OMCs on stronger wicket, oil producers stare at losses as crude plunges

Refiners like Reliance Industries may also see inventory losses adding pressure on already weak refining margins

The sharp fall in crude oil prices on Monday is not good news for domestic oil producers such as ONGC, Oil India and even privately-owned Vedanta, the natural resources major, whose subsidiary Cairn India is involved in oil production and exploration, as well as Reliance Industries (RIL). oil marketing companies (OMCs) will be hit in the short run too, but they stand to gain if oil prices sustain at lower levels.

Globally, while there continues to be a demand-supply mismatch, with oil supplies exceeding demand, it has led to storage issues for crude. This was a key reason for WTI crude oil May futures tumbling into negative territory, and Brent crude prices slipping to $25 a barrel levels on Monday, even as major oil producing countries have announced deep output cuts.

Not surprisingly, while stocks of oil producers such as ONGC and Oil India were down by 5 per cent-7 per cent on the bourses, and RIL was trading 5.6 per cent lower, OMCs fell by a lesser margin (between 2.7 – 4 per cent) despite the Sensex down 3.6 per cent (1.40 pm IST).

ONGC and Oil India fell the most as the decline in crude prices will hit their net realisations significantly. The cost of oil production for ONGC, including capex for maintaining output from oil fields, is close to $31 a barrel, while for Oil India it is $25-26 a barrel, according to analysts. Thanks to tumbling crude prices, these companies now stare at losses at the operating level, if the weakness persists.

For refiners like Reliance Industries (RIL), which is already seeing pressure in its refining segment's profitability due to demand woes, the fall in oil prices also means that it may report inventory losses thereby pulling down its refining margins further, say analysts.

Though Reliance Industries clocks relatively higher gross refining margins or GRMs (compared to OMCs) due to its crude sourcing ability and complex refinery, its GRM was estimated to decline to $7.5 in the March quarter from $9.2 in Q3'FY20.

Likewise, state-run oil marketing companies (OMCs; Hindustan Petroleum, Bharat Petroleum and Indian Oil), too, will feel the heat on refining margins and report inventory losses. But, they would also benefit from the ongoing positive trend in marketing margins. Further, lower oil prices benefit OMCs as they need to pay less for imports and hence it lowers their working capital requirements.

For the refining industry, GRMs have been under pressure in the last couple of months due to weak demand. The benchmark Singapore GRM had averaged at $1.2 a barrel during March quarter, lower than $1.6 in previous quarter and less than half of $3.2 a barrel in year-ago period.

Meanwhile, post the inventory write-downs, OMCs will remain in a sweet spot in a low oil price environment. Currently, OMCs are earning net marketing margin of Rs 13 per litre on petrol and diesel. This will likely improve given the fall in oil prices. Analysts estimate that a $1 fall in crude prices lead to Rs 0.45 per litre improvement in net marketing margins on petrol and diesel. Yogesh Patil at Reliance Securities says that marketing margin will remain at all-time highs subject to no increase in excise duty after normalisation of petroleum product sales. Amongst OMCs, Bharat Petroleum remains his top pick. The question is when will the economy crawl back to normalisation?