By Shreesh BiradarOil, the lifeblood of modern economies, is especially closely watched in India, where its impact on consumers can make or break elections. The Indian government has strategically invested in three oil marketing companies (OMCs) - Indian Oil (51.5% stake), Hindustan Petroleum(54.9% via ONGC) and Bharat Petroleum (53% stake). Together, these Big Three control nearly 80% of the domestic retail market.
After the spike in oil prices in 2022, India began buying cheap crude from Russia, providing the OMCs with higher gross refining margins (GRMs). These impressive margins however have been limited by lower prices at the domestic retail level.
The government’s back-and-forth on prices at the pump has put a ceiling on how much profit OMCs can make. It has caused a tricky balance between happy Indian consumers and the financial viability of India's oil marketing companies.
Although the OMCs (Hindustan Petroleum, Indian Oil and Bharat Petroleum) reported record profits of Rs 30,500 crore in Q1FY24, their stock prices haven't moved much. With consumption slowing down in Europe and crude prices rising, the margins of these companies have fallen. With elections coming up and Saudi Arabia extending oil production cuts until December, government intervention can further impact the profitability of OMCs.
In this week’s Analyticks:
- Oil Marketing Companies: OMCs stay undervalued despite record profits
- Screener: Oil & Gas stocks trading at lower PE than their industry average
Let it flow: India gets ready for post-monsoon surge in oil demand
Oil consumption in India usually takes a dip during the monsoon season, as rain disrupts transportation and mining activities. Over the past three quarters, India’s fuel consumption has flatlined at 57 million tonnes. Although the consumption in July increased by 1.9% YoY, it was still a month on month decline of 6.6%. The highest drop was in diesel consumption, which decreased by 13% MoM.
India’s fuel consumption flatlines over three consecutivequarters
However, India’s fuel consumption should rise again after a weak start in Q1FY24. According to S&P, India’s oil demand in 2023 is expected to increase by 7% from 2019 levels. This figure surpasses earlier estimates, which pegged the demand growth at 6%.
Marketing margins improve, but it's a rocky road ahead
FY23 was a tough year for OMCs. The freeze in retail fuel prices since April 2022 compelled OMCs to bear a blended loss of Rs 3.4/litre (with a profit of Rs 2.3/litre on petrol and a loss of Rs 5.9/litre on diesel).
However, as crude prices dropped from $82/barrel to $72/barrel in Q4FY23, OMCs’ marketing margins turned positive. With crude prices consistently below $75 in Q1FY24, OMCs managed to make a blended profit of Rs 11.9/litre.
Diesel retail margins surge to nine-quarter high in Q1FY24
The upswing in crude oil prices during July and August 2023 has once again impacted marketing margins for OMCs. As of August 2023, their margins stand at a profit of Rs 5.5/litre for petrol, and a loss of Rs 0.7/litre for diesel. Considering the approaching election, OMCs may also face pricing pressures from the government in the coming months.
Brent crude prices rise in Q2FY24
If oil prices climb above the $85 mark and stay there, OMCs could find themselves back in the red. Even if oil prices hover around $80-85, the government may ask the OMCs to reduce fuel retailing prices, denting their profitability. As an initial step ahead of elections, the government is already planning to cut excise duty on retail fuel to ease inflation.
Gross refining margins go lower
The strategic move by OMCs to import cheaper Russian Ural and export refined oil at higher prices to Europe helped expand gross refining margins (GRMs). In Q1FY23, GRMs surged thanks to leftover low-cost inventory, as crude prices rose above $100 per barrel. However, GRMs of the three OMCs declined in Q1FY24 from their peak levels in Q4FY23. The average GRM, which stood at $16.6/barrel in Q4FY23, fell to $9.43/barrel in Q1FY24.
OMCs’ gross refining margins contract in Q1FY24
The decline in GRM was due to the increasing prices of Russian Ural and reduced demand from Europe. Considering the sharp recovery in Singapore GRMs post-July 2023 to around $12.1/barrel, Indian OMCs’ GRMs are expected to increase in Q2FY24. However, the government increased the windfall tax on diesel exports from Rs 1/litre to Rs 5.5/litre starting from August 2023.
Singapore's gross refining margins are lower than Indian refineries
Refining margins are projected to drop from their peak in Q1FY24. As oil prices stabilise, GRMs are predicted to decline to around $8-9 for FY24 overall.
Investors and government to bear the brunt
The daily revision of fuel prices has been frozen since April 2022. This policy shift has led to huge losses for fuel retailers. To compensate for the loss, the government announced a Rs 30,000 crore equity infusion in the 2023 budget.
In line with that, IOCL and BPCL have both announced rights issues, while HPCL is expected to issue preference shares to the government. The rights issue of IOCL and BPCL is expected to draw capital of Rs 11,330 crore and Rs 9,500 crore, respectively, from the government. A similar amount is expected to be subscribed by investors, as the government holds substantial stake in both firms.
Even though the money raised through rights/preferential issues is for the OMCs’ capex plans, it is also compensation for the losses these companies incurred in FY23.
Investors are, no surprise, sceptical despite OMC profits
In 2018, India’s then Minister for Petroleum and Natural Gas, Dharmendra Pradhan, said that “the government has no business in interfering in the pricing mechanism of petroleum products, which should be left to the oil companies to decide on a daily basis”.
Fast forward to 2022 - when oil prices surged above $85, the government abandoned that policy fast, and OMCs froze retail prices, taking a hit to their profitability. Interestingly, the government denied any intervention and put the blame on OMCs. India’s current Minister for Petroleum and Natural Gas, Hardeep Singh Puri, said that “OMCs acted as good corporate citizens and insulated the economy and citizens from increase in energy prices”.
The problem faced by government-owned OMCs is that these listed firms, while designed to make profits, have begun to resemble charitable institutions, incurring losses as needed to protect the general public.
While the general public and economy approve of this, investors have largely steered clear of these stocks. Increased scepticism around government intervention has led to these stocks making negative returns over the past three months, despite record profits. And for now, with Saudi Arabia hinting at more production cuts in the coming months, that is unlikely to change.
Screener: Oil & gas stocks trading at a lower PE than their Industry average
Oil & Gas Valuation Leaders: Refineries and petro-products industry takes lead in valuation
The oil refinery industry is currently seeing some of the highest valuations in the oil & gas sector. This advantage comes from the availability of cheap oil from Russia and higher price realizations on refined oil exports to Europe. However, domestic retail prices have been frozen, causing losses in marketing and distribution. This screener shows stocks from the oil & gas sector that have been trading below the industry average PE.
Significant stocks that appear in the screener are Petronet LNG, Indian Oil Corporation, Mangalore Refinery and Petrochemicals, Hindustan Petroleum Corporation, Oil India, Bharat Petroleum Corporation and Chennai Petroleum Corporation.
Petronet LNG’s revenue declined by 18.3% YoY to Rs 1.2 lakh crore in Q1FY24, while its net profit increased by 12.7% YoY to Rs 7,899 crore compared to Rs 6,142 crore in Q4FY23. This oil marketing and distribution company’s EBITDA margins expanded by Rs 4 per metric million British thermal units (mmbtu) YoY and by Rs 8 per mmbtu QoQ. The margin expansion was led by softer LNG prices.
Hindustan Petroleum Corp’s revenue grew by 10.3% QoQ to Rs 1.2 lakh crore in Q1FY24. Its net profit also improved by 87.5% QoQ to Rs 6,765.5 crore, compared to a loss in Q1FY23. This oil & gas company achieved an operating profit margin of 8.1% during the quarter. This was aided by a decline in the cost of raw materials due to an 8.7% decrease in Brent crude oil prices to $72.7 per barrel.
Oil India’s revenue declined by 24% YoY to Rs 45,312 crore in Q1FY24, while its net profit increased by 3.7% YoY. This oil exploration and production company’s decrease in revenue was on account of lower price realizations for crude oil ($76.9/barrel in Q1FY24 vs. $112.7 in Q1FY23). However, its EBITDA margin expanded by 780 bps YoY on the back of a reduction in well write-offs, a decline in forex losses and a decrease in other provisions.
You can find more screeners here.
Signing off,
The Trendlyne Team
