OMCs flying high on higher refining margins

Rising benchmark Singapore GRM and diesel cracks should drive Sept quarter earnings

The benchmark Singapore complex gross refining margins (GRM) in the September quarter so far has seen strong gains. After staying flat sequentially at $6.4 a barrel (on an average) in the June quarter, the Singapore GRM has moved up to $7.6 a barrel (up 19 per cent sequentially and 48 per cent over a year), according to ICICI Securities’ data. This bodes well for the refining business of public sector refiners and Reliance Industries.
 
The public sector oil marketing companies (OMCs) such as Hindustan Petroleum (HPCL), Bharat Petroleum (BPCL) and Indian Oil (IOC) had seen good core GRMs in the June quarter but inventory losses due to falling crude oil prices hit. Consequently, the reported GRMs were lower. For instance, BPCL reported GRM of $4.9 a barrel, hit by inventory loss of $2.1 a barrel. Adjusted for inventory losses, per barrel GRMs of BPCL, HPCL and IOC at $7.0, $8.8 and $6.4, respectively, were ahead of the consensus estimate. Reliance Industries saw exceptionally strong GRM of $11.9, which were at multi-year high and at significant premium to the benchmark. Though sustenance of a high premium is also dependant on a company’s oil sourcing efficiencies, the benchmark moving up is clearly positive for all.
 

What will further aid companies is ‘diesel cracks’. At $13.3 a barrel in the September quarter (Q2) so far, they are up 18 per cent sequentially and 23 per cent over a year. Diesel forms significant portion of Indian refining output (42 per cent), and, hence, this development also augurs well for refiners.
 
Notably, unlike the June quarter, the September quarter should see OMCs report inventory gains, as oil prices have moved up. For IOC, its new integrated and more profitable Paradip refinery should also drive GRMs, while BPCL should benefit from commissioning of its integrated refinery expansion project at Kochi. For HPCL, which is entering a heavy capex (capital expenditure) cycle, benefits will be back-ended, say analysts. In short, the upswing in GRM will support earnings of OMCs. Every $0.5 a barrel increase in GRM, adds six-seven per cent to earnings of the three OMCs (on an annual basis), estimates Credit Suisse.
 
Beyond margins, the daily retail fuel pricing mechanism is also benefiting these. Diesel and petrol margins in July at Rs 3.7 and Rs 3.4, respectively, according to Ambit Capital, had come substantially better than Rs 2.5 and Rs 2.3, respectively, in June quarter and Rs 2.4 and Rs 2.7, respectively, in FY17. This along with continued price reforms on kerosene and LPG should further push up profitability.
 
HPCL stock hit all-time high on Wednesday, while IOC and BPCL, too, traded close to their respective highs. The appreciation should continue but for an earnings re-rating, analysts believe clarity on the impact of goods and services tax (GST) implementation is necessary. Fuel prices being kept out of GST ambit mean OMCs will not be able to take input credit, which will have a bearing on their profitability.