Oil and Gas share price target

Recent news reports (link) and the record level of marketing margins being earned by the oil marketing companies (OMCs) have given rise to speculation around an imminent cut in petrol and diesel retail prices.

FY23 saw multiple headwinds impact the oil & gas sector owing to the Russia-Ukraine conflict and resultant spike in input costs for midstream/downstream players. Additionally, imposition of windfall taxes limited the gains from pricing strength for refiners and upstream players as well.

Q4FY23 EBITDA/PAT for our oil & gas coverage universe was much stronger than in the preceding quarter. EBITDA grew 22% and PAT 29% YoY in Q4FY23 vs a flat EBITDA and 17% YoY decline in PAT in Q3FY23. Robust improvement in the results of RIL and the OMCs were primarily responsible for the aggregate earnings jump.

Crude prices and crude inventories have had a longstanding inverse correlation, with a rise in one mostly implying a fall in the other. The current softness in Brent crude price, however, does not seem to be following that trend, with bearishness in prices sustaining despite a marked drawdown in key product inventories.

Recent trends in downstream margins indicate a rapidly deteriorating demand scenario, with benchmark Singapore GRMs (SG GRMs) dipping sharply over the past few weeks. SG GRMs have declined to US$3.9/bbl levels over Apr’23 (last week’s average: US$2.8/bbl) and, as per our rough estimates, OMC GRMs for Apr’23 are averaging US$3.1-4.9/bbl.

The combination of the softer domestic gas prices expected over FY24E-FY26E and the persistent softness in spot LNG prices should be a comfort for margins of the CGDs (city gas distribution companies). Our estimates are building-in (‘spot LNG price of’) ~US$20/mmbtu over H1FY24E and ~US$30-32/mmbtu average price for H2, implying an average price of US$25-26/mmbtu for the full year in our base case estimates.

The government has, post a short delay, notified the new gas pricing norms on the 7th of April (link here) which is broadly in line with the Kirit Parikh committee (KPC) recommendations issued a few months ago.

We expect Q4FY23E earnings for the 12 oil & gas companies under our coverage to show strong sequential improvement, with operating earnings (EBITDA) likely to rise 10%/20% YoY/QoQ to Rs833bn and net income to be up 2%/26% YoY/QoQ to Rs438.2bn.