Oil & Gas Sector in Q2FY16: OMCs' marketing margin flat q-o-q; crude inventory losses to impact profits

Motilal Oswal | April 20, 2012, midnight


- OMCs’ auto fuel marketing margins were flat QoQ. Refining and marketing businesses would be impacted by inventory losses, led by crude price decline.

- Despite USD52/bbl YoY Brent decline, upstream PSU players’ net realizations are up USD4/bbl YoY, led by almost nil subsidy. However, realizations are down 18% QoQ due to 19% decline in crude prices.

- Refining margins are up USD1.5/bbl YoY, but are down USD5.6/bbl QoQ, led by sequentially lower light distillate cracks.

- RIL’s standalone PAT is likely to decline 6% QoQ to ~INR59b due to lower GRM.

Brent average down 19% QoQ; model marginal upstream subsidy in 2QFY16

- Closing price for 2QFY16 was down USD15/bbl. In 2QFY16, prices were mostly sub-USD50/bbl, unlike mostly above USD60/bbl in 1QFY16. This would result in inventory losses for refiners.

- We estimate 2QFY16 under-recoveries at INR31b (down 86% YoY). As LPG subsidy is now fully compensated by the government through DBTL, only kerosene subsidy needs to be shared.

- Of the INR31b kerosene under-recoveries, we model INR6.8b for upstream towards subsidy sharing; the rest would be borne by the government.

GRM at USD6.3/bbl (+31% YoY, -22% QoQ); polymer spreads mostly down QoQ, up YoY

- The regional benchmark Reuters Singapore GRM was up 31% YoY but down 22% QoQ to an average USD6.3/bbl, led by higher gasoline cracks.

- In petchem, polymer PE and PP spreads declined while PVC spreads increased QoQ. Polyster POY spreads declined QoQ while PVC spreads increased; polyester spreads declined YoY due to high spreads in the previous year.

- Brent crude average for the quarter was USD50/bbl (down 51% YoY, down 19% QoQ). The recent decreased price can be attributed to lower economic growth in emerging markets, primarily China; the price outlook is still subdued, led by additional exports from Iran. YoY and QoQ decline in light/heavy differentials would lower the premium for complex refiners.

Auto fuel marketing margins flat QoQ, largely in line with the regulated period

- Post the diesel deregulation on October 18, 2014, OMCs have demonstrated pricing power by tweaking marketing margins.

- We estimate average diesel marketing EBITDA at INR0.7-0.8/liter; flat QoQ and versus INR0.7/liter in the regulated era. PSU OMCs’ strategy to keep marketing margins lower would delay the entry of private players; however, we believe that marketing margins would comfortably move toward INR1.5-INR1.75/liter over the next one year.

- For subsidy sharing in FY16/FY17, we model OMCs’ share at nil and upstream sharing at 30%/41%, with the government bearing the rest. Any variation in this would impact our estimates for oil PSUs.

Valuation and view

- In the backdrop of lower oil price regime, auto fuel pricing freedom and stable marketing margins, we retain OMC’s (HPCL/BPCL/IOCL) as our top picks. While ONGC and OINL’s earnings revival is contingent on oil price increase, we remain positive due to attractive valuations.

- While RIL could outperform in the short term, we maintain Neutral on RIL because the next earnings growth phase is still some time away – we believe FY18, when the company’s new core business commissions. However, we await clarity on its telecom business plans.

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