Oil stocks may gain on likely reduction in windfall tax

On Thursday, several oil company shares like RIL and ONGC saw a sudden rally. That can be largely attributed to the expectation that government was considering a reduction in the windfall taxes. It may be recollected that on 01st July, the government had levied a windfall tax on oil exports as well as on domestically produced and extracted oil. However, with the sharp fall in the international crude prices, the windfall profits vanished. That has led to the assumption that the windfall tax should also see a gradual, if not total, winding down.

Even a report by Bloomberg had suggested that the Centre was seriously considering a cut in the windfall tax in the aftermath of the crash in global crude oil prices. This led to a rally of 3% to 6% across oil stocks ranging from RIL, ONGC, OIL, MRPL and Chennai Petro. This was after the fears of recession surfaced on the back of Fed hawkishness leading to the price of Brent Crude correcting sharply from $125/bbl to $98/bbl. This sharp fall in crude prices below the $100/bbl mark, actually rebuts the windfall argument about oil.

The tax imposed in the form of Windfall Tax was intended at taxing super-normal profits on local oil production as well as the export of petrol, diesel and jet fuel. The sharp fall in the crude oil prices meant that extractors will not get super normal profits any longer and even the gross refining margins or GRMs would come down to more normalized levels. The government had imposed a special levy of Rs6 per litre on exports of petrol and ATF and Rs13 per litre on exports of diesel. Crude produced in India will attract tax of Rs23,250/ton. 

The windfall tax were supposed to be the method for the government to cover the loss they had to take by cutting the excise levies on petrol and diesel. The windfall tax on exports and locally produced oil was supposed to generate $12 billion for the government in the current fiscal year and would have trimmed the profits of the likes of ONGC and RIL. Now that will be reversed. The earnings were to lower earnings of ONGC by Rs30 per share and of Reliance Industries by Rs36 per share. That would have been a big dent on valuations.

Brent crude prices had recently hit a 3-month low of $97.35 per barrel on the dual concerns of Fed hawkishness and China slowdown. The two economies account for over $40 trillion of world GDP. However, due to the slowdown expectations, the prices of crude fell sharply further depleting the margins on diesel, gasoline and aviation fuel. This belied the assumption that oil companies were making super normal profits. Also, there is a worry that under the circumstances the windfall tax may result in negative returns for oil producers.