Amid the ascent of both the dollar-rupee rate and the crude price, Indian oil PSU shares have underperformed broader index for the last twelve months. Some would argue that this has happened even though the core operating performance has been strong. Many view this underperformance as a continuation of the trend where any increase in global crude prices has impacted the profit potential of both upstream and downstream companies.
In particular, the downstream oil & gas companies, which means the refiners, have witnessed strong downward corrections year to date. Gross refining margins have hit recent highs in Q3 FY18, but have remained under pressure in the face of high crude prices. Consequently, investors seem to have pressed the panic button. Valuations have dipped as earnings have weakened in the last quarter. There is some good news at least for upstream companies. A sustained high crude should benefit upstream players. But the outlook is muddied by subsidy and profitability concerns, alongside the government’s restructuring of the oil & gas giants.
The underlying shift in global oil supply toward light oil and regulations to control pollution should drive outsized returns for complex refiners, as they not only have high flexibility in crude sourcing but are also able to vary product yields to cater to tighter fuel specifications and leverage on the demand surge in middle distillates.
The possibility of Lok Sabha election announcement this year has, some would say, hit sentiments when it comes to oil PSU stocks. While the government has passed on the recent spike in crude oil prices to consumers, this need not be the scenario, at least going forward. Should the crude prices flare up, politics will take precedence over economics.
Brent crude oil prices witnessed an upward trajectory in the past two quarters and are currently at high levels of US$75/barrel. In addition, depreciation of the rupee to an all-time low of 70 vs dollar is also a big concern. The consequent high petrol and diesel prices resulting in uncertainty over oil marketing companies’ or OMCs' ability to pass on the same to customers have weighed on the stock price performance. In the last six months, BPCL shares have dropped by 28 per cent, Chennai Petroleum by 29 per cent, HPCL by 38 per cent, MRPL by 36 per cent and IOC by 20 per cent. Benchmark Singapore Gross Refining Margins, a profitability measure for the refining sector, has also witnessed a drop over the last 15-20 days and this will further hit sentiment.
As OMCs’ marketing margins have contracted over the past few months with petrol and diesel final prices to customers not moving in tandem with the rise in international fuel prices, this is a major worry for investors. The window is open for significant lower marketing profits, going forward, as any restrictions due to an election year will dent marketing margins and OMCs' profitability.
Concerns around US sanctions affecting Iranian crude imports have intensified as US state department said there would be no waivers this time while US’ UN ambassador Hayley during her visit also reportedly told India to cut imports. Indian refiners indicate that other supply avenues are there, amid the Government of India maintaining its official stance to protect own interest.
Till the time that rising oil prices is demand led, the scary deterioration in India's terms of trade is thankfully offset by stronger exports. Historically, Indian earnings and stocks have grown along with a demand-led oil price rise. That said, the risks to the fiscal deficit and hence growth cannot be ignored today or tomorrow. Rising crude oil prices may lead to a tighter monetary policy as well. So, watch out very carefully.