its creditors thus accumulating debt and a negative outlook in the eyes of investors. This is what is happening now. Having not increased the price of petrol ( which is a huge % of the oil consumed), the government is under a lot of financial stress and this results in delay in payments to OMC’s which increases the OMC’s outstanding debt.

Now investors, lenders, banks and industry stakeholders bank on rating agencies like Fitch, S&P and Moody for many of their decisions. These rating agencies analyze a company and rate its capacity to fulfil financial obligations. A company with a good credit rating would be deemed to be stable and profitable, while a company with a bad credit rating would be seen as a risky investment. Neutral is a good rating, and rankings go above — positive and below- negative. There are various denominations and levels even in both positive and negative ratings. (rankings are very much detailed and categorized and this explanation is just to explain the concept). A rating outlook refers to the direction in which the agency sees the company going in the immediate future and might not necessarily mean a change in credit rating. So a company could have a negative credit rating and have a positive outlook means that a rating may be raised for the near future.

When lenders lend money, the risk profile of the investment is a very important aspect. Higher the risk higher the return expected. Because of this increasing deficit in ‘outstanding payments’ of OMC’s, rating agencies perceive them to be more risky and this in turn is increasing the rate at which OMC’s can borrow further capital from lenders.

Ratings depend on a bunch of factors both globally, industry specific and company specific. Ratings of government controlled OMC’s along with other government controlled companies also were affected with lowering of India’s rating for long-term foreign and local currency. Foreign currency ratings refer to an entity’s ability and willingness to meet its foreign currency denominated financial obligations and local currency is an entity’s ability and willingness to meet all of its financial obligations on a time.

In day to day working of infrastructure projects, cash inflows occur after a period while cash outflows might happen every day ( operations and maintenance). Many a times to fund daily expenses companies take short term loans which they then pay off through sales. Sometimes to pay off a short term loan companies take yet another short term loan relying on cash inflows and pay more interest. It is not an uncommon practice, but one that is executed with great care. Mismanaging this can lead to a spiral of loans engulfing the borrower in a vicious debt trap. Without increase in diesel and fuel prices, the financial stress on the government would continue, putting more pressures on revenue lines of OMC’s. While increasing borrowing rates, some of them (speculative) might have also had to borrow further in absence of revenues thus increasing the deficit.

As explained earlier only the rating outlook has been lowered and the agencies have still maintained their view of the OMC”s ability to fulfil its financial obligations. A credit downgrade would pose serious concerns and ring alarm bells

The government might deliberately not be increasing prices keeping in mind the socio- economic situation. An increase in price hurts the local common consumer and creates a negative sentiment. Though a temporary step some action would have to be taken soon. If not then the subsidy amount outstanding will increase leading to more economic problems; and which will then have to be corrected through other means like the taxation system. The rating agencies are still very confident about the OMC’s as being government controlled the government will not let them fail.

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