Escalating tensions between Israel and Iran are likely to further pressure prices of crude oil. However, brokerages believe that OMCs shall see strong margins, even if crude remains above $75/bbl.
International brokerage UBS said while crude prices are up sharply, the OPC+s spare capacity of oil limits the upside to crude prices. Further, OMCs will see above normal margins for the quarter.
The possibility of crude prices spiking beyond the $80/bbl mark occurs if Iran is able to disrupt crude supply through the key Strait of Hormuz via which ~20 percent of global oil & LNG shipments takes place.
"The probability of this, though, is low; the Strait of Hormuz has never been blocked during earlier wars in the region, and its blocking is extremely unlikely this time as well, as US and Western countries are likely to take strong measures against any such disruptions given the huge risk it can pose to global oil and gas prices and, hence, inflation," said JM Financial.
Israel had launched airstrikes against Iran, and the conflict between the two escalated over the weekend with a series of attacks from both sides. Further, Iran rejected a ceasefire deal, extending the conflict for the fourth day.
Brent crude climbed as much as 5.5 percent before paring most gains to trade around $75 a barrel, while West Texas Intermediate was near $74. Israel launched an attack on the giant South Pars gas field, forcing the halt of a production platform, after strikes on Iran’s nuclear sites and military leadership last week.
While an attack on Iran’s gas-producing infrastructure is a concern, the biggest fear for the oil market centers on the Strait of Hormuz. Middle East producers ship about a fifth of the world’s daily output through the narrow waterway, and prices could soar further if Tehran attempts to block the route.
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In the previous session, OMC stocks saw selling pressure, with HPCL, BPCL, and IOCL falling up to four percent during the session. On the flip side, oil exploration companies such as ONGC and Oil India recorded strong gains.
When crude oil prices rise, shares of oil marketing companies often come under pressure, as their input costs increase but they may not be able to fully pass on the hike to consumers due to pricing regulations or demand concerns - impacting their profit margins.
On the other hand, oil exploration companies such as ONGC and Oil India benefit from higher crude prices, as they earn more per barrel produced while their costs remain largely fixed. As a result, investors expect better earnings from exploration firms, leading to gains in their stock prices.
On June 12, Thursday, Emkay Global noted that until the average of Brent crude prices stands at $75/bbl, the brokerage does not see any downside to its earnings. The continuation of the current earnings run-rate, reduction in international LPG prices, and payment of LPG subsidy is likely to offer a material upside potential for OMCs.
The brokerage reiterated its 'buy' calls on HPCL, BPCL and IOCL, favouring the stocks in that order, with a target price of Rs 500, Rs 400 and Rs 170, respectively.
On the other hand, JM Financial maintained its 'buy' rating on ONGC and Oil India as they are key beneficiaries of high crude prices. According to the brokerage, the current market price of these stocks are discounting $65/bbl crude realisation; every $1/bbl higher oil price boost their EPS by 1.5-2 percent.
JM Financial also maintained its 'sell' tag HPCL/IOCL and 'hold' on BPCL as the brokerage believes OMCs’ risk-reward is not favourable given their aggressive capex plans and as valuations are 10-30 percent above the historical average.
"We expect OMCs’ integrated refining-cum-marketing margin to normalise around historical levels due to either sustained high crude price or government retaining benefit of any sustained fall in crude price via excise duty hike and/or cut fuel price to pass."
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