RIL, ONGC set to move higher as government unwinds windfall taxes, says Morgan Stanley

• Shares of oil exporting companies Reliance Industries and state-owned ONGC top gainers today.
• This comes as the government has lowered the recently implemented windfall tax on diesel and aviation fuel shipments offering relief to fuel exporters and producers.
• Government reduces tax on export of petrol and aviation turbine fuel (ATF) from ₹6 a litre to ₹4 along with tax on diesel to ₹11 from ₹13 per litre.

Shares of Reliance Industries surged nearly 3% while ONGC rallied nearly 5% in the early hours of trade, as the government provided a relief by lowering taxes on July 19. Less than a month after levying these windfall taxes on oil producers and exporters, the government had eased them yesterday.

The government, which had promised that it will review these taxes regularly, reduced tax on export of petrol and aviation turbine fuel (ATF) from ₹6 a litre to ₹4 along with tax on diesel to ₹11 from ₹13 per litre. Further, the ₹23,250 per tonne additional tax on crude oil produced domestically has been cut to ₹17,000 per tonne.

“A quicker than expected restart to reverse the windfall taxes on the sector should normalize equity multiples steadily higher. While windfall taxes are not yet zero, we believe government action provides clarity on the path ahead. RIL, ONGC and OIL are key beneficiaries,” says Morgan Stanley.

What is windfall tax and why was it imposed?
Windfall tax is a one-off tax imposed by the government on companies or sectors that have made unexpectedly high profits due to favourable market conditions. Crude oil prices have been hovering over $120 per barrel for the last three months – going as high as $130 per barrel in early March.

Windfall taxes were imposed by the government to gain from windfall gains that oil producers were minting when international crude oil and derivatives spiked. An export tax was also slapped on refiners who exported petrol and diesel abroad.

The move to slash the taxes came after crude oil prices fell significantly in July on fears of a possible recession and has been range bound between $100-105 per barrel.

The decision has brought a relief rally to shares of ONGC and RIL who have been under pressure in the last couple of weeks. Analysts believe the move will boost equity prices of these companies.

“Reliance, OIL and ONGC will see reduction in overhang and equity valuations should start pricing in high sustainable energy margins as government intent gets clear. The two should imply 25-40% upside to equities as energy markets are expected to remain tight despite the current volatility in oil and reduction in global fuel margins from peak levels,” said Morgan Stanley.

In the fiscal year ended March 2022, the telecom-retail-oil giant RIL generated about 41% of consolidated pre-tax profits from its oil-to-chemicals business.

Gross refining margins of RIL are estimated at nearly $13 per barrel while that of ONGC is estimated to see profit per barrel at $25, i.e.20% above last year's levels, as per the brokerage report.

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