Sector Update | 12 October 2020
Oil & Gas
Oil & Gas
CGDs to record 10% volumes CAGR
over next decade
Marketing margins: more than firefighting…
…in a poor refining margin environment
SG GRM witnessed a downward spiral to USD3.2/bbl in FY20 from USD4.9/bbl in FY19
(USD7.2/bbl in FY18). The margin plummeted further to loss of USD0.1/bbl in FY21YTD.
Decline in FY20 was primarily led by massive refining capacity additions to meet
incremental diesel demand on account of IMO 2020. Furthermore, the margin
worsened in FY21YTD due to COVID-led demand destruction.
However, the deregulation of auto fuel prices has come as a boon. We estimate that
increase of INR0.7/0.5/0.3/lit in gross marketing margin of petrol/diesel would suffice
for a USD1/bbl loss in refining margin of IOCL/BPCL/HPCL respectively.
Gross marketing margins of auto fuels stand at INR3.8–5.8/lit for petrol and diesel,
27–94% above the erstwhile normalized gross margin of INR3/lit.
Oil marketing companies (OMCs) are trading at a discount to one-year forward PB of
25-51% and PE of 36-51% (apart from BPCL PE which trades at 13% premium) v/s the
truly deregulated period of FY15-18 during which there was no interference of the
government in pricing of auto fuels amidst benign crude oil prices.
We reiterate our positive stance on OMCs, with a preference for IOCL.
Flying high on NGT’s besom
Longest stretch of poor refining margins
During the past two decades, average annual global oil consumption has grown
at ~1.2mnbopd (and at 1.0mnbopd in 2019). In 2020, global oil consumption is
expected to contract ~9.5mnbopd, while 2021 consumption would grow
6.6mnbopd (as per OPEC).
Further, an expanding glut of ~1.3mnbopd in global refining capacity in 2020,
coupled with COVID-related demand destruction, resulted in a refining margin
of USD0.2/bbl in CY20 YTD, the worst ever seen in the past two decades.
Some refiners have announced the conversion of their refineries into marketing
and logistics terminals or biofuel refineries. However, refining margins still
appear subdued due to the lack of revival in the consumption of petroleum
products. Cracks spreads for petrol/diesel stand at ~USD3.0/bbl / USD5.5/bbl in
CY20 v/s ~USD10.7/bbl / USD12.0/bbl over the past five years (excl. 2020).
Since the deregulation of petrol (2010) and diesel (2014), OMCs have used gross
marketing margins of auto fuels to offset poor refining margins or inventory
losses. We estimate that a reduction of USD1/bbl in refining margins could be
compensated through increase in gross marketing margin of auto fuels by
INR0.7/0.5/0.3/lit for IOCL/BPCL/HPCL respectively.
There are signs of revival in consumption of petroleum products in India. Petrol
witnessed consumption growth of +3.3% in Sep’20 (up v/s -7.5% in Aug’20);
while diesel still recorded a decline of 6.0% YoY, although the decline was much
lesser than 20.7% in Aug’20. With increased economic activity, diesel
consumption is also expected to revive soon.
We continue to prefer IOCL. Despite annual capex of ~INR260b (the highest
among the OMCs), IOCL is expected to report ~10% cumulative FCF yield in
FY21/FY22E. Additionally, dividend yield appears attractive at 6–9%. IOCL trades
at 4.4x consol. FY22E EPS of INR17.2 and 0.6x FY22E PBV. IOCL has traded at a
Marketing margins to the rescue
Valuation and view
Swarnendu Bhushan- Research Analyst
Sarfraz Bhimani - Research Analyst
12 October 2020
Investors are advised to refer through important disclosures made at the last page of the Research Report.
Motilal Oswal research is available on www.motilaloswal.com/Institutional-Equities, Bloomberg, Thomson Reuters, Factset and S&P Capital.