Sentiment takes a U-turn for OMCs

Upward bias in crude oil prices adds to woes over marketing margins

Until last month, it was mostly good-going for oil marketing companies (OMCs) such as Hindustan Petroleum, (HPCL), Bharat Petroleum (BPCL) and Indian Oil (IOC). But, sentiment did an aboutturn when their share prices tanked 8-11 per cent in the last one month.

If analysts are to be believed, the near-term headwinds in the form of volatility in crude oil prices would continue to weigh on the stock prices.

The OMC stocks had scaled to their 52-week highs about a month ago, following a spike in Singapore benchmark gross refining margins (GRM). The OMCs, which have huge refining capacities, benefit when GRMs rise.

GRM is the difference between the total value of petroleum products produced by processing a barrel of crude oil and the price of the raw material (oil plus costs).

After the disruption caused by hurricane Harvey in the US, benchmark GRMs had increased to $11 per barrel at the start of September, from the $7.4-level. These have retreated to $7.7-levels recently. While they are still higher than the June quarter average of $6.4 per barrel, the spike in Brent crude could outweigh the gains. Crude oil prices touched their two-year highs on Wednesday, dampening investors’ sentiment.

Analysts at Edelweiss say going by the past trend, the OMC stock prices are counter-cyclical to oil prices. With oil approaching $60 per barrel and with the debate on free-pricing intensifying, Edelweiss anticipates some pressure on the stock prices. Besides, concerns over marketing margins, which oil companies earn to retail fuel (petrol and diesel), have also elevated with the rise in oil prices.

Investors, however, should note that there is no pricing control on retailing fuels like petrol and diesel. Analysts say the Street would keep an eye on OMCs future moves, especially as oil prices are seen rising.

Prices remain firm as oil demand is on the rise, and can see further upside with the winter season approaching. Geopolitical tensions, too, will keep the prices elevated.

Analysts at IIFL, referring to recent IEA upgrades of 2017 crude oil demand to 1.6 million barrels per day (mbpd), from 1.4 mbpd, say over the medium term, India, China and the US will continue to drive demand. Thus, looking at an upward bias in oil prices as well as unfavourable macros, including mounting competition from domestic private players and aggressive vehicle electrification plans, IIFL has downgraded its rating on OMCs.

Among the three, HPCL remains most sensitive, given its high exposure to fuel retailing. Analysts say a 10 per cent increase in oil price will impact their FY19 earnings estimates for HPCL by 88 per cent, for BPCL by 39 per cent and for IOC by 50 per cent. BPCL with an exposure to upstream operations can still be a beneficiary with its exploration assets being awarded higher valuations following higher crude prices.

However, there is some silver lining. One, the companies will gain from higher output, given their expanded refining capacities. Second, rising crude oil prices also tend to result in inventory gains for OMCs. These could offset some of the likely pressures.