Understanding the Dynamics of the Oil & Gas Industry

Inflation is sky-rocketting these days and one of the major factors impacting the rising inflation includes the rise in prices of oil related commondities.



When reading articles about the oil & gas industry in newspapers and magazines there's industry specific jargon that one may not be aware with. To acquaint with the same, this article looks at some of the commonly used terms. While reading, you would also understand how oil industry actually works..



Firstly we shall bifurcate the oil and gas industry according to the nature of work done-it can be divided into mainly two categories-upstream and downstream sectors. The upstream sector includes companies engaged in exploration and production of oil & gas. The downstream sector is into the refining as well as the selling & distribution of oil & gas products. So all the products made from oil refining-including LPG, gasoline & diesel oil are produced by the downstream sector. Oil Marketing Companies (OMC) are part of the downstream sector. Popular OMC's in India include Indian Oil, HPCL, BPCL etc. Upstream companies in India include-Oil India, ONGC & GAIL.



Although the prices of petrol have been deregularized and there is much hue & cry amongst the price-sensitive aam aadmi, the fact remains that diesel & LPG is adminstered at prices lower than the international prices. OMC's suffer heavy losses due to difference between the selling price(i.e. the price at which is sold finally to the Indian consumers) and the market price (the price at which it is sold internationally). This is called under-recoveries. The burden of under-recoveries is borne by the government (which provides cash compensation to OMC's), Upstream Co.'s (in the form of price discounts to OMC's) & finally by the OMC's themselves. The large chunk, however is borne by the government which is almost equal to 70%. One may think that the losses of OMC's should subside due to deregualtion of petrol last year. However, the irony here is that petrol constitutes only a tiny portion of the fiscal burden that the government has to bear due to under-recoveries. Diesel and LPG consitute the large chunk.



Recently oil touched the $100 per barrel mark (& rising...) due to the political turmoil in Egypt and the middle east, this would definetely hit the balance sheets and financial reports of OMC's bad.



Although OMC's suffer heavy losses due to under-recoveries, the concept of losses and under-recoveries should not be used interchangably. Under-recoveries occur due to difference in the market price and the selling price of oil products whereas losses occur if cost exceeds the selling price.



If we carefuly look at the quarterly and the annual financial statements of OMC's, we would find there is great variablity in the profitability position amongst consecutive time intervals. This is due to the fact government compensation to the OMC's for under-recoveries is often delayed. Due to this OMC's profits yo-yo widly according to when they receive the compensation from the government. When there is delay in compensation, OMC's infuse huge amounts of cash to keep the show going.

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A quick trivia: After the collapse of Bretten Woods, one of the key reasons why the US Dollar bounced back was because oil per barrel was denominated in terms of USD. Sufficient oil reserves & a resurgent demand of US currency helped the US Dollar get back on track..!

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By:Tejas Singh

Returns on ULIPs are too good to be true- Why investing in them is not a Good Choice

What will an investor think when he pays Rs. 1 lakh one time, and promised to get upto 30% returns per year after 3 years. And when this kind of offer comes from most reputed insurance service provider like LIC, its just an icing on the cake. Recently, I saw a huge rush of people grabbing a limited time offer by LIC, the LIC Wealth Plus scheme. Just every other person I knew was buying one. It was a Unit Linked Insurance Plan (ULIP) which means a portion of your investment goes towards stock market and rest towards insurance. So, people thought they would get double benefits, getting good returns from the bullish markets and insurance cover as well. But all is not as rosy as told by the agents.


I will not get into all the details about the scheme but highlight few major points to explain my point that ULIPs are worst of the investment options, when you compare them with combination of mutual funds and term insurance plans and all the hype created around it is just to get lucrative commissions by the agents. In India, insurance is all about mis-selling rather than buying. Lets talk about LIC Wealth Plus. Highest Net Asset Value(NAV) in 7 years. Like if you invest Rs100, in 1st year, the value in the stock market of the shares bought by that money will be, lets say Rs110, next year Rs120, next year Rs 115 and so on. So you get the highest value, which may be at whichever time during 7 years. Insurance cover of 5 times the premium paid per year for 3 years, etc. It is sold as a win-win situation by the agents.

BUT, what they 'forgot' to tell you is that the commission to the agents and other charges can go upto 40% of the premium paid in the first year, and 15-20% in the subsequent years as no limit set by IRDA. So what actually gets invested in the markets is very less amount, so high returns on that amount(which also is not guaranteed) makes overall returns too low or even negative at the time of maturity. In mutual funds, the charges are fixed by SEBI(around 1.5% or so plus Rs200-700) so money actually invested in the markets is much higher than ULIPs.


Now, the insurance part of the ULIP. The cover is generally only 5-8 times of the premium paid. So, invest Rs 50000 per year in ULIP and get insurance cover of Rs 3 lakh. But, in 10 years life insurance plans the cover is normally Rs 10-12lakh for the same premium.

So if you compare ULIP with Mutual fund+ term life insurance, ULIPs are a total disaster mainly because of exorbitant commission and charges deducted by the companies ranging from 20-60% in the first year and 10-40% in subsequent years. So it takes 4-5 years MINIMUM to break-even on the investment made, let alone any profits, in case of a very good stock market. So chances are high that you get negative or minimal returns on the investment in ULIPs rather than the huge returns promised by the agents.

So beware of the advice of your agent and be aware of the (no)benefits of ULIPs before investing in them next time and help your parents too. Because their money is your money, after all :)


Written By- Rahul Bansal

A detailed step by step explanation given here.

The Financial Crisis of Greece Would Not Sound All Greek To U, If U Read This Article..

The recent economic crisis in Greece has taken the entire European Union by a storm. The Greek economy was one of the fastest growing economies in the Euro zone from the turn of the millennium till 2007. The ruckus began in 2008 when two of the country’s largest industries-shipping & tourism were both terribly affected by the slump with revenues falling 15% in 2009.

The Root Cause

The main cause for the crisis was increase in govt. deficits and debt levels to an exorbitant amount. In 2010, the Greek govt. deficit was anticipated to be 13.6% which is one of the highest in the world in relation to the GDP. The Greek govt. bond market is heavily reliant on foreign investors, estimates suggesting 70% of the Greek bonds are held externally. Standard & Poor’s {a credit rating agency [CRA]-which rates public and private sector on the basis of their credit worthiness} downgraded Greek debt rating to “junk status” on 27^th April, 2010. [This means that according to S&P, the govt. is mostly likely to default on the payment of debt]. Following the downgrading by other CRA’s like Flitch, Moody’s, the Greek govt. yields rose drastically in 2010. {Yield is the rate of return the investor gets on a bond.....to compensate the investor for the increase in risk that he takes when he invests in a Greek govt. bond (which is likely to default according to credit rating agencies), the return on bonds i.e. the yield increased}.

Austerity Measures and Protests from the Public

The govt. had taken a round of austerity measures like the Economic Protection Bill which included public sector pay cuts, pension reductions, new taxes on company profits, and increase in value added taxes amongst others. On 23 April 2010, the Greek government requested that the EU/IMF bailout package be activated. In response to a new round of cost cutting actions taken by the government a nation wide strike was called for May 5. The estimated 100,000 protestors marched through Athens and accused the govt. of being “thieves”. Demonstrators broke windows, threw petrol bombs, rocks, bottles at the police, burnt cars on fire across the city.

Limitations of Greece and Effect of Crisis on other Countries

Without a bailout agreement, there was a possibility that Greece would have been forced to default on some of its debt. Due to the fact that Greece is part of EU, it cannot print its own currency. This limitation prevents it from doing away with a portion of obligations or stimulating its economy with monetary policy.

There is a possibility that Greek crisis will cause investors to lose faith in investors in other Euro zone countries like Portugal, Spain & Ireland all of whom have debt and deficit issues.

Controversies

There have also been many controversies surrounding the whole issue that took place. The Credit Rating Agencies have been under fire for a tendency to act conservatively. In Greece, the market responded to the crisis much before the downgrade of Govt. bonds was declared by CRA’s. The role of Goldman Sachs is under severe scrutiny, because it was discovered that the govt. of Greece paid the bank millions of dollars in fees 2001 (along with other banks) for arranging transactions that hid the level of borrowing. This enabled the govt. to spend beyond what they actually could by effectively hiding it from EU overseers.

The Trillion Dollar Rescue Package

On 9^th May, 2010, Europe’s Finance Ministers approved almost a trillion dollars for crisis aimed at ensuring financial stability all across Europe. Stocks worldwide surged as fear of Greek debt crisis subsided. The Euro made its biggest gain in 18 months. Commodity price also rose after the following announcement.

However the package is conditional on all the countries doing fiscal adjustment & structural reform. An immediate revival of economic fortunes cannot be expected.

Decoding The Jargon: Hedging..

Hedge your investments to weather tough times

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What: Hedging allows a risk-free investor to transfer his risks by paying some cost to a risk taker

Why: Hedging is important because it allows its investments as per his risk apetite

How: Some famous instruments of hedging are futures and options that are traded through stock exchanges

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When everything is going your way, it looks natural to get carried away by the upside and completely forget the downside

When you are crossing a road, looking to your left is just as important as looking to your right. This rule could be applied even to your investments. But many investors forget this simple rule when they are standing in the middle of markets going up and down. When everything is going your way, it looks natural to get carried away by the upside and completely forget the downside. Then one fine day, you get knocked down by something coming from the other side. For this simple reason, it is always better to keep your investments hedged if you are not sure if you could survive unexpected knocks.

Think of hedging as a kind of insurance that you buy to protect yourself from unforeseen losses.

Hedging could be used in a wide range of circumstances. The techniques of hedging would be as much relevant to your leaking umbrella as to your investments. You keep the second option ready, just in case. Like insurance, hedging involves participation of a risk-taker and someone who is risk-averse. For transferring the risk or what we call hedging, a risk-averse person has to pay a price to a risk-taker.

Hedging keeps a risk-averse person protected from a negative event while someone else assumes the risk in the hope that the negative may not materialize.

The key to hedging is that it allows limiting of loss on the downside. However, at the same time, the cost involved in hedging leads to reduction of upside potential of profit. The risk-taker makes some profit in terms of the price received from the hedger in case the negative event does not actually materialize.

If Hedging is a reduction of risk at the cost of reduction of potential profit, then why anybody would go for hedging?

Hedging is closely connected with the equation of risk-return trade-off. As per the risk-return equation, to generate a higher return you may have to take a higher risk.

A lower risk investment generates a lower return. That’s the normal equation the market follows—it is risk that’s ultimately getting translated into money. Interestingly, all of us have the same appetite for money but all of us may not be having the same appetite for taking risk.

The solution is to go for a compromise. Be satisfied with that much return which is commensurate with your risk-taking appetite. If you never put yourself in a situation offering higher risk than your risk-taking appetite, then you would probably never need to hedge.

But it’s at this point that many slip. The problem is that the equation of risk and return doesn’t come clearly written on the face of your investments. You have to judge for yourself. You may realize only after making an investment that you have entered a wrong lane. Hedging, in a way, provides you a chance to set your investments on the right track, as a result of which you are back to the level of your risk-taking appetite. However, as I said, you have to sacrifice some of the returns on your investments. So, before going for hedging, it is important to make some evaluation based upon its cost and benefit. A long-term investor may decide to ignore any short-term fluctuations rather than sacrifice a part of the profit. It all depends upon individual circumstances.

How can we hedge?

The simplest approach would be to create a natural hedge around your investments. Remember this age-old advice from simpletons: never put all your eggs in the same basket. Diversification works as a natural hedge for your investments. Some of your investments would perform well, some would perform badly but diversification on the whole ensures that you get a balanced return during normal times. But diversification alone can’t always fully protect your investments. A more aggressive approach would be to use derivative instruments for hedging. Many derivative instruments such as options, futures and other derivatives of more exotic kinds are available. Derivatives could be used to hedge a wide range of risks covering stocks and commodities or even currencies and interest rates. For retail investors, derivatives such as futures and options, which are easily tradable on stock exchanges, are most suited. You can hedge your investments by making investments in any of the available derivative instruments. But before that, you should try to understand how different derivative instruments work.

I have always found derivatives a bit puzzling. But for avoiding a sea of risks, you need to make friends with a devil.

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Budgetonomics

BUDGETONOMICS

Key Highlights of Budget 2010-11 in a Simple, Uncomplicated Manner

Personal Income Tax Slabs Revised-Indian Middle Class Happy

Upto Rs. 1.6 lacs- No Tax

Rs 1.6-5 lacs-10%

5 lakh-8 lacs-20%

More than 8 lacs-30%

Minimum Alternate Tax: Raised From 15% to 18%-Not a Very Positive News for India Inc.

The concept of Minimum Alternate Tax (MAT) was introduced in the direct tax system to make sure that companies having large profits and declaring substantial dividends to shareholders but who were not contributing to the Govt by way of corporate tax, by taking advantage of the various incentives and exemptions provided in the Income-tax Act, pay a fixed percentage of book profit as minimum alternate tax.

Central Exercise Duty: Raised From 8% to 10%

Central Excise duty is an indirect tax levied on goods manufactured, again corporate sector unhappy

Estimated Fiscal Deficit: may be reduced to 5.5% this financial year-Good News

Fiscal Deficit: When a government's total expenditures exceed the revenue that it generates (excluding money from borrowings).

Excise Duty: Petrol and Diesel hiked by Rs 1/litre-May put a burden on the consumer’s pocket

Although, not much to worry as the revised tax slabs will result in more income in the hands of aam admi

Goods and Services Tax [GST] to be introduced from April 1, 2011

Major reforms in the field of indirect taxes, GST would be a comprehensive value added tax on goods and services

GST would not be in addition to existing taxes. GST will include central excise duty , service tax, and additional duties of customs at the Central level; and value-added tax, central sales tax, entertainment tax, luxury tax, octroi, lottery taxes, electricity duty, state surcharges related to supply of goods and services and purchase tax at the state level.

Increased Spending In Health and Education

Plan allocation for school education raised from Rs26,800 crore to Rs31,036 crore in 2010-11.

Plan allocation for health and family welfare increased to Rs22,300 crore from Rs19,534 crore.

Rural Sector Development

NREGA allocation: raised to 41,000 Crore

The National Rural Employment Guarantee Act or NREGA is an Indian job guarantee scheme, enacted by legislation on August 25, 2005. The scheme provides a legal guarantee for one hundred days of employment in every financial year to adult members of any rural household willing to do public work-related unskilled manual work at the statutory minimum wage of Rs.100 per day.

This act was introduced with an aim of improving the purchasing power of the rural people, primarily semi or un-skilled work to people living in rural India, whether or not they are below the poverty line. Around one-third of the stipulated work force is women.

Bharat Nirman Allocation-Rs 48,000 Crore

Bharat Nirman Yojana is an action-oriented business plan for rural infrastructure. It is an important step in bridging the gap between rural and urban areas and improving the quality of lives of rural masses. It comprises of projects on irrigation, roads (Pradhan Mantri Gram Sadak Yojana), housing (Indira Awaaz Yojana), water supply, and electrification and telecommunication connectivity.

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