The scenario is far from refined for oil refiners. For the March quarter (Q4 FY19) so far, benchmark Singapore gross refining margin (GRM) has dropped to $2.5 a barrel, a 37-quarter low, according to ICICI Securities Ltd. This comes after a miserable December quarter when the measure had averaged $4.3 a barrel.
GRM, a key measure of profitability for a refiner, refers to the realization from turning a barrel of crude oil into finished products.
Singapore GRM bottomed out at $1.7 a barrel in the week ended 25 January 2019, informs the brokerage firm. There has been a notable improvement lately. Over the past four weeks, it has recovered by 64% to $2.71 per barrel in the week ended 22 February, says ICICI Securities.
However, that is hardly enough. The Singapore GRM is still painfully low and doesn’t move the needle dramatically for refining firms. Accordingly, Q4 outlook for Indian Oil, HPCL and BPCL, as well as Reliance Industries Ltd (RIL), is not looking good.
Refining margins are expected to get a fillip as International Maritime Organization’s new regulations come into effect in 2020. These require ships to use oil with lower sulphur content. That is expected to boost diesel demand, which will reflect in refining margins. Until then, analysts do not foresee a sharp improvement in the measure, as global net refining capacity addition is expected to be more than demand growth.
Nonetheless, there are some comforting factors at play for RIL. About 50% of the company’s product slate comprises diesel and aviation fuel, says Probal Sen, senior vice president at IDFC Securities Ltd, adding that margins on diesel especially have been relatively healthy.
“On the other hand, share of gasoline in Singapore GRM is much higher and gasoline margins have collapsed in the past few months," says Sen.
In short, RIL’s GRMs may not drop as sharply as the Singapore GRM.
In any case, RIL investors don’t seem perturbed by the softer refining environment. The refining segment Ebit (earnings before interest and tax) contributed almost 32% of the total consolidated Ebit for the nine months ended December. Still, RIL shares have increased by as much as 8% in the past three months. It appears that investors are more optimistic about the potential of the company’s consumer businesses—Reliance Retail and Reliance Jio—rather than worry about the cyclical refining business.
“The Street appears too optimistic, in our view, on free cash flow too, as 3QFY19 demonstrated when net liabilities rose to ₹45.7 billion," analysts at Jefferies India Pvt. Ltd wrote on RIL in a 19 February report.