A crude conundrum for oil marketing companies

Lower prices can improve margins, but could impact inventory

The supply-demand equation in the global crude oil market is expected to change from a supply deficit to supply-surplus by January. Crude oil and gas prices have started correcting as a result.

One reason for this is that the US and Canada are ramping up production. Also, global growth estimates have been downgraded because of the current Covid-19 wave.

In general, lower energy prices are good for India. But it will mean lower growth on the export front, if there’s a trade slowdown. If domestic lockdowns are reimposed due to a third wave, it will definitely hurt Indian growth as well. The Indian crude basket saw a small decline in price to $80.64 per barrel in November, versus a calendar year high of $82.11 in October. But a sharper decline could occur through December 2021-June 2022.

A change in prices leads to a review of the PSU oil marketing companies (OMCS) BPCL, HPCL, and IOC. They import feedstock, refine, and sell products from retail outlets (and to aviation companies). If prices drop, refining margins rise. On the other hand, revaluation of inventory could mean a (non–cash) hit on the bottom line if inventory was acquired at higher prices.

While in theory OMCS set prices according to market rates, there are political considerations. Given several Assembly polls due in 2022, it is possible the government will ask for price cuts.

Consumption data for the April-october period across categories was 113.5 million tonnes (MT) versus 103.6 MT in FY21, and 123.9 MT in prepandemic FY20.

In terms of financial results, HPCL declared consolidated PAT of ~1,919 crore in Q2FY22, versus ~2,976 crore in Q2FY21. IOC’S consolidated PAT was ~6,235 crore in Q2, versus ~6,165 crore in Q2FY21. For BPCL it was ~2,694 crore in Q2, versus ~2,589 crore in Q2FY21. There is an indication of margin pressures when comparing results. This is due to differences in crude prices, which averaged $43 per barrel in Q2FY21 and averaged $72 in Q2FY22. All three companies gained from this.

The share prices of all three OMCS have seen big corrections in the last month. BPCL is down 7 per cent, IOC 7.8 per cent, and HPCL 5 per cent. If crude prices drop, and demand does not reduce, there could be an upside for these stocks. But if there’s a downgrade to domestic growth due to a third wave, or global growth falling, there would be a reduction in consumption, which would hurt them.