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As Brent crude crosses the $80/bbl mark, India is staring at a crude problem. Rising prices of crude oil will likely weigh on oil marketing companies such as IOC, BPCL and HPCL, especially in the backdrop of elections, analysts at CLSA have said in a report.
However, it sees Vedanta, GAIL and ONGC as good buy options based on factors such as favourable risk reward and lack of subsidy burden.
Assuming continuing depreciation in the rupee and rising spot crude prices, under-recoveries in FY19 for LPG and kerosene will rise 124 percent year-on-year to Rs 57,400 crore. For 4QFY18+9MFY19, under-recovery may stand at Rs 41,600 crore, which is double of budgeted oil subsidy amount (Rs 20,800 crore).
Under-recovery denotes notional losses that oil companies incur due to the difference between the price at which the oil marketing companies (OMCs) sell oil products like diesel, LPG & kerosene and the price which they should have received for meeting their cost of production,” according to Arthapedia, a portal for facilitating understanding of the Indian economy.
Even in a scenario where ONGC/OIL absorb the budgeted oil subsidy amount of Rs 20,800 crore, at spot crude/rupee price, the stocks will still not see further downside, analysts wrote in the research note.
In case of Gas Authority of India (GAIL), the up move in crude could make it raise spreads in its LPG production business and mean higher LNG trading margins.
“Spot crude/rupee from the second half of this fiscal could raise GAIL’s FY19/20 EPS (earnings per share) by 10/14%. Moreover, the firm also does not foresee any subsidy burden on GAIL.”
For Vedanta, CLSA noted that every USD 1 per barrel rise in crude price adds 0.9% to EPS and Rs 2.7 per share to its fair value. It sees Vedenta as another beneficiary of strong crude price.
Crude output to be hit
CLSA, in the report, also highlighted that crude production is set to take a hit, going forward. Factors at play are forced production cut by Iran due to sanctions and lower output from Venezuela.
“If we see this against the backdrop of below-average inventory levels and decade-low OPEC spare capacity, the market picture appears to be highly vulnerable to any further geopolitical disturbances which the oil market is prone to,” the report further added.
How are OMCs placed?
In this backdrop, OMCs such as IOC, BPCL and IOC may be take a hit ahead of elections in 2019.
Despite 5% spike in crude and 2% fall in rupee this month, average marketing margin on diesel and petrol will be slightly higher in 2QFY19 versus 1Q. Though this is still below long-term average margin, it underscores 5% rise in petrol/diesel price which OMCs have managed to take during second quarter.
So, the government has shown strong resolve in continuing with subsidy reforms. But in the upcoming six months, the government may see its toughest test as crude may spike further at the crucial time of elections and rising opposition on higher fuel price.
“The next six months could provide periods when marketing margins decline notably and raise doubts from investors. Although we believe diesel/petrol subsidies will not come back, these doubts will continue to hurt the stock performance of IOC, BPCL, and HPCL.”
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