Sentiment positive for OMCs amid lower oil prices, marketing margins

Geopolitics is impacting the energy sector with crude oil prices falling below $70/barrel (bbl) last month for the first time since December 2021. And, gross refining margins (GRMs) have collapsed to $2/bbl, due to weak demand from China.

While weak GRMs will hurt oil marketing companies (OMCs), high retail and marketing margins will offset that impact.

Going forward, if these trends persist, OMCs could see strong profits. One potential issue may be government intervention to reduce retail prices ahead of the Maharashtra state election.

While this would restrict profits if crude prices stay down, it would lead to losses for OMCs if crude bounces back.

While benchmark Brent dropped below $70/bbl, the Singapore GRM fell to $2/bbl from an average of $6/bbl in 2024 till date.

The decline was due to fall in petrol and diesel refining margins, which fell from averages of $15/bbl and $19/bbl to below $10/bbl.

Brent was earlier estimated to average $84/bbl in FY25, but demand weakness and possible production increases from OPEC-plus (after Dec ’24) could keep prices down.

OMC marketing margins have spiked, with the gross marketing margin for petrol and diesel at Rs 10 per litre and Rs 8.5 a litre, respectively, compared to a long term average of Rs 3.5 per litre.

Supernormal marketing profits can over-compensate for lower refining profits.

The Centre cut retail prices in March 2024, just ahead of the general elections. And, Maharashtra and Jharkhand elections could lead to price cuts again, especially if high marketing margins persist.

Potentially, if the trends of low crude prices and high marketing margins persist, OMCs could enjoy an upside.

However, in Q2FY24, OMCs may see 30 per cent or more year-on-year (Y-o-Y) drop in earnings due to weak GRMs and the LPG buffer deficit (which the government may eventually compensate for).

HPCL will be the worst hit with Q2FY25 net profit crashing over 40 per cent Y-o-Y. BPCL will probably see a 30 per cent decline in profit after tax (PAT).

The 6.3 per cent Y-o-Y decline in Q2FY25 crude price trends have boosted pump margins to about Rs 7.5/litre despite the price cuts imposed in March.

Gas majors like Gujarat Gas, Mahanagar Gas and Indraprastha will also see sharp net profit decline due to rising liquefied natural gas (LNG) prices and shortfalls in cheaper administration pricing mechanism (APM) gas. 

For OMCs, the boom in retail margins is mitigating the impact of weak GRMs. However, there is a potential risk of rising crude due to the Iran-Israel tensions.

Companies also await government compensation for the deficit in LPG buffer at Rs 1,800 crore per quarter each for BPCL and HPCL and more than twice this for IOC.

Diesel marketing margins grew by two times quarter-on-quarter (Q-o-Q) to Rs 5.3 per litre in Q2FY25, while petrol margins also jumped to Rs 9.1 per litre from Rs 4.3.

Lower crude prices resulted in refining inventory losses of $2-3/bbl each for BPCL and HPCL (IOC could see lower inventory loss).

Russian crude discounts remained range-bound.

Overall, this could result in HPCL seeing a big improvement in operating profit Q-o-Q due to base effect and higher marketing leverage. IOCL and BPCL may see smaller but significant upticks in operating profit.

While operating profit will rise Q-o-Q, this will be at least partly offset by weak GRMs and inventory losses.

Q2FY25 average crude inventory loss will be around $1.9/bbl vs $0.8/bbl gain in Q1FY25.

The volatile geo-political situation should lead to some caution for investors. But given the weakness in global and China demand, these trends could persist.

Long-awaited compensation for LPG would be a booster.