Thanks to rising crude oil prices, stocks of oil marketing companies (OMCs) have corrected 4-9 per cent in the last month, versus a 1.6 per cent rise in the BSE Oil & Gas index. Analysts believe there could be a further downside to these companies amidst the burgeoning under-recoveries, pending deregulation and uncertainty on subsidy sharing.
After the petrol deregulation in June, the government has been quiet on freeing up diesel prices. An elevated inflation level coupled with the upcoming state elections in early 2011 (in a few states), is likely to push the deregulation beyond mid-2011. Analysts expect an eventual move to deregulation only in FY13. However, there could be ad-hoc price hikes in diesel driven by surging crude oil prices — a meeting is scheduled for December 22.
While many analysts remain neutral to bearish on oil marketing companies (OMCs), Reliance Industries and GAIL are among their top picks in the oil and gas space.
| VALUATIONS | ||||
| CMP (Rs) | EPS (Rs) FY11E | FY12E | PE (x) FY12E | |
| IOC | 368 | 37.30 | 41.70 | 8.90 |
| ONGC | 1,305 | 114.50 | 126.10 | 10.40 |
| OIL | 1,371 | 126.40 | 143.30 | 9.60 |
| BPCL | 691 | 47.90 | 56.80 | 12.20 |
| HPCL | 417 | 44.30 | 48.80 | 8.60 |
| RIL | 1,057 | 66.00 | 77.80 | 13.70 |
| CAIRN | 329 | 25.50 | 44.20 | 7.50 |
| E: Estimates Source: Bloomberg | ||||
Crude oil prices to remain firm
Crude oil has averaged $79 for 2010 till date. With signs of a steadier recovery in key global economies, the onset of winter and firm Chinese demand, analysts expect crude oil prices to remain firm in the near term. Major brokerages like Goldman Sachs and JP Morgan expect prices to rise above $100 a barrel in 2011. The Indian basket of crude oil has averaged around $88.60 per barrel in December, up by over 5 per cent from the November average of $84.26. Analysts expect the FY11 and FY12 average prices of the Indian basket at $80 and $90 per barrel, respectively.
Thanks to rallying crude oil prices, under-recovery concerns for OMCs have resurfaced. A $1 a barrel increase in the oil price increases the under-recoveries by $700 million, estimate Citi analysts. Given the current scenario, under-recoveries could potentially rise to Rs 88,000 crore, resulting in a rise in the subsidy bill for 2010-11— the under-recovery for December alone is estimated at Rs 8,300 crore.
More price rises in the offing?
Among the few ways to reduce the burden on oil companies are raising retail fuel prices or cutting taxes. While petrol pricing has been freed up, public and private retailers are estimated to be losing Rs 50 crore a day on petrol sales. This is because while the companies have so far raised the petrol price by Rs 2.95 a litre, it is below the desired level of Rs 4.17 a litre, making these companies lose about Rs 1.20 on every litre of petrol sold.
The bigger concern, however, is the losses on diesel, which accounts for a large share of the total under-recoveries. Analysts estimate that a hike of Rs 6.5 per litre is necessary to curb losses on retail diesel sales.
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The government is expected to review fuel prices on December 22nd. While oil companies are lobbying for a rise of Rs 5.40 per litre in the diesel price, the oil ministry wants to increase prices by about half of that. The government could also consider trimming the excise duty on petrol (now at Rs 14.35 a litre) to partially offset higher petrol prices.
Winners & losers
Unless OMCs pass on the full increase in costs (or are compensated for the under-recoveries), their margins will remain under pressure. Marginal respite though could come from an improvement in gross refining margins (GRMs). In the current quarter (till date), GRMs are at $5.4 per barrel versus $4.2 in the September quarter. In the near term, refining margins could inch up due to a seasonal tightness in distillate markets, a severe winter, and strong demand east of the Suez. Analysts estimate margins to average at $4 a barrel in FY11 as against the FY10 average of $3.5. However, on the back of over-capacities in the system, they expect margins to remain range-bound the next fiscal.
For ONGC and Oil India, crude oil revenues may not increase in the same proportion as crude oil prices, as their contribution (in the form of subsidy) will move up. The cost increase is marginal, as most of the components are fixed in nature. However, any disproportionate increase in the subsidy contribution can lead to lower margins.
On the other hand, higher crude oil prices are positive for companies like Reliance Industries, GAIL and Cairn India. For Reliance, while revenues from refining, crude oil sales and petrochemical segments would rise, gas sales would remain constant as the prices are fixed.
The cost increases will be marginally lower than the revenue increase, improving margins.