Crude below $80/barrel to support OMCs in near-term; ONGC, Oil India key beneficiaries of high prices

Oil marketing companies (OMCs) in India will find support with international crude oil prices sustaining below the $80 per barrel mark in the near-term. The three major OMCs - Indian Oil Corporation Limited (IOCL), Bharat Petroleum Corporation Limited (BPCL), and Hindustan Petroleum Corporation Limited (HPCL) reported decent earnings growth in the July-September quarter of fiscal 2023-24 (Q2FT24) with improved gross refinery margins.

Indian Oil reported a net profit of ₹12,967 crore in the September quarter against a net loss in the year-ago period on steady fuel prices, while Bharat Petroleum also returned to black after reporting a net profit of ₹8,243.5 crore in the quarter-under-review.

International Brent crude price has normalised to sub-$80/bbl driven by easing of supply side concerns as there has been no major material impact on oil supply flows so far, on account of the war between Israel and Hamas, and easing fears of it escalating into a wider regional conflict.

Also Read: Crude oil to average at $120/bbl in 2024; World GDP growth downgraded on Middle East tensions: Fitch

Domestic brokerage firm JM Financials said in its latest report that OMCs’ gross auto-fuel marketing margin has jumped to ₹7.9 per litre compared to the historical margin of ₹3.5 per litre and gross auto-fuel integrated margin has risen to ₹16.8 per litre compared to the historical margin of ₹11.3 per litre. 

‘’Optimism on OMCs will be contingent on crude sustaining below ~$80/bbl with OMCs’ FY24 P/B valuations (at ~0.9x for HPCL/IOCL and 1.1x for BPCL) being only 10 per cent discount to historical average after recent rally,'' said JM Financials.

Which oil explorers will benefit from high crude prices?

The brokerage has maintained a ‘buy’ rating on Oil and Natural Gas Corporation (ONGC) at a target price (TP) of ₹225 and Oil India at a target price of ₹355, given the strong dividend play (of 6-8 per cent) 

‘’Our TP is based on $65/bbl net crude realisation, and various changes in windfall tax suggesting the government is fine with ONGC/Oil India making net crude realisation of ~$75/bbl,'' said JM Financials.

Brent crude price of $75-80/bbl is a sweet spot for ONGC/Oil India, as it improves visibility for net crude realisation of $75/bbl by eliminating the risk of ad hoc fuel subsidy burden, according to the brokerage.

OPEC's pricing power to support Brent at $80/bbl

The Organization of the Petroleum Exporting Countries and its allies (OPEC+) will meet for its next oil output policy decision on November 26, to consider whether to make additional oil supply cuts.

Saudi Arabia and Russia have extended their combined oil output cut of 1.3 million barrels per day (bpd) till the end of the year, which the oil majors first announced in July 2023, in a bid to support the stability of the oil market.

Analysts believe that OPEC+ will continue to use its strong pricing power to support Brent crude price ~$75-80/bbl, which is the fiscal breakeven crude price needed by Saudi Arabia

‘’Saudi and Russia may agree to extend their 1.3 million barrels per day (mbpd) voluntary supply cut into CY24 as well vs. the current plan of extending it till end-CY23,'' said JM Financials.

Also Read: From $89 to near $100 and back: How Brent crude moved since last Diwali over OPEC+ cuts & more

The pricing power of OPEC+ has strengthened over the past 2-3 years due to the following reasons:
-US oil production continue to be at ~13 mbpd only (vs. pre-Covid peak of ~13.1 mbpd) as US shale investors are disciplined in capital investment.
-OPEC+ having shown strong ability to cut output by ~10 mbpd in early CY20 to offset the ~10 per cent decline in global oil demand post Covid.

OPEC+ still has enough headroom to cut output by another 4-5 mbpd to offset any macro-related risk to global oil demand growth, according to the brokerage. 

‘The new normal for Brent crude price may be $80/bbl (except in the event of a global macro shock). This is a departure from the pre-Covid normal price of around $60-65/bbl, which was driven by marginal cost of US shale oil production,’' said JM Financials.