HPCL most vulnerable to falling refining margins; RIL best placed

Topics HPCL | RIL | BPCL

Brent crude prices have set a firm trend of late, but there are expectations of oil prices softening with a rise in US inventories. This is the reason benchmark Singapore gross refining margins (GRMs) continue to see softness. 

This is not good news for Indian oil marketing companies (OMCs), which are feeling the heat of soft GRMs. The Indian Oil Corporation (IOC) and Hindustan Petroleum (HPCL) stocks have corrected more than 18 per cent since their highs in October. 

Bharat Petroleum (BPCL) — whose earnings are equally vulnerable to a change in refining margins — though, has been an exception and continues to trade firm on the back of news flow regarding divestment by the government. This is because such a move would mean value unlocking for investors and the possibility of higher valuations. 

Amongst other refiners, Reliance Industries also continues to gain, led by improving prospects in its telecom and other consumer businesses, and a relatively better positioning in the refining space.

Brent crude prices, which had fallen to $57 a barrel in early October, have risen gradually and are trading above $65 a barrel. While rising crude prices mean OMCs will have to spend more on imports (thereby pushing up working capital requirements), it also increases the risk on marketing margins. Besides, higher product prices could hurt demand, which is already soft.

However, refining margins remains the bigger concern. The soft refining margins have already led OMCs to post subdued earnings. The benchmark Singapore refining margins (on average) had rebounded in the September quarter to $6.3 a barrel, from $3.5 a barrel in Q1, but have softened thereafter. 

Analysts say the continued softness in demand, combined with normalisation of fuel oil supply, has resulted in this weakness. In fact, refining margins between October and the start of December were estimated to have averaged at their lowest levels in many years. 

The consolation, say analysts, is that unlike Singapore GRMs — in which the weight of fuel oil is higher — the proportion of diesel after processing a barrel of crude is much higher for Indian refiners. 

A higher diesel spread means refiners will see better GRMs as compared to the benchmark.

According to Kotak Institutional Equities, Indian refining margins, benchmarked to the domestic refined products mix, have shown moderate improvement in the December quarter so far, from their H1FY20 levels (average $4.9 a barrel), which is in contrary to decline in Singapore complex margins. However, it may be lower than Q2’s $6.3 a barrel. The imminent implementation of IMO 2020 rules for marine fuel has led to a sharp correction in fuel oil prices, and an increase in the sweet-sour crude premiums, which may continue in the near term, say analysts. 

Sweet crude oil has very less sulphur content compared to sour crude. RIL is expected to be impacted the least by nil fuel oil yields. It’s highly complex refining capacities also allows it to process heavy sour crude oil that is cheaper than the sweet variety.

Among public sector OMCs, HPCL is expected to be most impacted given its high fuel oil yield of around 10 per cent, well above the 4-5 per cent for BPCL and IOC. IOC also has a diversified portfolio, including petrochemicals, whereas BPCL has upstream assets. Comparatively, HPCL is more dependent on refining and fuel retailing, say analysts. 

Analysts at Emkay Global estimate IOC-BPCL’s GRMs to decline $0.3-0.6 per barrel sequentially in Q3FY20, while HPCL could see a higher dip of $1 a barrel.

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