S. Vaidya Nathan

INVESTORS in UTI Petro can stay with the fund, while fresh exposures can be avoided. The risk to our recommendation would be any move by the government to require oil companies to bear a higher share of the deficit than what is the case now.

The limelight is on the oil sector as the crude price is hovering around $55 per barrel. Crude price could see an upward bias over the next few months, especially if the winter in the northern hemisphere turns out normal or severe.

A further drawdown of US inventories could also have a bearing on price trends. Unless there is a substantial shrinkage in demand, the crude price may exhibit a firm undertone. Eventually, the price may tend to decline (this appears unlikely for a few months at least), but now appear set to settle higher levels than what has been the case in the past.

This may not be in the vicinity of present price levels; they are, however, likely to be substantially higher than what the Indian economy has been used to as well as the target of $25-28 a barrel, which remains OPEC's benchmark.

China's move to build an enhanced level of strategic reserves over a two-to-three year period as well as strong demand from its economy are likely to ensure that crude prices do not retreat to sub-$35-a-barrel levels. This may be a picture from a medium-to-long-term perspective.

Apart from crude prices, the other factor that impacts the performance of the companies in this sector as well as this fund is the government policy on petro-product pricing.

So far, only a small proportion of the increase in crude prices this year has been passed on to customers in form of higher prices of petrol, diesel and LPG; kerosene prices remain untouched.

The government has resorted to cuts in Customs and excise duties to bear a part of the burden even as oil companies are doing likewise.

This policy tilt is likely to continue. A separate package to contain the effect of subsidies on LPG and kerosene on oil companies is a possibility.

The subsidies on these products are unlikely to be phased out and if the government decides to take the burden on its account through deferred payments and issuance of bonds to oil-sector companies, it may be a positive as it would be a long-term solution for the companies.

The consolidation story that centres around creating two mega corporate entities through mergers is at a nascent stage, and is unlikely to a factor in valuation of the stocks till there is greater clarity.

Progress on this front could, however, create room for valuation gains. ONGC, which is the top holding (about 20 per cent of the fund's assets are invested in this stock), would reap a rich harvest, even though it may be required to share a higher part of the deficit.

Enhanced borrowing to finance their share of the burden may lead to a higher interest burden.

If the government adopts the bonds route to aid refining and marketing companies to cope with the effect of crude prices on other products, too, that may also alleviate pressures on cash flows.

In this backdrop, investors can retain their exposures.

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