Improved prospects, attractive valuation for oil marketing companies

OMCs hold 45 days inventory priced at around $75 per barrel crude

Brent has dipped to $65 per barrel due to the tariff war and OPEC+ deciding to raise output. Blended global gross refining margins (GRMs) may recover to the range of $5-6 per barrel over the next few months, driven by 1 million barrels per day (bpd) of permanent refining capacity shutdown, lower Chinese product exports, and continuing Russian price discounts as OPEC+ hikes output by up to 2.2 million bpd. The tariff fallout is hard to estimate. Sustained demand weakness could accelerate permanent capacity shutdowns even as new capacity ramp-up slows. Tariffs may also hit US refining, given the cost of medium-heavy crudes the US imports.

 

The Government of India (GoI) has hiked petrol and diesel excise duties by ₹2 per litre each, and increased domestic LPG by ₹50 per cylinder. The petroleum ministry has also assured compensation for LPG under-recoveries amounting to ₹41,340 crore in the financial year 2024-25 (FY25). Minister Hardeep Singh Puri said oil marketing companies (OMCs) have decided to not increase retail prices of petrol and diesel, after the excise duty hike.

 

OMCs hold 45 days inventory priced at around $75 per barrel of crude. The minister has also said LPG prices may be reviewed fortnightly. The LPG under-recovery before the ₹50 per cylinder hike was ₹226 per cylinder, while the excise duty hike will lead to revenue of ₹32,000 crore-plus for the GoI, which may be used for compensating OMCs for LPG losses. But no provision for this compensation was made in the Budget or the first supplementary grant.

 

There is also high probability of decline in LPG prices, which would further reduce under-recoveries. If there is a fortnightly review of LPG prices, this may also mean calculated hikes that gradually eliminate under-recoveries on cylinders.

 

The current blended auto-fuel gross marketing margin for OMCs at $65 Brent is at ₹11-12 per litre, which implies ₹1 trillion-plus of auto-fuel over-recoveries in FY26, significantly exceeding the projected LPG under-recoveries of less than ₹40,000 crore. There is about ₹3-4 per litre auto-fuel margin cushion, which indicates OMCs can sustain up to $75 per barrel of Brent. 

 

All this translates into an improved scenario for OMCs, with some caveats. Retail prices may be cut soon but price cuts, if any, may still leave a comfortable margin. The OMCs’ lack of pricing freedom is, of course, a key concern but the political situation is stable, which may allow them free rein. The refining outlook is weak. OMCs’ premiums to the benchmark Singapore complex GRM have moderated in 9MFY25, and may further weaken. There is also a chance of GoI hiking excise duty again if crude stays low, which would cut into marketing margins.

 

Some analysts are assuming that OMCs may sustain LPG losses of ₹20,000-30,000 crore in FY26, and a downside risk to GRM of $2-4 per barrel and inventory losses of $2-5 per barrel in Q1FY26. They would need to generate gross marketing margins of ₹7.5-plus per litre to compensate. Their current margins are ₹12-plus per litre, which seems comfortable. OMCs’ earnings are higher by 10 per cent for every ₹0.5 per litre higher margins. While further excise duty hikes could cut margins, global LPG prices may also come down and GoI may be open to more cylinder price hikes.

 

As of December 31, 2024, Hindustan Petroleum (HPCL), Bharat Petroleum (BPCL), and Indian Oil Corporation (IOCL) had cumulative negative net under-recoveries on LPG losses amounting to ₹7,600 crore, ₹7,200 crore, and ₹14,300 crore, respectively.

 

OMCs’ share prices are down significantly. All three OMCs are trading at valuations of between 4x and 4.5x of Enterprise Value/Ebitda, with HPCL trading at 1.2x FY27 Price/Book Value (P/BV), BPCL at 1.2x FY27 P/BV, and IOCL at 0.9x FY27 P/BV. Value investors and commodity traders may find those valuations attractive.