Any correction in oil marketing companies could be a buying opportunity

Trends in the global energy markets are crucial if India's growth outlook is to remain healthy.

Prices for the Indian crude basket were averaging around $86.2 per barrel through Q1FY25 and then moderated to $84 in July and to $78-79 in August (so far).

But global crude supply may outpace weak global demand in the short term.

Lower crude prices are in general, good for India and these help the oil marketing companies (OMCs) in particular.

Oil producers have profits capped at around $75-80 a barrel by the windfall tax.

This is the sweet spot for Oil India and ONGC.

However, the oil market could turn into a significant surplus supply in CY25.

The gross refining margins (GRMs) and gross marketing margins for OMCs are critical.

OPEC-plus supply cuts will expire in Q3FY25 when the oil-exporting group takes a call on future action.

Indian refiners would continue to report a premium to the GRM benchmark due to a higher share of the higher-crack product, diesel.

India's oil demand remains strong with a 7.2 per cent Y-o-Y increase in total petroleum product consumption in Q1FY25.

Diesel and petrol?gross marketing margins (as of August 20) were at Rs 7.4 and Rs 10.6 per litre, respectively, and Q2FY25 average is running at Rs 4.2 and Rs 7.6 a litre.

The average for?Q1FY25 stood at Rs 3.7 per litre and Rs 5.4 a litre.

The fall in the crude price has been supportive of OMC margins.

If the trend of lower crude prices and good GRMs is maintained, there are upsides for the OMCs.

According to CMIE, the discount on Russian crude to India was at $1.7 per barrel in June 2024 versus $1.4 per barrel in May 24 (far lower than the discount of $6-10 per barrel in H1CY23).

Further, Russia s share of India s crude imports improved month on month to 42 per cent in June 2024 as compared to 37 per cent in May 2024.

But LPG under-recovery continues at Rs 2,500 crore per month.

Current LPG under-recoveries are at Rs 160 per cylinder and the industry is hoping for policy action to cover the accumulated losses.

OMC valuations look reasonable and investors will factor for a dividend yield of Rs 3-4.

The decline in crude oil prices could result in refining/marketing inventory losses for OMCs, but these are less significant.

More importantly, a drop in GRMs will hurt the OMCs and analysts will watch for signs of GRM normalisation.

The OMCs  risk-reward equation for investors may still be hard to judge, or even unfavourable, despite the above developments in their favour.

The current valuations imply sustainable GRM will stay higher than the historical average, which is an assumption that may be at risk.

Also, it's assumed that gross marketing margins will stay above the historical average of Rs 3.5 per litre.

Hence, valuations are also trading at a 10-40 per cent premium to the historical price to book.

Moreover, the OMCs have big capex plans, which means that the new projects must create long-term value for shareholders, and deliver an acceptable internal rate of return.

LPG under-recovery dragged down performance in Q1. Earnings took a big hit with LPG under-recoveries of Rs 4,120 crore for IOC, Rs 2,350 crore for HPCL and Rs 2,000 crore for BPCL.

IOC did manage strong marketing margins (Rs 4.8/litre) and a turnaround in the petrochemical division.

However, HPCL missed estimates due to a lower-than-expected marketing margin of Rs 3 per litre.

BPCL s operating profit was in line, with the implied marketing margin well above estimate at Rs 4.8 per litre.

For all OMCs, the reported GRM was in line with or above estimates.

There could be share price corrections if the misses by OMCs impact market sentiment.

If share prices do correct, investors may receive an entry opportunity.

Apart from reported Q1FY25 results, investors must track gross marketing margins trends, GRM trends and booked inventory gains or losses.

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