Elevated concerns for OMCs in the near term amid rising oil prices

Stocks of oil marketing companies (OMC), which had rebounded from their February lows, have corrected up to 11.5 per cent in April. A key concern for the Street is the pressure on marketing margins of HPCL, BPCL and IOC in the election season amid rising crude oil prices. There could be some pressure on their stocks if OMCs don’t hike retail prices commensurate with the rise in crude prices.

The pressure on marketing margins add to already existing concerns over gross refining margins (GRMs) that have remained weak for these companies with weakness in benchmark Singapore GRMs. The benchmark was on an average 26 per cent lower sequentially during the January-March quarter. Analysts say weaker benchmark GRM and lower polymer cracks will affect earnings of OMCs during the quarter. Inventory losses, too, are expected to remain high. What’s more, analysts at Edelweiss Research feel, marketing margins will contract sharply as OMCs stopped passing on the rise in product prices in the March’19 quarter.

Given elevated concerns over the rising crude prices, and marketing and refining margins, their credit profiles, too, could be affected. Moody’s investor services recently said that if oil marketing companies are to maintain high dividends payments as well as conduct share buybacks in FY20, it will increase their aggregate borrowings and constrain credit profiles.

The OMCs have already committed significant capex towards upgrading their refineries. The concerns are more for IOC and BPCL, which need to invest to upgrade their refineries over the next 12-18 months to comply with tighter emission norms. Among the two, analysts say that IOC is better positioned than BPCL to maintain its credit quality given its large scale and stronger credit metrics.

In the meanwhile, the outlook for refining margins already remains weak and all eyes are on the implementation of the 2020 IMO fuel Sulphur regulations to lift up refining margins. Moody’s Investor services feel that refining margins will meaningfully improve only in the second half of 2019.

Though the sharp fall in the share prices of OMCs has undoubtedly rendered valuations more compelling, the uncertain outlook may mean that they may not see much upside in the near term.