Reliance Industries, which announced it fourth quarter numbers late on Tuesday, reported gross refining margin (GRM) of USD 10.1 per barrel compared to USD 7.6 per barrel reported in the same period previous year. But in the coming quarter the company may not be able to report a robust GRM because benchmark Singapore GRM has halved month-on-month, says Jai Irani, MD - Oil & Gas Research, Macquarie Group.
“Refining margins do tend to fluctuate significantly either on quarter on quarter or half over half because there is a reasonable amount of global capacity in refining. As margins guided, excess capacity either shuts down temporarily or restarts,” he says in an interview to CNBC-TV18.
Meanwhile, Irani feels the demand-supply equation is responsible in determining the refining margins. He anticipates a global increase in demand for crude of about 1.25 million barrels per day which is in excess of net capacity additions of about 900,000 barrels per day.
According to Irani, the whole bunch of oil and marketing companies (OMCs) looks good on the back of reforms by the government like capping LPG cylinders, increasing diesel prices. He suggests Bharat Petroleum Corporation Ltd (BPCL) as his top pick.
Below is the verbatim transcript of Jal Irani’s interview on CNBC-TV18
Q: Your estimates were almost bang on with what Reliance delivered. How would you call the next couple of quarters in terms of whether you expect to see consistency in this refining margin improvement that they had?
A: Refining margins for the last two quarters have been at significant highs. Month on month, Singapore complex refining margin, as a benchmark, has nearly halved from USD 10/bbl to USD 4.90/bbl. That is not abnormal. Refining margins do tend to fluctuate very significantly either on quarter on quarter or half over half because there is a reasonable amount of global capacity in refining.
As margins guided, excess capacity either shuts down temporarily or restarts. Therefore, we are likely to see on an average weaker quarter for refining margins but at USD 4.90/bbl Singapore complex, that is very low. We are likely to see a fair bit of capacities around the world that are sitting on margin especially in Japan and Europe that will cut back on production. So net-net, this quarter has got off to a weaker start than the previous one indeed.
Q: The key development over the last few days is the way price of crude has started collapsing. What correlation is established between the price of crude and refining margins?
A: We had done an analysis where we established reasonable correlation of about 65-70 percent between crude and refining margins. Part of the correlation is surreptitious. There is some degree of correlation but not a very high correlation. It is essentially on the balance, the demand-supply equation which drives the refining margins. What we are essentially looking at this year is demand supply equation improving.
We are anticipating a global increase in demand of about 1.25 million barrels per day which is in excess of net capacity additions of about 900,000 barrels per day. On an average for the year, we are looking at stable Singapore complex margins as a benchmark. So it is the demand supply balance which drives refining margins a lot more than crude oil prices.
Q: The big stars have been the oil marketing companies (OMC). Any thoughts on companies like BPCL and whether a case can be made for significant price upside for these stocks from here?
A: These companies do present significant opportunities on several fronts especially BPCL. Now, conventionally, these companies are counter cyclical to oil and that’s been well established. Therefore, the recent move suggests that for diesel which is half the subsidy burden, we are looking at roughly a breakeven price of about USD 90-92 per barrel of crude which is not very far out of reach.
The government has been fairly steadily reforming whether capping LPG cylinders, increasing diesel prices. So this entire sector is looking extremely promising. Between these stocks, BPCL has also got an extremely large upstream portfolio. In fact, a little less than half its value comes from now upstream which has all been created in the last two or three years. Not only Mozambique, but within next one year in Brazil as well in Kaveri onshore in India, looks extremely promising. So indeed, whole OMC bunch looks good on the back of reforms but by far, BPCL would be our top pick.
Q: The confusing one for a lot of investors is Cairn India because on one hand the price of crude could be headed lower. On the other hand, their production ramp ups are quite impressive. How would you position yourself in a declining crude scenario on that name?
A: One can attempt to forecast crude prices, but if you could do it accurately you wouldn’t be sitting here doing this, you would just be punting crude. Best way of looking at Cairn is not worrying about where crude oil prices are moving.
The big kicker for Cairn is not even the expected production increases but the fact that they have been allowed exploration work to be done after a five year hiatus. They do have 100 prospects within their existing Barmer, Rajasthan block itself. Some of the geological plays there, are indeed significant. They are going to be drilling about 1/3rd of those prospects within the next one year. It is likely that we are going to see a significant amount of news flow and that’s what we need to be watching out rather than worrying about crude prices or even near term production increases which are a given.