Oil exploration and refining companies have been in focus over the last couple of months thanks to soaring global crude prices. This has provided a big boost to upstream exploration companies through higher realisation, and to downstream refining companies by way of higher refining margins.

After a dream rally beginning March 2020, which lasted up to April 2022 (with gains of 130 per cent in the 25-month period), the BSE Oil and Gas Index took a breather in May 2022. For oil refining and exploration stocks, which were hoping for a recovery in July 2022, the Government’s announcement on windfall tax last Friday came as jolt.

The BSE Oil and Gas Index has shed about 3.7 per cent since last Thursday’s close price. According to a Government notification, refineries will levy windfall tax on exports of diesel (at Rs 13 per litre), petrol (Rs 6 per litre) and Aviation Turbine Fuel (Rs 6 per litre) and a cess of $40 per barrel on domestic crude production. This has accentuated the fall in the stock prices of exploration and refining companies.

Since the announcement till close of markets on Tuesday, while the stock of exploration and refining major Reliance Industries Ltd has been relatively resilient, declining about 6 per cent, state-owned oil exploration players ONGC - down 15 per cent - and Oil India - down 24 per cent - were the top losers. For the other refiners, it was a mixed bag. While refiners such as Bharat Petroleum (up 1.5 per cent) and Hindustan Petroleum (up 4.2 per cent) bucked the trend, Indian Oil Corporation (down 1 per cent) and Chennai Petroleum (6 per cent) were prominent losers.

Reason for imposing the tax

The reasons for imposing the new export tax are possibly three-fold. First, the government wants to restrict dollar outflows given that India is a net importer of energy products. Second, higher availability of domestic petroleum products may also help crude prices given tight supply, as this can help reduce import demand from India, given that it is a large importer globally. Third, government is looking for a share of the windfall made by exploration companies, given that oil and gas assets in the country are owned by the Government.

While this move will help the exchequer clock an estimated income of over Rs 1 lakh crore if it is continued for the full year, it is expected to cause a dent in the revenue and profits of exploration companies and lower the margin for refiners.

The gross refining margin (GRM) impact for RIL is estimated at $7-8 per barrel, while the current margin is estimated at $24-25 per barrel. This translates into an operating profit impact of over Rs 30,000 crore for Reliance Industries. However, given that the estimates by most brokerages have factored in a lower GRM for RIL (under $15 per barrel), the downside to the current estimates is limited.

The impact may be more pronounced on ONGC’s exploration business, wherein crude realisation will see a straight $40/ barrel haircut, and this will be besides the 20 per cent Oil India Development Board cess. All these can potentially lead to an over 55 per cent reduction in ONGC’s crude realisation vis-à-vis international crude prices. For instance, if the international crude price is $110, the realisation for ONGC may be capped at $60 per barrel.

While the market has reacted sharply to the news, at least with respect to exploration companies, the extent of earnings impact remains to be seen, given the Revenue Secretary Tarun Bajaj’s statement that the Government will review the tax rate every 15 days, considering the global crude oil price and the exchange rate of INR against US dollar, among other factors.

While the Government has said it will withdraw the tax if crude were to correct by $40/ barrel, investors will be hoping that itconsiders lowering the windfall tax, from the current $40 per barrel, should the global price continue its downward trend. How exactly it plays out is a wait and watch game, as it is not easy to let go off taxes!