Street realigning to the new scenario for oil marketing companies

Many more price hikes though required to return to positive margins; moderate valuations offer some comfort

It may be time to review and re-rate the impact of the Ukraine war upon the Indian oil refining and marketing companies (OMCs). Fossil fuel prices are stratospheric and India imports over 50 per cent of its gas and 85 per cent of its crude oil.

Two oil marketing PSUs, Indian Oil Corporation (IOC) and Hindustan Petroleum Corporation (HPCL) have recently bought around 5 million barrels of crude from Russia at discounted rates. Since India consumes around 4.5 million barrels a day, this is a token quantity but it could be an indicator of future deals with geopolitical implications.

India actually has very low dependence on Russian crude – importing less than 2 per cent of its annual needs from Russia. But India and the former USSR had a long-standing trade relationship where they spent accumulated rubles / rupees to buy goods or services bilaterally. (India had a similar deal with Iran for a while). It may revert to a similar arrangement with Russia, in the face of sanctions.

To some extent, this would reduce fears of supply disruptions and perhaps, help to lock-in better prices for fuel imports. Also after a long hiatus due to election schedules, the prices of petro products and of gas has been hiked.

Although the profit and loss accounts of OMCs have been kept afloat by inventory gains as oil prices have escalated through the past four months, the OMCs have suffered from under-recoveries through December 2021 and all of Q4 (Jan – March 2022).

Even the increases that have now been mandated will not be enough. However, the Q1, 2022-23 could be better if OMCs now possess the headroom to gradually hike their retail prices until marketing margins recover. In one estimate, marketing margins (blended/ averaged across fuels) were estimated to be at Rs 5.3/ litre for Q3 and deep into the red for Q4.

Budgetary estimates assumed that crude prices would stay below $80 per barrel. At the prevailing range of prices of between $100-120 per barrel, OMCs will need to raise petrol prices by between Rs 11-22 per litre and diesel prices by between Rs 13-25 per litre. So the two price hikes of Rs 0.8 per litre each (and Rs 25 per litre for bulk diesel consumers) just initiates a process of raising retail prices. It could take another 20-30 hikes of the same quantum to pull back to a positive margin.

The refining margins are also likely to be volatile. There’s some demand reduction due to the fourth wave and the downgrading of growth prospects. There’s also a big supply shock of course. But around 2.7 million barrels per day of global refining capacity is being shut down, which could mean that supply realigns down and helps maintain refining margins. If refining margins are maintained at current levels for 2023-24, then the public-sector OMCs are moderately priced at enterprise value (EV)/ EBITDA ratios of 5-6 on estimated 2021-22 earnings.

Stocks of IOC and HPCL have responded positively to the price hikes and news of the Russia deals, although these are tiny. Both are up in the last seven sessions and IOC is up for the last month. BPCL is also up over the last month. This could indicate that the market is adjusting to the new situation after the initial panic reactions.