Although uncertainties remain on the policy front, the decline in crude oil prices should be beneficial for oil marketing companies.
The impending US recession and fears of demand destruction due to slowdown in other regions have seen crude oil prices head southwards from its peak of $147 per barrel to $60-61, currently. Since India imports around 70 per cent of its oil requirements and considering the administered pricing system, the impact for domestic oil companies, both private and public, is likely to be different. Companies are categorised as upstream (ONGC, Cairn India, OIL and GAIL) and downstream - refining and oil marketing companies (OMC) like HPCL, BPCL and IOC.
The movement in crude oil prices has various implications including on inventory value, the quantum of under recoveries, the realisations for oil producers and refining margins. That apart, the fate of public sector oil companies is highly dependent on government's policy actions in terms of subsidy formula and price of fuels among others. To know the impact for each of these companies, read on.
Downstream companies
The high crude prices in the first quarter (Q1) of FY09 had given sleepless nights to OMCs. This was primarily on the back of the dramatic increase in under-recoveries, which were estimated to rise nearly three-fold (from FY08 levels) to nearly Rs 245,000 crore, based on crude oil prices of around $140 a barrel. Thereafter, as crude oil prices declined, the worries emerged in the form of inventory losses (as companies held stock that was bought at higher prices), which severely impacted their financial health. Put together, their combined losses stood at Rs 13,000 crore in Q2 FY09. The decline in GRMs (gross refining margins), to single digits in Q2 FY09 for OMCs from around $15/barrel in Q1FY09, also added to the worries. Going forward, the refining margins may remain under pressure as additional capacity (globally) comes on-stream.
As per estimates, the OMCs were losing around Rs 13 and Rs 23 on every litre of petrol and diesel sold, when the crude prices were at their peak. Subsequently, in June 2008, OMCs hiked prices per litre of petrol by Rs 5 and diesel by Rs 3, which was in addition to the reduction in duties. Even after these moves, in the second fortnight of October, OMCs were losing around Rs 3 and Rs 7 on every litre of petrol and diesel sold, respectively.
However, there is good news for OMCs on the back of sustained fall in international crude prices since the peak levels of July. According to estimates, the under-recoveries could be in the range of Rs 1.30-1.45 lakh crore, which is lower by almost 40-45 per cent from the peak levels. S V Narasimhan, director Finance, IOC says, "Our under-recoveries have reduced from the peak of Rs 410 crore per day to around Rs 80 crore per day presently." This is an improvement of almost 80 per cent in under recoveries as on date from the highs. "The falling under-recoveries will certainly have a positive impact across all OMCs as it means better profitability," says Deepak Parikh, analyst --oil & gas, Angel Broking.
On the flip side, the depreciation of the rupee has played spoil sport. Although crude price might have corrected by around 57 per cent in dollar terms, it has contracted by 52.5 per cent in real terms due to the nine per cent rupee depreciation in the last four months.
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The recent slide in the rupee has meant that break-even point for OMC has been lowered much further. An industry source says, "The crude's cut-off was around $67-68 per barrel when the rupee was trading at Rs 41-42 levels. But, on account of rupee depreciating to levels of Rs 49, recently, the cut-off has been revised to $59/barrel." Thus, the OMCs would make meaningful profits on their direct sales of petroleum products, if the crude prices sustain below break-even rates for a reasonable amount of time.
The fall in global crude prices has also raised voices, calling for a reduction in the domestic petrol and diesel prices. The government would also want to lower inflation (to RBI's target of 7 per cent by March 2009) to ease the monetary policy further, and to boost the decelerating economic growth. The government may also want to score some brownie points as the are some state elections round the corner. Should that happen, says Deepak Mahukar, associate director, PWC, "it will be a negative on the profitability of OMCs, as the under-recoveries for these companies is still high."
To conclude, the augmented drop of crude from the higher levels will lessen under-recoveries, thus improving the financial health of OMCs in the future. The crude prices have to consolidate at around these levels ($60/barrel) for them to earn meaningful profits again.
Analysts believe that it is difficult to ascertain the quantum impact, given the uncertainty over the government policies with regards to the subsidy sharing and the fuel prices. On the broader basis, as estimated by analysts, the under-recoveries are down by around Rs 15.5 per litre on diesel since their peak, so even if the government cuts diesel prices by say Rs 1-2 per litre, the situation would still be better as compared to July 2008.
| SUBSIDY SHARING Rs crore | |||
| Crude oil price ($/bbl) | 79 | 90 | 100 |
| Subsidy loss | 77,100 | 106,500 | 130,500 |
| Payment by govt (oil bonds) | 35,300 | 50,000 | 61,300 |
| share of HPCL | 8,600 | 11,800 | 14,500 |
| share of BPCL | 7,700 | 10,500 | 12,800 |
| share of IOCL | 19,000 | 27,700 | 34,000 |
| Net under-recovery of oil companies | 41,800 | 56,500 | 69,200 |
| share of ONGC | 22,000 | 30,400 | 37,200 |
| Net under-recovery of BPCL, HPCL & IOC | 16,100 | 21,000 | 25,700 |
| Source: analyst estimates, share of upstream companies assumed at 33.33% | |||
Upstream companies
While the falling crude oil prices might be positive for OMC companies, it may not mean the same for ONGC and Cairn India, as they would earn less on account of lower realisations per barrel of crude oil sold.
On the realisation front, each company is affected in a different way. For instance, the average realisations of Cairn for quarter ended September 2008, was down by 8.3 per cent to around $87.3 per barrel on q-o-q basis. But, in the case of ONGC, the net realisations fell significantly by 32.4 per cent to $46.4 per barrel. The notable drop of realisations in the case of ONGC, is partly on account of lower crude oil prices and to a major extent due to the increased subsidy burden.
However, the depreciating rupee has partially offset the drop in realisations. In the context of rupee depreciation by 15 per cent over the last three months, will be positive as their realisations are pegged in dollar terms.
Kumar Manish, associate director, KPMG says, "Overall, as long as prices remain above $60 per barrel levels, the industry returns shall continue to be attractive."
Lastly, within upstream, the impact among companies will vary based on their exposure to oil or other products like gas, etc. For instance, Cairn earns about 97 per cent of its revenues from sale of crude oil, which is higher than ONGC's 75 per cent.
| FINANCIALS | |||||||||||
| Rs crore | Net sales | EBITDA | PAT | EPS (Rs) | P/E (x) | Mkt cap | |||||
| FY08 | FY09(E) | FY08 | FY09(E) | FY08 | FY09(E) | FY08 | FY09(E) | FY08 | FY09(E) | ||
| ONGC | 96,773 | 124,000 | 40,434 | 50,600 | 19,872 | 25,500 | 92.9 | 120.0 | 8.0 | 6.2 | 158,619 |
| RIL | 137,509 | 165,600 | 23,300 | 26,000 | 15,277 | 17,000 | 132.4 | 108.0 | 9.2 | 11.3 | 177,045 |
| Cairn India* | 1,012 | 1,340 | 667 | 940 | (25) | 100 | NA | ||||
NA
IOC
Indian Oil Corporation (IOC) is a "Fortune 500" company but of late its fortunes haven't been great with net loss of Rs 7,047.13 crore in Q2 FY09 as against a net profit of Rs 3,817.75 crore in Q2 FY08. These losses are attributed to increase in net under-realisation on the sale of petroleum products, foreign exchange losses due to rupee depreciation, inventory losses due to falling crude oil prices and increasing interest expenditure on the back of higher interest rates and borrowings.
The company has a strong platform in this business as it operates 10 of India's 19 refineries and also owns around 47 per cent of the fuel pumps in India (marketing). In the long term, IOC will command diversified revenue streams from exploration and production with interests in eight oil & gas and two coal-bed methane blocks in India as well as blocks in Iran, Yemen and Nigeria. IOC has also set up a venture, Ind-OIL Overseas, with Oil India to acquire assets overseas.
IOC is also diversifying its downstream business with a foray into petrochemicals business with the construction of a Linear Alkyl Benzene plant and a refinery-cum-petrochemicals complex at Paradip, which will shore up its export earnings in future. Analysts believe that the company can recover lost ground by volume sales (sells around 56 per cent of all petro-products in India), accounting for 40 per cent of India's total refining capacity and is an investment case for bravehearts. The company is currently trading at a PE of 12 its estimated FY09 earnings and 6.1 times FY10 earnings, and can be considered for your portfolio. The investments (bonds and listed stocks) of about Rs 33,000 crore also provide comfort.
BPCL
There has been a declining trend in gross refining margins in Q2 FY09 with the softening of crude oil prices. BPCL's Mumbai refinery reported GRM at $1.82 per barrel against $9.29 per barrel in Q1FY09; its Kochi refinery's GRM stood at $6.24 per barrel against $18.65 per barrel in Q1FY09. The under-recoveries for BPCL for Q2 stood at Rs 10,277 crore along with inventory losses amounting to Rs 606 crore.
This has led to net losses of around Rs 2,625 crore, even after, the company accounted for Rs 4,782 crore worth of oil bonds (yet to be received) and Rs 3,420 crore in the form of subsidy (discounts) from upstream companies. Although BPCL has over 12,000 fuel pumps, largely in the metros, it does not mean a profitable proposition due to the consistent under-realisations it has to bear. The stock is trading at a PE of 12.4 its estimated FY09 earnings and 7.2 times FY10 earnings. While there are other cheaper options, the stock is cheap in terms of replacement cost and investments (Rs 10,000 crore) the company holds.
HPCL
While the drop in crude oil prices has brought closer the break-even levels for OMCs, competition might brew from private players like Reliance and Essar, which have re-opened their retail fuel pumps, unviable for OMCs like HPCL due to subsidised rates. Hindustan Petroleum Corporation (HPCL) reported a nearly 47 per cent y-o-y growth in revenues at Rs 35,522 crore in Q2 FY09.
This is primarily on the back of increased realisations of petrol and diesel sales, as fuel price were hiked in Q1 FYO9, and an increase of 7 per cent in volumes. At the EBITDA level, losses have been to the tune of Rs 2,540 crore in Q2 as there was a decline in GRMs and higher under recoveries. The company's interest costs increased 276.8 per cent due to higher interest rates and increased borrowing to meet the working capital needs. The stock is trading at a PE of 27 times its estimated FY09 earnings, which is high as compared to others.
Reliance Industries
The share price of Reliance Industries (RIL) was holding up for some time. However, the recent underperformance of the stock viz., decline of about 36 per cent since October 2008 compared to the BSE Sensex's fall of 23.6 per cent, was on account of issue pertaining to refining margins, low crude oil and gas prices, outlook of petrochemical business and overall slowdown in the global and Indian economy.
The Singapore GRMs were about $8.17 per barrel in Q1FY09, which later corrected over 28 per cent to about $5.86 per barrel in Q2FY09. In light of the current environment, analysts have cut their future Singapore GRM estimates to about $5-5.5 per barrel for FY10 and FY11. This is also a reason that RIL and RPL (Reliance Petroleum) refining margins could be lower. RIL has already seen its refining margins dropping from $15.7 a barrel in Q1FY09 to $13.4 per barrel in Q2FY09.
Analysts thus, have estimated RIL's FY10 and FY11 GRMs to be in the range of about $10-11 per barrel. Accordingly, the earnings estimates for RIL have be cut by about 10-20 per cent to Rs 108 for FY09 and by 15-20 per cent to Rs 160 for FY10.
RPL, where RIL holds a 70.4 per cent, is setting up a 28 million tonne refinery, where almost 97 per cent of the project work has been completed. Analysts also believe that there are pressures in its petrochemical business as well. The factors like slow demand coupled with the cut in product prices might impact profitability going forward. The petrochemical segment reported a revenue growth of 20 per cent in Q2FY09, whereas it reported a decline of 6.3 per cent in the EBIT margins.
On the E&P side, the oil production from RIL's KG-D6 block has already commenced having current production of about 10 kbd (thousand barrels per day). The company believes that the peak production level of 80 mmscmd (million metric standard cubic meters per day) of gas and 40 kbd of crude oil would be reached progressively over the next six to eight quarters.
Overall there could be concerns in the near-term, though the commissioning of RPL refinery and start of E&P business in full swing will be a positive (leading to higher volumes) in the medium- to long-term. Moreover, analysts believe the stock is trading at attractive valuations of 11.2 times FY09 earnings and 7.6 times FY10 earnings.
ONGC
ONGC, India's largest exploration and production (E&P) company, reported a decline of 6 per cent on y-o-y basis and 27 per cent on q-o-q basis in net profit at Rs 4,810 crore in Q2FY09. The drop in profits was on account of lower net realisations at $46.7 per barrel (down 32 per cent q-o-q) partly due to lower crude oil prices and higher subsidy burden of Rs 12,660 crore (up 29 per cent q-o-q).
In light of the current scenario and taking cue from Q2, there could be more worries in the near term. Also, if there is a cut in domestic fuel prices, it might have an impact on profitability. Some analysts have already revised their earnings estimates downwards by about 5-7 per cent for FY09 and FY10.
According to analysts, if the international crude oil price averages out at $90-100 per barrel, then, ONGC's FY09 EPS could range between Rs 92.6-120 assuming subsidy burden of Rs 35,700 crore (calculated on the basis of 1/3 of total subsidy). At the upper end, this is 29 per cent higher compared to FY08 earnings of Rs 92.91 per share.
Also in the near term, OVL its overseas arm, which does not have to bear the subsidy burden, will be impacted in terms of realisations as its crude oil sales are linked with international crude oil prices. Besides, since OVL's earnings are in dollars, even after considering the gains due to rupee's depreciation, it could still impact the consolidated numbers of ONGC.
However, OVL is taking efforts and scouting for opportunities to increase its assets. OVL's current 2P reserves are estimated to be about 1,798 MMBOE (million barrels of oil equivalent). It has already acquired 11 E&P projects in six countries during FY08 taking its participation to about 38 projects in 18 countries. In a recent development, OVL has been given the go ahead to acquire Imperial Energy Corp having 2P reserves of about 920 MMBOE. If the acquisition goes through, analysts estimates the overall consolidated reserves to go up by 19.5 per cent. Nonetheless, lower crude oil prices mean that the short-term concerns remain.
Cairn India
Cairn India, whose fortunes are highly sensitive to international crude oil prices, was an outperformer for some time. However, the stock has fallen following the recent decline in crude oil prices. This was also reflected in its Q3 results, where the average realisations dropped by almost 8 per cent on q-o-q basis to $87.3 per barrel. But, since crude oil prices were lower in the corresponding quarter (Q3CY07 or July-September 2007) last year, the margins were still higher on y-o-y basis by about 50 per cent in Q3 CY08. Relatively, Cairn India was in better position considering that its revenue was driven by market rates as against PSU companies, which suffered on account of higher subsidy sharing.
Cairn however, is no exception to falling crude oil prices and the increasing threat of slowdown has resulted in analysts revising their earnings estimates downward by 10-15 per cent. Analysts have lowered their crude oil prices estimates to about $90 per barrel for CY09 and about $80 per barrel for CY10. This will also have an impact on realisations and thus, Cairn's profitability. Accordingly, they expect the company to report an EPS of Rs 9.7 per share in CY09 and Rs 37 per share in CY10. The higher growth in CY10 will be driven by the start of oil production from Mangala field in Rajasthan (2P reserves of about 695 mmboe). The stock is trading at 14 times its CY09 earnings and 3.8 times CY10 earnings, and can be considered on declines.