The Hindu Business Line : Outlook for oil and gas stocks

I bought UTI Petro Fund after Business Line recommended it in one of the recent issues. What is the outlook for the fund now? Should I hold or sell the units? What is the outlook for sector funds that invest mainly in oil and gas stocks? Should I invest in them now?

Autar Dhesi

Sanjeev Bhat

We have a buy recommendation outstanding on the UTI Petro Fund, which has been featured twice in our Investment Focus column in 2004. Investors who had taken exposures would be out-of-the-money with losses ranging between 15-20 per cent.

Our buy recommendation was linked to fundamentals as well as likely gains from disinvestment in oil sector stocks. The outcome of the Parliamentary elections has thrown a spanner into the works as far as disinvestment goes.

The planned disinvestment in HPCL through the strategic route and in BPCL through an offer for sale now appear unlikely as securing Parliamentary approval would be tough.

The possibility of offers for sale in other oil sector stocks in a manner that ensures the government's stake does not slip below 51 per cent cannot, however, be ruled out. But even if such an exercise is carried out (this may take a year or two at the least), it may not be of a value-enhancing nature.

The decline in the prices of oil sector stocks over the past month-and-half has factored in the uncertainties on the disinvestment front. Going forward, valuation levels are likely to be driven by fundamentals. Several oil sector stocks now appear attractively priced. But what stands in the way of a hold or buy recommendation now is the absence of a free hand for oil companies in pricing their products.

This situation has prevailed since January 2004 even in respect of products such as petrol, diesel and aviation turbine fuel, where pricing had been linked to global market trends.

The general elections forced the previous government to persuade oil companies to put price hikes on hold. The new Government has announced price hikes as part of a package that would also require oil sector companies to bear a sizeable part of the burden of rising crude prices.

This policy tilt is likely to continue and cast a shadow on the sector over the next couple of years. An upward revision in the price of natural gas may also be a casualty as this may hurt the interests of fertiliser companies.

The Government is also unlikely to accept lower dividends from the oil companies as part of this process as this could cut into its finances. Government policy has emerged as a bigger risk than was the case when we shifted to an invest mode on this fund about a year ago.

These factors could affect the earnings and cash flow levels of oil sector companies. There may be some respite if crude prices stabilise or decline. But a populist tilt in pricing decisions would remain a risk.

In this backdrop, investors in the UTI Petro Fund could partially cut exposures. The level of exposure reduction would depend upon individual risk preferences.

We would not advocate a complete pull-back from the fund as an exposure to the oil and gas sector may be beneficial from a long-term perspective.

Unless crude prices go through the roof, the downside risk from present levels appears limited. Holdings that are retained may be earmarked to the Dividend Option as dividend tax exemption appears set to continue.

We also still hold the view that the UTI Petro Fund offers a superior window to this sector for investors who cannot afford to build a portfolio of oil sector stocks.

Queries may be e-mailed to mf@thehindu.co.in, or sent by post to Business Line, 859/860 Anna Salai, Chennai 600002.

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