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What's fuelling stocks of OMCs?

While shares of OMCs have recouped from the 52-week lows, they have put up a weak show from a slightly longer-term perspective.
While shares of OMCs have recouped from the 52-week lows, they have put up a weak show from a slightly longer-term perspective.

Summary

The OMCs include Hindustan Petroleum Corp. Ltd , Bharat Petroleum Corp. Ltd and Indian Oil Corp. Ltd.

Shares of state-run oil marketing companies (OMCs) have recovered smartly from their respective 52-week lows seen in September-October, rising by about 20-23%. The OMCs include Hindustan Petroleum Corp. Ltd (HPCL), Bharat Petroleum Corp. Ltd (BPCL) and Indian Oil Corp. Ltd (IOCL).

A key factor that has fuelled a recovery in these shares is the softening of crude oil prices amid steady retail prices of petrol and diesel. Plus, estimated refining margins have been healthy. From around $100 per barrel levels at August-end, Brent crude oil prices have now fallen to around $82 per barrel. Blended marketing margin for petrol and diesel based on refinery transfer price averages for the fortnight ended 13 December reached a 10-month high of 2.4 per litre, according to ICICI Securities. However, the margin based on 13 December prices only are higher at 6.4 per litre, reckons the brokerage.

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If the trends sustain or improve, marketing margin outlook for the fiscal second half (H2FY23) is looking better than the first half (H1FY23) when the OMCs incurred heavy losses. Combined net losses of OMCs stood at 21,200 crore during H1. But the drop in crude prices should lead to inventory losses in the December quarter (Q3), taking the cumulative losses higher for the nine-months ended December.

As Varatharajan Sivasankaran, analyst at Antique Stock Broking points out, “The $15 per barrel drop seen in Brent crude prices over the past few months would mean combined inventory loss worth about 16,000 crore for the OMCs. This can be recovered if the benefit of drop in crude prices is not passed on to retail consumers for the next 45 days."

While the scenario is expected to improve in Q4, it is unlikely to make a big difference to the overall profitability of FY23. “We believe that the OMCs have an opportunity to earn stellar margins in Q4. This should also help reduce the debt levels of the companies from September-end levels. Despite the recent appreciation, valuations of the OMC stocks are not too demanding," said Sivasankaran.

While shares of OMCs have recouped from the 52-week lows, the stocks have put up a weak show from a slightly longer-term perspective, bringing some comfort on valuations.

So far in CY22, shares of HPCL and BPCL have declined by about 16% and 9%, respectively, while those of IOC have gained by 5%.

ICICI Securities believes FY24 can deliver fairly normalized earnings with trends being seen in refining and now sharply higher marketing margin scenario. While this bodes well, the big risk ahead is whether global oil prices stay at lower levels for longer. It is rather challenging to predict oil prices. At this moment, global recessionary fears weigh on the demand outlook, and is a factor that could support a lower price environment. But at the same time, the re-opening of the Chinese economy with easing covid restrictions is expected to support oil demand and in turn, prices. Moreover, supply outlook could worsen. Kotak Institutional Equities expects the Organization of the Petroleum Exporting Countries (Opec) to cut output by about 1.2-1.3 mb/d (of the announced 2 mb/d cut), and sees upside risks. “If oil prices remain weak, Opec+ can announce further (output) cuts as well," the analysts at Kotak said in a report on 12 December.

Needless to say, should crude prices spike sharply in the coming days, the recent optimism around the stocks could dampen sooner than later. Hereon, investors should closely track if the margin trends sustain. Also, retail price trends would be key. Remember that the retail prices of petrol and diesel have not been changed for many months now.

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