Confusing signals for OMCs with crude supply-demand equation set to change

Lower oil prices can improve margins, but they could impact inventory value while a third Covid wave can potentially hurt growth

The supply-demand equation in the global crude oil market is expected to change from a supply deficit, to supply-surplus by January 2022. Crude and gas prices have started correcting down as a result.

Part of the reason for this is that the US and Canada are ramping up production. Also, global growth estimates have been downgraded due to the current Covid wave which has put pressure on the EU’s healthcare system and led to lockdowns on global travel.  

In general, lower energy prices are good for India. But it will mean lower growth on the export front, if there’s a trade slowdown. If domestic lockdowns are re-imposed due to a big third Covid wave (whether caused by Omicron or Delta), it will definitely hurt Indian growth as well.

The Indian crude basket saw a small decline in price to $80.64 per barrel in November, versus a calendar year high of $82.11 in October. But a sharper decline could occur through December 2021-June 2022.

A change in energy prices leads to a review of the PSU oil marketing companies (OMCs), BPCL, HPCL and IOC. The three have similar value–chains. They import feedstock, refine, and sell products from retail outlets (and to aviation companies). If prices drop, refining margin rises, which is good. On the other hand, revaluation of inventory could mean a (non–cash) hit on the bottomline if inventory has been acquired at higher prices.

While in theory, OMCs set prices according to market rates, there are political considerations. Given several assembly elections due in calendar 2022, it is possible the majority shareholder will ask for price cuts that reduce margins, even if prices fall.

Consumption data for April-October 2021 across all product categories is 113.5 million tonnes versus consumption of 103.6 million tonnes in the same period of 2020-21 and 123.9 million tonnes in the same period of 2019-20, which was a year of normal activity. This is a clear indicator that the economic recovery is not complete, and activity is not yet back to pre-covid levels.

In terms of financial results, HPCL declared Consolidated PAT of Rs 1,919 crore in Q2FY22, versus Rs 2,004 crore in Q1FY22 and Rs 2,976 crore in Q2FY21. IOC has consolidated PAT of Rs 6,235 crore in Q2FY22, versus PAT of Rs 6,141 crore in Q1FY22 and Rs 6,165 crore in Q2FY21. BPCL has PAT of Rs 2,694 crore in Q2FY22 versus Rs 1,501 crore in Q1FY22 and Rs 2,589 crore in Q2FY21.

There is an indication of margin pressures when comparing year-on-year results. This is due to differences in crude prices, which averaged $43 per barrel in Q2FY21 and averaged $72 in Q2FY22. All three companies gained from revaluations of inventories during the price rise.

The share prices of all three OMCs have seen big corrections in the last month. BPCL is down 7 per cent, IOC is down 7.8 per cent and HPCL is down 5 per cent. Technically all three stocks are looking weak. If crude prices do drop, and demand does not reduce, there could be an upside for these three stocks through the next two quarters. But if there’s a downgrade to domestic growth due to a third wave, or due to global growth falling, there would be a reduction in consumption, which would impact them adversely.