What’s fuelling oil marketing companies' stocks?

Investors are excited about the subdued outlook for crude-oil prices and expectations of a strong December quarter on the back strong marketing margins even as refining margins have softened sequentially. Prices of Brent crude have dropped from a recent high of around $95 a barrel in September and are now hovering around $77.

For now, concerns that crude prices will rise in the near term have been mitigated. In a meeting on 30 November, Opec+ agreed to cut oil production by about 2.2 million barrels a day for the first quarter of 2024. Opec+ comprises the Organization of Petroleum Exporting Countries (OPEC) and its allies, including Russia.

Oil prices have not reacted meaningfully to the news even thought the cuts amount to roughly 2% of global supply. One reason for this could be that the cuts are insufficient to counter the growth in non-Opec output. Concerns about a weakening global economy also continue to weigh on the market.

Falling crude prices have a positive effect on OMCs’ profits as they reduce input costs and raise marketing margins. It also helps that earnings are expected to be strong this financial year. “FY24 turning out to be a blockbuster year for OMCs with strong dividends," analysts from Emkay Global Financial Services wrote in a report on 24 November.

"After a robust first half of the year, the second half has been better than expected for OMCs, except for some intermediate inventory losses likely in Q3 if oil prices stabilize at $80-85 a barrel. This would, however, mean strong core earnings in Q4," they added.

In the six months to September (H1FY24), HPCL and BPCL profits surpassed any of their previous annual earnings thanks to higher refining margins. IOCL’s H1 performance also exceeded market estimates.

HPCL’s management has indicated that its leverage may be nearing peak levels, given that its large expansion projects should start in the next six months. The new projects will help support HPCL’s vast expansion plan at a cost of $9 billion over the next five years.

Meanwhile, BPCL aims to spend about ₹1.5 trillion over the next five years to expand segments such as refinery and petrochemical, exploration and production, city gas distribution, and renewables. The management expects to execute a substantial part of this capital expansion from FY26-28, driving up leverage in those years. To be sure, the onset of leverage from expansion plans poses a risk to returns over the long term.

For now, the prospect of better marketing margins positions OMCs for growth in the foreseeable future. “Gross marketing margin (GMM) on petrol stands at Rs8.2 a litre in Q3 so far, while there is a gross marketing loss of ₹0.6/litre on diesel. In the week ended 28 November, GMMs on petrol and diesel stood at ₹9.7 a litre and ₹4.7 a litre, respectively," according to Prabhudas Lilladher. “However, sustainability of higher-than-normalized GMMs is questionable in light of the upcoming elections," read the broking firm’s report dated 30 November.

To be sure, there is speculation about potential cuts in retail prices of auto fuels ahead of the elections. If this happens, it will dampen companies' marketing margins. The recent rally in OMC stocks suggests investors are factoring in the brighter picture adequately. As analysts JM Financial Institutional Securities said, “The market’s optimism on OMCs will depend on whether crude sustains below about $80 a barrel."