Limited gains for OMCs from easing of Iran sanctions

The stocks of oil marketing companies (OMCs) such as Hindustan Petroleum Corporation (HPCL), Bharat Petroleum Corporation (BPCL) and Indian Oil Corporation (IOC), after surging 2.5-6 per cent on Monday, fell 2.3-6.3 per cent on Tuesday. While the Street celebrated the relief companies would get as sanctions on petrochemical exports from Iran will be eased, it seems to have realised later that gains, if any, will take five-six months to materialise. Also, crude oil prices recovered on Tuesday, after falling on Monday.

However, ONGC remained flat (down 0.57 per cent) against 3.7 per cent gains on Monday, while Mangalore Refinery and Petrochemicals (MRPL) fell 1.52 per cent to close at Rs 42.2 on Tuesday after rising 5.9 per cent a day earlier. While MRPL is seen as the biggest gainer from the easing of sanctions on Iran, ONGC’s gains can be attributed to its majority stake in MRPL as well as the recovery in crude oil prices on Tuesday. ONGC’s subsidiary, ONGC Videsh does not have to bear any subsidy burden and its realisations are linked to global crude oil prices.

The recent agreement between Iran and European Union, however, should lead to higher crude oil supply in the market and consequently, should result in lower prices in the medium to long term. Lower crude oil prices reduce the underrecoveries on regulated fuels for the OMCs and consequently the subsidy burden (discounts they provide) on upstream companies such as ONGC, Gail and Oil India, too, comes down. The immediate gains though could be marginal, believe analysts.

Niraj Mansingka, associate director, institutional equities, research, Edelweiss Securities, says, “Global increase in Iran’s production by 1.5 mbpd (million barrels per day) can lead to large fall in crude oil prices. However, we do not see any impact on crude prices immediately as it is difficult to believe that Iran may implement all the conditions. If Iran does comply, we can see a fall in crude prices to $85-95 a barrel, which is the breakeven price of oil sands and shale oil (marginal production).”

MRPL, which is India’s largest buyer of Iranian crude oil, benefits as the process to make payments to Iran smoothens. It should also benefit from better credit period, thereby easing pressure on its working capital cycle and possibly some reduction in interest expenses. MRPL has seen its debt rise sharply after March. It had debt of Rs 10,600 crore (debt-equity ratio at 1.7) as of September 30, compared to total loans of Rs 6,980 crore, which is a key concern for investors.

Nitin Tiwari, oil and gas analyst, Religare Capital Markets, says, “The impact can be broken in two segments, namely pricing and ease of access. While India and China continued to import from Iran even after the sanctions, they were unable to raise the off-takes. Now, it (India) is likely to shift the payment to euros as against the rupee settlements done so far. We do not expect any significant correction in crude oil prices and expect them to remain flattish with only minimal correction in the short term.”

Going ahead, MRPL also stands to gain post the commissioning of its Phase-III refinery project (around March 2014), which should boost refining margins given the higher complexity of the refinery.

Lower subsidies or underrecoveries mean OMCs should also benefit. Their gains will emerge from the easing of pressure on working capital. So far, the compensation for underrecoveries (post discount by oil producers), while fully paid by the government, is done in an ad-hoc manner, which at times stretches their working capital cycle leading to higher interest costs.

What’s equally important for them is that the gradual diesel price deregulation continues. Currently, the underrecovery on diesel is about Rs 9 a litre. Diesel price deregulation is also positive for ONGC as its subsidy burden will be reduced. Given that valuations are cheap, most analysts remain positive on the OMCs.

In the long-run, the impact for OMCs, MRPL and ONGC would also depend on the global demand-supply equation, which may turn unfavourable if demand increases faster as developed economies gain traction. Then, if prices have to remain stable, supply will have to catch up.