The outlook for oil stocks

In June, APM (administered pricing mechanism) gas price was increased for priority sectors to $4.2 (Rs 190 today) per million British thermal unit and brought at par with Reliance Industries Ltd’s (RIL) KG D6 field rates. Petrol prices were deregulated and diesel, liquefied petroleum gas and kerosene prices were increased. Importantly though, the government’s intention to deregulate diesel prices eventually has not materialized thanks to rising crude oil prices and higher inflation.

Rising global crude oil prices and delay in diesel deregulation along with absence of clarity on the subsidy sharing is not good news for downstream and upstream companies. Under-recoveries, or the loss of revenue from having to sell fuel at below-cost prices, will increase as crude prices rise. Upstream? firms would have benefited in a rising crude environment if not for the fact that they share the subsidy burden of the downstream companies. Given this, the outlook for upstream and downstream firms appears muted.

So which stocks can investors look at in the sector at this point in time?

An obvious answer in the rising crude oil scenario would have been Cairn India Ltd, the only direct crude play in the country. But unfortunately the uncertainty surrounding Cairn India’s purchase by Vedanta Resources Plc has been a major overhang on the stock. Analysts maintain that Cairn India would have otherwise gained as crude prices are likely to rise.

That leaves RIL on the table. RIL’s stock has underperformed since the beginning of the fiscal and declined by 3% against a 13% increase in the Sensex. Concerns over the ramp-up of KG D6 gas has been a major disappointing factor for RIL this fiscal. While those concerns still persist, the outlook for the refining and petrochemicals business has improved in the recent past.

“Global oil demand has surprised on the upside and should outstrip refining capacity growth in 2011; spare capacity, though high, should fall, beginning to help margins. Consensus estimates of RIL gross refining margin (GRM) increase in FY12 over FY11 may not see large misses," wrote analysts from Credit Suisse in a note to clients on 14 December. The report further adds, “global ethylene utilization rates are high on strong demand/capacity shut downs and have led to recent margin surprises. High cotton prices are helping polyester segment margins. Petchem Ebitda (earnings before interest, tax, depreciation and amortization) run rates for RIL are most likely above consensus estimates."

Singapore GRMs have been strong this quarter led by demand from Asian economies and cold weather in Europe and some parts of the US. The obvious concern, though, is whether the improvement in refining margins is sustainable. Much depends on the recovery in the US and a soft landing in China and global oil demand should outpace growth in refining capacity next year. Nevertheless, in the near-term RIL is likely to do well; there is also the fact that it has underperformed for some time now. Needless to say, any positive news on the gas front would be positive. Since the beginning of this quarter, RIL’s stock has risen by 5% compared with a 2% decline in the Sensex.

We welcome your comments at marktomarket@livemint.com

Milestone Alert!
Livemint tops charts as the fastest growing news website in the world 🌏 Click here to know more.

Unlock a world of Benefits! From insightful newsletters to real-time stock tracking, breaking news and a personalized newsfeed – it's all here, just a click away! Login Now!