Oil & gas producers to gain as crude rises, refiners to be hit

Fitch Ratings says the credit metrics of PSU oil & gas firms could weaken due to large downstream capex and potential consolidation

With the rise in global crude oil prices, analysts expect oil and gas producing entities to gain but refining ones to see tough times.

In sector jargon, these are respectively termed upstream and downstream companies. 

Upstream entities hunt for, find and extract crude oil and natural gas. Examples are GAIL, Reliance Industries (RIL) and Oil & Natural Gas Corporation (ONGC). 

The downstream ones refine and process crude oil or gas. Examples are the government’s three oil marketing companies (OMCs) — Indian Oil Corporation (IOC), Bharat Petroleum Corporation (BPC) and Hindustam Petroleum Corporation (HPC). Some are in both; RIL, for instance, is also a refiner.  

Prices for the Indian crude oil basket have moved up in four months to $61.57 a barrel, from $48.1, an increase of 28 per cent. 

This, say analysts, will put the OMCs in a tough spot. Since the prices of petrol and diesel are decontrolled, the hike here will be passed on through an increase in product prices; for cooking gas, which is controlled, their finances will take a hit. 

Of the three government OMCs, says an analyst with a brokerage who wishes to not be named: “HPC will be hit the most”. According to an IIFL research report dated November 22, the company’s share of  earnings before interest, tax, depreciation and amortisation (inclusive of pipelines) from the marketing is the highest at 60-70 per cent; the other share of earnings is from the refining segment. The share of marketing for the other two are less than 60 per cent.

Inventory gains could offset a small portion of this impact. “On the refining side, if the price remains firm, we should be ending with some inventory gain by the end of the quarter,” said another analyst with a domestic brokerage. 

Amongst the three OMCs, Indian  Oil is expected to see better inventory gain. RIL is also expected to gain here; it will also gain from its presence in the petrochemical segment,” said the analyst quoted earlier.

The gain, however, is immense for the upstream companies as crude prices rise. ONGC and Oil India are expected to be the main beneficiaries.

According to Fitch Ratings, the credit metrics of Indian state-owned oil and gas companies could weaken due to large downstream capital expenditure and potential consolidation. “BPC, HPC and HPC-Mittal Energy are likely to see an increase in leverage due to large debt-funded capex,” the agency said last week. 

It expects downstream entities’ refining margins to remain solid overall this financial year, despite some compression from the FY17 levels due to slightly higher crude prices and tapering product spreads. “We expect higher gross refining margins for RIL and BPC, as a result of their recently completed capex programmes.”

GAIL, the natural gas processing and distribution company, is expected to see short-term gain. “Gas prices have not moved up quarter on quarter,” the second analyst added. However, these gains might cease once gas prices are revised in March.  

In the event of crude prices seeing an upward trend for a longer period, analysts say government regulations would be key. For instance, if the OMCs are not allowed to pass on the rise in crude oil prices to end-customers. 

Analysts expect elections in various states over the next year to influence the regulatory decisions. “Private companies in the retail segment might be hit in the event of unfavourable regulations,” says a third analyst with a brokerage.