OMCs incur losses on petrol, diesel sales as Brent rises to $91/bbl; Kotak cuts Q2 growth outlook for IOC, HPCL, BPCL

Oil marketing companies (OMCs) including Indian Oil Corporation (IOC), Bharat Petroleum Corporation Ltd (BPLC) and Hindustan Petroleum Corp Ltd (HPCL) saw a downgrade in their July-September quarter (Q2) growth outlook after international crude oil prices sharply rose above $91 per barrel. Domestic brokerage firm Kotak Institutional Equities has ‘reduced’ their ratings on all three OMC stocks and has said that the companies have incurred losses over petrol and diesel sales with frozen retail prices and high crude oil rates.

When the brokerage ‘reduces’ its rating on a stock, it means that it expects the stock to deliver -5-+5 per cent returns over the next 12 months. The potential crisis for OMCs comes on the back of high crude oil prices. Last week, oil producers Saudi Arabia and Russia extended their voluntary oil output cuts of a combined 1.3 million barrels per day (bpd) to the end of the year which resulted in a sharp surge in international crude prices - reaching a 10-month high peak.

These are on top of the April cut agreed by the Organisation of Petroleum Exporting Countries and its allies (OPEC+) running to the end of 2024. On Tuesday, Brent futures rose $1.42 or 1.6 per cent, to settle at $92.06 a barrel, while US West Texas Intermediate (WTI) crude rose $1.55, or 1.8 per cent, to settle at $88.84. Both benchmarks remained technically overbought for an eighth straight day, and closed at their highest levels since November 2022.

Why are OMCs incurring losses?

Sustained efforts by the OPEC+ alliance, and particularly Saudi Arabia, to cut production are finally bearing fruit. After four quarters of declines, oil prices have moved up to $90/bbl in recent weeks. With Saudi Arabia and Russia extending their additional voluntary cuts to end-2023, oil prices are likely to remain firm and could move up further. 

Fuel crack margins - particularly on diesel- have increased sharply. Ironically, in the current regime of frozen retail prices, higher cracks on fuel hurt OMCs. Compared with gains in refining, marketing losses are higher, due to higher volumes.

Notably, oil prices and fuel cracks weakened in the January-March quarter of fiscal 2022-23 (Q4FY23) and April-June quarter of current fiscal (Q1FY24), because of which OMCs had large over-recoveries in marketing and reported strong earnings in both the above-mentioned quarters. With past losses largely re-couped, there was a case to cut retail prices.

But now, with a sharp increase in oil prices, losses on retail diesel and petrol sales are back. In the last two years, retail price hikes have also been difficult. With key elections on the horizon, the likelihood of a diesel or petrol price hike is low.

From over-recoveries on retail fuels until July 2023, the tide has turned for OMCs in a few weeks. Conclusively, OMCs are incurring losses on retail sales of petrol and diesel due to higher oil prices, higher cracks and frozen retail prices.

Kotak Securities cuts fair value, maintains ‘reduce’ on OMCs

With no pricing freedom on retail fuels, the brokerage has been cautious on OMCs and have preferred upstream companies. Higher oil prices and the likelihood of them remaining firm in the near term makes it even more cautious.

‘’Our Brent oil price assumption of $85/90/80 per barrel in FY2024/25/LT is unchanged. On our estimates, if oil prices were to sustain at around $90/bbl, and even as fuel cracks moderate, OMCs would have under-recoveries of nearly ₹420 billion in the second half of 2023, compared to over-recoveries of nearly ₹220 billion in the first half. While 2QFY24 would likely be resilient due to inventory gains, OMCs will likely be back in losses in 2HFY24,'' said Kotak Securities.

The brokerage states that the fair value (FV) reduces to ₹90 for IOC (from ₹95), ₹375 for BPCL (from ₹390) and ₹260 for HPCL (from ₹280). While maintaining ‘reduced’ rating on OMCs, it added that it continues to prefer upstream PSUs over OMCs.

‘’We cut our FY2024E earnings by 16-17 per cent for IOC/BPCL and by a higher 32 per cent for HPCL due to its higher leverage to marketing,'' said Kotak Securities.

Inventory gains should help OMCs in 2QFY24, but 2HFY24E would be tough if oil prices remain firm. However, the brokerage remains optimistic that pricing freedom will return after the 2024 general elections. 

Also Read: Brokerage downgrades OMC stocks as Brent above $90/bbl plays spoilsport; maintains ‘buy’ on BPCL, HPCL

On Tuesday, OMC stocks declined by 3-5 per cent during the session. Shares of IOC settled 3.78 per cent lower at ₹91.57 apiece on the BSE. BPCL also settled 4.11 per cent lower at ₹348.75 apiece on the BSE, while HPCL ended 5.30 per cent lower at ₹251.75 apiece on the BSE.