OMC stocks unlikely to move into a long-term bull market

Share prices for the 3 PSU stocks plummeted through the April-October period. There is now a rebound. In the past 30 days, BPCL is up 18%, HPCL is up 15% and IOC is up 6.5%

The reversal in crude prices over the past three weeks has altered trading equations. In October, the Indian crude basket, a combination of Oman, Dubai and Brent, cost $80/ barrel according to the Ministry of Petroleum & Natural Gas. The average cost of the basket between April-October was $74.61 a barrel. The average cost through financial year 2017-18 was $56.4. 

One rule of thumb is that every $1 increase in crude prices leads to Rs 105 billion increase in India’s import bill. Every hike also hits the margins of the marketing and refining sector. The major private player in this space is Reliance Industries (RIL). 

The other oil-marketing companies (OMCs) as they are known, are all PSUs such as BPCL, HPCL and IOC. All the OMC PSUs have been hit by higher oil prices through 2018. The OMCs are making under-recoveries and they have incurred big forex losses as the rupee has fallen. 

The three majors, BPCL, IOC and HPCL have seen profits nosedive and incurred forex losses during the Q2, 2018-19. BPCL saw its average gross refining margin down to $5.57 per barrel from $7.97 per barrel a year earlier in Q2, 2018-19. This included inventory gains on crude bought at lower prices.  It had massive forex losses. Neither details of inventory gains, or forex losses are available. 

HPCL had an average GRM of $4.81, down from $7.61 per barrel gross refining margin in the year ago period. HPCL also had a foreign exchange loss of Rs 8.87 billion, and an inventory gain of Rs 12.76 billion in Q2. IOC had a forex loss of around Rs 20 billion. The GRM, including inventory gains, was $6.79, versus $7.98 a year ago. The inventory gain was a whopping Rs 44 billion for IOC.  

In November, Brent came down to the $65 level and it could fall further. Analysts estimate that the Indian crude basket will have reduced by 25 per cent in cost in November. That would mean inventory losses but it would also boost margins for the PSU OMCs. Since the rupee also strengthened in November, there should be lower forex losses in Q3 as well. 

Share prices for the three PSU stocks plummeted through the April-October period. There is now a rebound. In the past 30 days, BPCL is up 18 per cent, HPCL is up 15 per cent and IOC is up 6.5 per cent. Is this a pure trading rally or worth investing in for the medium-term? 

Technically speaking, it looks like a pure trading rally. The stocks are all trading well below their respective 200-day moving averages and look unlikely to move into a long-term bull market in the recent future. There are big resistances. However, there is a fair chance that this pullback will continue so long as the price of crude remains below $65. The possible upsides could be in the range of another 20-25 per cent.  

It's worth pointing out that this is a relief rally but the pain is not over. The OMCs are going to pay at least 20 per cent more in terms of raw material costs compared to last year. It's just that they were paying 35-40 per cent more before the November bear market occurred in crude. Also, there's every chance of some populist measure that restricts their ability to pass on costs since this is election season. 

So it's worth going long on the OMCs as a trader. But watch the price of crude like a hawk and be prepared to exit, or sell short (“double-minus”) if there’s a spike in crude prices.