Oil prices buoyant; Singapore GRM down 4% QoQ to USD7.6/bbl

Oil prices buoyant; Singapore GRM down 4% QoQ to USD7.6/bbl

Brent crude prices averaged USD119/bbl (USD110-127) during 4QFY12 led by the likely sanctions on Iran and the threat by Iran to close down the Strait of Hormuz in retaliation. The regional benchmark Reuters Singapore GRM averaged USD7.6/bbl v/s USD7.9/bbl in 3QFY12. Light distillate cracks recovered sharply but the gains were offset by the decline in middle distillate cracks. We expect Singapore GRMs to remain in range of USD7-9/bbl in medium term as the continued shutdown of refineries would help absorb new capacity coming up in 2012-13 to some extent. However, demand destruction due to high product prices poses a downward risk to our assumptions.

Petchem spreads decline sharply; volume remain flat in 4QFY12:

In polymers, PE and PP spreads over naphtha declined 9-16% QoQ, while PVC spread was down 46% QoQ (a decade low level). Integrated polyester spreads were down 8-10% QoQ. Margins are likely to remain under pressure led by continued supplies from the Middle East.

Full-year under-recoveries at INR1.4t; model upstream share at 40%:

We expect under-recoveries to increase 27% QoQ to INR410b led by high oil prices and increased international diesel prices. The subsidy-sharing would be again ad-hoc and as was the case in previous years, it will be finalized in this quarter. We have modeled upstream sharing at 40%/38.8% and downstream sharing at nil/7% for FY12/FY13, respectively, with the balance being the government's share. However, given that the government is already reeling under high fiscal burden, we believe there remains upside risk to our FY12 upstream sharing estimate.

Valuation and view:

High crude oil prices do not augur well for OMCs. However, the likely nil subsidy sharing during the current fiscal and likely price hikes after the budget session makes them attractive. Among OMCs, BPCL is our top pick due to the upside potential from its E&P business.  We remain neutral on GAIL and GSPL as operational earnings are unlikely to surprise positively led by headwinds for incremental gas availability in India. Strong earnings sustainability augurs well for Petronet LNG.

Maintain Neutral on RIL to factor in the continuous decline of gas from the KG-D6 basin, non-clarity on cash utilization, RoE reaching sub 15% levels and increased share (80%) of cyclical refining and petchem businesses, where the outlook continues to remain weak.

Cairn India, being an upstream pure play, would be the biggest earnings beneficiary of higher oil prices. But the key things to watch out in the near future are production ramp-up, reserve upgrade and dividend policy.

Our key assumptions:

Our crude price assumption for FY12/13/14 is USD114.5/ 110/100/bbl and USD90/bbl over long term.

We expect regional benchmark Singapore Reuters GRM to remain in range of USD7-9/bbl in the near term.

We model Singapore GRM at USD8.2/bbl in both FY13 and FY14.

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