UPDATE 2-India ONGC Q3 profit falls 5 pct, subsidy costs weigh

* Q3 net profit 67.4 bln rupees vs. expected 72.6 bln

* Gets 31.42 bln rupees in royalty payments from Cairn India

* Shares close down 1.1 percent

* Chairman says under recoveries next quarter will also be large (Adds management, analyst comments)

By Prashant Mehra

MUMBAI, Feb 8 (Reuters) - India's state-run Oil & Natural Gas Corp posted a 5 percent drop in quarterly net profit, falling short of market expectations, as a sharp rise in provisions for subsidy payments offset higher selling prices for oil and gas.

The profit would have been lower but for royalty payments of 31.42 billion rupees ($638.55 million) from Cairn India Ltd that began in the quarter.

ONGC has a 30 percent holding in an oil and gas block in western India that is operated by Cairn India.

Vedanta Resources bought a majority stake in Cairn India last year and as part of the deal Cairn India is required to share the burden of royalty payments earlier paid by ONGC to the government.

ONGC, India's second-most valuable company, reported a net profit of 67.41 billion rupees ($1.4 billion) for its fiscal third quarter ended Dec. 31, down from 70.83 billion rupees a year earlier.

Analysts, on average, had expected a net profit of 72.6 billion rupees, according to a Reuters poll of 10 brokerages.

"Subsidy burden is a major overhang on the company," said Harishchandra Sable, a sector analyst with brokerage FINQUEST Securities. "Its oil production should increase from the next fiscal year helped by new investments that they are making."

The company's revenue dropped 2.4 percent to 181.99 billion rupees, as crude oil output fell to 6.74 million tonnes in the quarter from 7.03 million tonnes a year ago.

ONGC said its gross discounts to state-run refiners nearly tripled to 125.36 billion rupees in the quarter ended December, which reduced its profit by 71.72 billion rupees.

Net realisations from oil sales fell to $44.96 per barrel from $64.79 a barrel a year earlier.

"Under-recoveries in the next quarter will also be very large and if we don't get any support the results will be much worse," ONGC chairman Sudhir Vasudeva said. "However, the trend in nine months indicates we will be able to surpass our profits of last year."

ONGC shares ended down 1.1 percent at 283.20 rupees, while the overall market rose 0.5 percent. The stock, valued at nearly $50 billion, fell by a fifth in 2011, compared with a 25 percent decline in the main stock index.

FUEL PRICE CONTROL

India allows state-run refiners to set retail prices for petrol, but the government controls the prices of diesel, cooking gas and kerosene. This means producers such as ONGC must share the shortfall by selling crude to refiners at a discount.

New Delhi has said it wants to loosen control of fuel prices, but has found this difficult with global crude prices staying well above $100 a barrel most of 2011.

Because of the subsidies, the total revenue losses of India's state-run oil companies are expected to rise to $28.5 billion in the fiscal year ending March, nearly double the amount in the previous year.

Earlier this week, the government asked upstream oil companies to share 37.91 percent of revenue losses during April-December, up from a third in the first two quarters of the fiscal year.

India is the world's fourth-largest oil importer, importing about 80 percent of its crude needs. It is scouting for oil and gas assets abroad to meet demand in a rapidly growing economy, and to feed its expanding refining capacity.

ONGC, which has been investing heavily to maintain output from its old fields, has outlined capital expenditure of 310 billion rupees in the financial year starting April 1.

The company has said it aims to raise crude oil production by 15 percent to 28 million tonnes, or 560,000 barrels per day (bpd), by March 2014.

($1= 49.2 rupees) (Writing by Sumeet Chatterjee; Editing by Subhadip Sircar)