Oil marketing companies eye a strong Q3, but LPG could be a dealbreaker

OMCs include Bharat Petroleum Corp Ltd (BPCL), Hindustan Petroleum Corp Ltd (HPCL) and Indian Oil Corp Ltd (IOCL). Analysts estimate an almost 40% sequential rise in Singapore gross refining margin (GRM) in Q3 at $5 a barrel, against $3.6 a barrel in Q2. The figure almost tripled to $6 a barrel in November from the lows of $2.1 a barrel in September, according to ICICI Securities.

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Singapore GRM is often considered a proxy for refining margins in the Asia-Pacific market. “Around $4-5 a barrel of Singapore margin is something that seems to be sustainable. However, these are not top-of-the-cycle margins, but more like a mid-cycle margin environment that we expect over the next few weeks,” Probal Sen, vice president of equity research at ICICI Securities said. “Moreover, whatever little Russian crude is coming through the system is an added benefit for the OMCs.”

Gross refining margins fall sharply

Recall that higher discounts on Russian crude oil were instrumental in pushing up gross refining margins (GRMs) of OMCs in the September quarter (Q2) of FY24. However, in Q2FY25, GRMs of OMCs fell sharply owing to lower discounts, the falling share of Russian crude, heavy inventory losses and a higher-than-expected slump in demand. Coupled with aggregate losses worth ₹7,800 crore from LPG under-recoveries, OMCs’ net profit fell as much as 86% in Q2.

Unsurprisingly, shares of BPCL, HPCL and IOCL have slipped about 12% on average over the past three months, making current valuations appealing from a near-term perspective. “There is a short-term tactical advantage in buying these (OMC) stocks now. But their current valuations leave little room for a material upside in the long term,” said Swarnendu Bhushan, co-head of institutional research at PL Capital.

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A steady drawdown of key product inventories in the US, a marginal recovery in Chinese economic indicators, and steady fuel consumption growth in India over the past couple of months point to better profitability prospects for OMCs in the near term.

Moreover, Brent crude prices largely hovered around $71-72 a barrel in November, lower than in H1FY25. Thus, retail product margins on petrol and diesel have also expanded over the past quarter. The average gross marketing margin on petrol and diesel for Q3 so far has risen almost 40% and 54% sequentially to ₹13.6 a litre and ₹9.7 a litre, respectively, according to a PL Capital report on 9 December.

Will LPG spoil the party?

The important question now is whether the gains from refining and marketing in H2FY25 will offset further inventory and LPG under-recovery losses. With no government support, OMCs raked up a collective loss of ₹17,500 crore from LPG under-recoveries in H1FY25. Analysts estimate an incremental loss of ₹22,500 crore during H2 owing to higher propane prices.

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Against this backdrop, investors will watch the government’s move on LPG compensation closely. ICICI Securities has factored ₹17,000-18,000 crore of unrecovered LPG losses in its FY25 estimated earnings, assuming only about 50% of the cumulative losses in the year will likely be compensated by year-end. On the other hand, PL Capital believes that there will be no compensation from the government on LPG under-recoveries as they have not cut retail prices of petrol and diesel yet. 

“Even in the event of a worst-case scenario of zero government aid, the robust H2FY25 performance driven by strong GRMs and healthy marketing margins could help offset the said impact,” said a Yes Securities report from 4 December.