RIL: Margin blues

The Street is anxious that refining margins could come off sharply in the next few years.

The Reliance Industries (RIL) stock has come off by more than 20 per cent in the last two trading sessions and from the peak of Rs 3,216, which it hit at the start of the year, the stock has lost over 60 per cent.

What’s worrying the Street is the fresh refining capacity of about 3 million barrels per day expected to be added in 2008 and 2009 with around 2 million barrels coming up in India and China. Industry watchers reckon that incremental supply could outstrip demand by a factor of two times over the next three years which could result in refining margins for RIL coming off sharply.

Indeed after five years of robust margins, refining margins are clearly reversing. For most of this time, RIL, thanks to the superior configuration of its refinery, has enjoyed gross refining margins (GRMs) that were at a premium to the benchmark Singapore complex margin.

Between FY05 and FY08, the premium increased from $2 per barrel to about $7.4 per barrel. One reason for this was that margins on transportation fuels—diesel, gasoline and jet fuels—rose smartly with a pick up in global growth. However, this trend, say analysts, could reverse as new refining capacity targets transportation fuels.

In the September 2008 quarter, RIL’s GRM was $13.4 per barrel, somewhat lower than the $15.7 per barrel posted in the June 2008 quarter. Nevertheless, the company reported an increase in the net profit, of 7 per cent, to Rs 4,120 crore, thanks partly to better margins from the chemicals segment as also a weaker rupee.

Analysts expect GRMs for RIL to average $13.5 per barrel for the current year. Refining contributes about 55 per cent to the company’s revenues, which were Rs 1.4 lakh crore in FY08. With oil now being produced at the KG-D6 basin and the Reliance Petroleum refinery expected to go on stream in December, RIL should post a net profit of around Rs 15,500 crore in the current year, an increase of about 6 per cent over FY08. Revenues are expected to grow to Rs 1.8 lakh crore.