Lower crude price gains may be capped for OMCs

The average Brent crude price has dropped to about $70 per barrel in September so far from over $80 in August. Yet, the companies face uncertainty due to a possible government cut in retail fuel prices, which would limit their gains.

But first, why are crude prices falling?

Notably, crude is down about 20% from its peak of over $90 per barrel in April. Subdued demand outlook, especially from China, has weighed on prices. Further compounding the woes is the expectation that the Organisation of the Petroleum Exporting Countries and its partners (Opec+) will gradually reverse their additional voluntary production cuts of 2.2 million barrels per day (mbpd) from December.

The International Energy Agency (IEA) estimates the global crude oil market to reach a surplus of 1.8 mbpd in 2025 versus 0.1 mbpd in 2024 and a deficit of 0.2 mbpd in 2023. Against this backdrop, estimates for crude oil prices have been tapered. For instance, ICICI Securities Ltd expects FY25 crude to average below FY24’s average of $83 per barrel. The brokerage has reduced FY25/FY26 Brent estimates to $80/$85 per barrel versus $85/$87 per barrel earlier.

Coming to OMCs, these companies’ integrated margin (refining plus marketing businesses) is expected to get a fillip owing to strong marketing margins even though softening crude has dragged down refining margins sharply.

Gross marketing margins on petrol and diesel for the September quarter till date (Q2FY25-TD) are at ₹7.3 a litre and ₹5.2 a litre, up from ₹3.9 a litre and ₹3.5 a litre in Q1FY25, respectively, pointed out analysts from Kotak Institutional Equities’ analysts in a report on 12 September.

“With petrol/diesel/LPG (about 80-85% of OMCs’ sales) retail prices frozen, overall integrated margins rise at a lower oil price,” according to the brokerage. “Based on the current ~$70/barrel oil prices, the integrated margins are $29-30/barrel for petrol/diesel (versus the average of $15-20 per barrel) over FY2018-23,” said Kotak’s analysts in the report.

The dampener

Sure, a possible cut in retail prices is a looming threat. The adverse impact can be limited if the cut remains in the range of about ₹2 per litre. Emkay Global Financial Services projects aggregate Ebitda for the three OMCs to increase by over 50% in Q2FY25 over Q1 level, assuming Brent crude at $75 per barrel and the fuel price cut of ₹2 per litre. Ebitda stands for earnings before interest, taxes, depreciation, and amortization.

Hindustan Petroleum Corp. Ltd (HPCL) ‘s gains could increase further in H2FY25 with the completion of its Vizag expansion and modernization project expected this month. ICICI Securities does not expect earnings-per-share to be much impacted as long as the retail price cut is in the reasonable range of ₹2-3 per litre.

OMCs are making significant investments to reduce their vulnerability to oil price fluctuations, especially in the downstream petrochemicals segment. Indian Oil Corp. Ltd (IOC) is investing ₹61,000 crore in building a petrochemical complex in Orissa, its largest single-location investment so far. IOC expects its petchem capacity to rise to 14mtpa by FY30 from 4.3mtpa now, with petchem intensity rising to 15% from 6.1%. Petchem intensity is the percentage of crude oil processed to produce petrochemicals.

Bharat Petroleum Corp. Ltd (BPCL) estimates the intensity will grow to 8% by FY29 with two new petrochemical projects in Bina and Kochi. Over the next five years, BPCL and HPCL have planned a total capex outlay of about ₹1.7 trillion and ₹75,000 crore, respectively. To be sure, potential gains from these projects may take time to reflect in the performance of these companies.