Mark to Market | Hazy outlook for refiners

Shares of refining companies fared well in the September quarter compared with the preceding three months. Stocks of Reliance Industries Ltd (RIL) and Mangalore Refinery and Petrochemicals Ltd (MRPL) gained by 13-14% in the second quarter. The oil and gas index on the Bombay Stock Exchange delivered a return of 7% in the same period.

add_main_imageOne reason for the outperformance is the improvement in refining margins. From an average of $6.64 a barrel in the April-June quarter, the benchmark Singapore gross refining margins (GRMs) increased by 37% to $9.13 a barrel in the second quarter. Higher margins are expected to help the refining firms post better operating numbers in the September quarter.

IDFC Securities Ltd expects RIL, whose refining business contributes three-fourths of its revenues, to report a 19% sequential growth in GRMs. “RIL is expected to report a strong sequential improvement in earnings (19%) due to higher refining margins and marginally higher other income,” the brokerage firm said in a an earnings preview note. NextMAds

Higher petrol and diesel spreads are also expected to help MRPL report a better performance on a sequential basis. “Our estimates suggest that MRPL’s core GRMs should improve to $4.7/bbl (vs $1.77/bbl in 1QFY13),” Aishwarya Deepak of HDFC Securities Ltd said in a note.

Even though the second quarter was quite remunerative, the outlook is hazy for refiners. Maintenance shutdowns and capacity outages have pushed up the Singapore GRMs in July-August this year. As production resumes, GRMs are expected to ease. IIFL Institutional Equities says that Singapore GRMs fell from $10.2 a barrel in August to around $7 a barrel by the end of second quarter due to resumption of production at refining complexes.

Even though the GRMs clawed back above $8 a barrel last week, analysts say weak economic activity could weigh on the fuel demand. Like India, emerging economies such as China are slowly increasing fuel prices. The demand is estimated to soften as the price hikes sink in. “The economic environment is not conducive for fuel demand. We expect the diesel spreads to ease on weak demand,” said Nitin Tiwari, analyst at Religare Institutional Research. “This could lead to consolidation in Singapore GRMs to $7-8 a barrel.”

Another factor that could weigh on the refining margins is new capacities. An estimated 1,020 kilo barrels per day of new capacities are coming on stream in the next six-nine months. The new supplies could weigh on the margin expansion. “If all of this were to come through, it would lead to significant oversupply of petroleum products in the medium term,” IIFL Institutional Equities said in a note. “This is likely to keep refining margins under pressure, in our view.”

Some analysts expect the closure of refineries in Europe and other western countries could offset the impact of new supplies on refining margins. While that is difficult to understand, a clear pick-up in global demand for fuel products will prove to be long-term positive for refiners.