Parlous state of Indian refining segment threatens clean energy projects

Govt-run refiners may not be able to aggressively invest in clean energy projects as they stare at a rough road amid dwindling margins, volatile crude prices, shrinking discounts on Russian oil buys

India’s oil ministry made a show of record profitability of state oil marketing companies last fiscal — a performance that had more to do with geopolitics and some luck with global crude oil prices than with management or the government — but the noise generated failed to bury a poor fourth quarter and uncertain prospects moving forward. Moreover, such profits would not have been possible if state oil companies had stopped making supernormal margins on selling fuels, and had passed on lower costs from crude sourcing to Indian motorists, industry officials said.

Now, the road ahead looks unpaved. State-run refiners led by Indian Oil are staring at a rough year amid dwindling refining and marketing margins, volatile crude prices, shrinking discounts on Russian oil purchases, and, more important, an inability to set prices for the fuels they sell.

A projected downside in performance raises concerns over the capability of these companies to aggressively invest in clean energy projects that require billions of dollars, and the level of support they will require from the exchequer towards capex and operational needs — barring a one-time grant of Rs 22,000 crore to refiners in FY23 for losses that they incurred from selling LPG, the Narendra Modi government has refrained from subsidising refiners directly in the last few years. Also, after setting aside Rs 30,000 crore to fund energy transition initiatives of state oil companies, the government spent nothing, and cut the allocation by half after carrying forward disbursement to this financial year.

What will a coalition government's role be amid lower margins, shrinking discounts, and growing clean energy spends in a volatile global environment remains to be seen.

 

Gross refining margins, a measure of a company’s profitability while processing crude to fuels, will dip sharply this fiscal from a year earlier in line with benchmark Singapore GRMs, which plunged to a fourth of August 2023 levels, according to industry reports. Marketing margins, generated by selling petrol and diesel at the pump, are also facing headwinds. Put together, they will impact cash flows and profitability, industry officials said.

“While FY23 and FY24 were exceptional years for Indian refiners, FY25 is expected to witness some normalcy with moderation in refining and marketing margins as a result of contracting discounts and lower product cracks,” said Hardik Shah, director at CareEdge Ratings. The rating agency expects a refining margin of $6-$8/bbl in FY25, with full utilisation of refining capacities, around half of last year's levels.

“In the long term, given adequate capacity expansions in China and India, and weak demand prospects, we expect GRMs to remain weak,” said Swarnendu Bhushan, co-head, institutional equities, Prabhudas Lilladher. The Mumbai-based brokerage built in a GRM of $6/bbl for FY25/26E, a third of what refiners earned in FY23.

The performance of oil marketing companies in the January-March 2024 quarter may set the tone for the year ahead. Combined profits of Rs 12,987 crore fell by around 40 per cent or by over Rs 8,300 crore in the January-March quarter. The shrinkage in profits was because of lower product cracks, shrinking Russian discounts, and lack of pricing power over petrol and diesel.

GRMs of Indian refiners in FY24 dropped to an average of $10-$12/bbl from a record average of $16-$18/bbl a year earlier. For instance, Indian Oil reported a GRM of $8.4/bbl in the January-March period, lower than an estimate of $12.3/bbl, contributing to a decline of 49 per cent in consolidated net profit during the quarter at Rs 5,488 crore from a year earlier, Prabhudas Lilladher said.

Supernormal marketing margins have supported record annual profits at refiners despite lower GRMs. The operating profit of oil players jumped multi-fold last fiscal due to higher marketing margin, CareEdge’s Shah said. Indian Oil, BPCL and HPCL posted combined profits over 25 times higher than the previous fiscal, the oil ministry had said.

Strong marketing margins were led by a decline in the price of the Indian crude basket to $82.6/bbl last fiscal from $93.2/bbl a year earlier coupled with discounts on Russian oil in January-June 2023 averaging as high as $15/bbl, according to the oil ministry and industry data. At the same time the retail price of petrol and diesel was unchanged since April 2022.

But profits from selling fuels at the pump are declining. Margins in May 2023 on petrol and diesel were as high as Rs 13 and Rs 12/litre, respectively, Prashant Vasisht, senior vice president and co-group head, corporate ratings, at ICRA said in an email. That slumped to Rs 2 and a negative Rs 0.03/litre this April after New Delhi cut pump prices by Rs 2/litre prior to the general elections. In normal times, marketing margins are typically around Rs 2.50-Rs 3/litre, refining officials said.

Prospects of lower profits from both refining and marketing leave state oil companies with less to invest, especially when capital expenditures are set to soar, led by the twin planks of fuels and clean energy. Strained finances leave them even more dependent on New Delhi to part-fund their clean energy projects, with refiners seeking a PLI equivalent scheme to build new facilities, industry officials said.

Indian Oil, Bharat Petroleum and Hindustan Petroleum have announced around Rs 3.5 trillion investments in energy transition projects but execution is slow. Oil marketing companies are capable of financing their refining investments but as far as clean energy is concerned, it will take a much longer time to pan out, Bhushan said. But state ownership eases the process of securing funds, he added.

All three refiners have planned a combined capital expenditure of Rs 55,000 crore in refining and petrochemicals for FY25, according to budget documents. Bharat Petroleum announced Rs 1.7 trillion of investments in five years on refining, chemicals and clean projects, averaging around Rs 35,000 crore annually, but in the 2024-25 budget, the refiner's annual capex is just Rs 11,000 crore. Surprisingly, the budget makes no mention of a capex for clean energy projects for any refiner.

Product cracks have eased while oil prices are expected to be higher this fiscal by $5-$7/bbl from current levels, forecasts show. State interference in setting fuel prices looks set to continue in a coalition government, shrinking the headroom for refiners to diversify into energy transition while speeding up spending, leaving the state to step up its support.