Oil marketers take pause after reforms-inspired dream run

With refining margins at seven-month lows and demand remaining soft, concerns are rising

Oil marketing companies (OMCs) saw a fabulous rally on the bourses, after the government kick-started fuel price reforms about three years ago. Declining crude oil prices also rained benefits. While Hindustan Petroleum Corporation Limited (HPCL) has been the largest gainer among all, rising almost 440 per cent in past three years, Bharat Petroleum Corporation Limited (BPCL) and Indian Oil Corporation (IOC), too, have seen their stocks triple in the same period. All of them hit their all-time highs in February before falling. While the multi-month rally seemed justified, concerns surrounding business fundamentals have sparked the recent fall. 

On the international front, petrol cracks (margin on producing petrol from crude oil) have weakened, with US petroleum demand slackening and oil production rising. As a result, gross refining margin has come under pressure. GRM is the difference between the sale price of a product and the cost of producing it from crude oil. Consumption in the US this year is down six per cent, while US oil production is up six per cent in this period. Declining US consumption has seen petrol cracks decline to $8.6 a barrel, say analysts at ICICI Securities, which is the lowest in past seven months. At start of the March, Reuters Singapore GRM at $4.5 a barrel is also lowest since last week of August (or in past seven months). Also, analysts say the benchmark Singapore GRM is down 12 per cent year-on-year in Q4FY17 (till end-February). All these will also affect domestic players.

For OMCs, diesel-marketing margins have been a strong profitability (margin) driver after freeing of diesel pricing by the government. The improving fuel demand, too, helped. Inventory gains added to their profitability in 2016-17 (FY17) as crude oil prices rebounded from their February 2016 lows. All these have led to strong improvement in earnings in FY17 so far as well as in the previous one to two years.

However, with the petroleum products' demand in India slackening, the equation is changing. February has seen oil demand declining (2.8 per cent year-on-year, going by analysts) with weakness across all major products. Diesel demand fell 0.5 per cent year-on-year and has been declining for the past three months. Credit Suisse says demand, going by three-month moving average, has seen 2.4 per cent decline. Analysts note that truck freight rates have been flattish, indicating weak demand, which in turn slackens up diesel demand. Demand for petrol, which showed a 13.6 per cent growth in previous year, has slowed, with three-month moving average pegged at 4.6 per cent. With industrial demand remaining soft, the pressure on marketing margins for OMCs may also be felt. Marketing margin denotes profit earned by selling fuel at retail outlets (fuel stations). Analysts at Credit Suisse say that with one-off inventory gains behind, OMCs earnings could get hurt in near term by recent the GRM correction, slowdown in India demand, and losses from fuel discounts and merchant demand charges. 

 

Analysts at ICICI Securities say FY18 EPS (earnings per share) of OMCs will be down 6-19 per cent year-on-year in the absence of crude oil and inventory gains, which boosted FY17 EPS 19-43 per cent. Going by reports last month, Religare says EPS will decline in FY18.

Thus, on the back of weakness in fundamentals (GRM, marketing margins, demand), concerns on OMCs profitability remain elevated. Some experts have highlighted rising competition from private players, leading to pressure on marketing margins and market-share losses. 

Part of the reason for fall in HPCL and BPCL can also be the rising buzz around their union with ONGC (Oil and Natural Gas Corporation), which may remain a near-term overhang, given no clarity on it yet. Such attempts in the past have not succeeded. Analysts at Jefferies said that even if the plan does not fructify, it could remain an overhang on public-sector oil and gas companies in the near term.

Among the three OMCs, IOC could still do better as benefits will pile in from ramp-up at its new Paradip refinery, which is far more efficient and could ease the impact of declining GRM.