Narrowing refining margins crimp gains from declining crude prices

NEW DELHI : The decline in crude oil prices may offer some respite to state-run fuel retailers and help them narrow their marketing losses in the September quarter. Brent Crude, which was at over $120 a barrel in June, is trading at $90 per barrel now—levels last seen before Russia invaded Ukraine in February.

The state-run fuel retailers—Hindustan Petroleum Corp. Ltd (HPCL), Indian Oil Corp. Ltd (IOCL), and Bharat Petroleum Corp. Ltd (BPCL)—are likely to see some respite on their marketing margins in the three months ended 30 September.

While retail prices of auto fuels had remained range-bound despite higher crude prices, it led to a rise in under-recoveries, analysts said. Under-recoveries are losses incurred by fuel retailers for selling products below market price.

“Our calculations suggest the OMCs (oil marketing companies) have incurred auto fuel under-recoveries of 65,000-70,000 crore in the first half of FY23 (under-recovery of around 11.5 a litre on diesel and 6.5 a litre on petrol, or 10 a litre on weighted average basis; volumes of 45 billion litres of diesel and 20 billion litres of petrol),” analysts at JM Financial Institutional Securities Ltd said.

With a decline in crude prices, fuel retailers can recoup the losses incurred on the marketing front. Notably, current crude prices are near the breakeven levels. Analysts said under-recoveries for the second half of the fiscal would depend on whether the crude price is significantly above or below the breakeven crude price of $85-88 a barrel (and diesel and petrol product cracks).

However, while growth slowdown and recession concerns are leading to a significant correction in crude prices, refining margins, which had remained supportive of the earnings of OMCs, are also declining.

The gross refining margins (GRMs) had surged during the first quarter, and the benchmark Singapore GRM average was strong at around $21.4 a barrel in the June quarter, a significant jump from the $8 a barrel seen in the March quarter. According to analysts, refining margins have continued to fall since and maybe even below March quarter levels in the September quarter.

The declining trend is likely to continue and take away all benefits accrued due to improving marketing margins.

Outlook for refining margins is expected to be weak, said Citi Research. China’s potential growth in oil product export quotas could hurt Asian gross margins upside due to the European Union ban on diesel imports from Russia, analysts said. In addition, looming European recession risks and demand slowdown for gasoline in the US may impact refining margins, too.

A lower refining margin outlook is not good news for fuel retailers. Strong refining performance lifted June results despite weak marketing performance. GRMs for IOCL, BPCL and HPCL stood at $31.8 a barrel, $27.5 a barrel and $ 16.7 a barrel, which were significantly better than $18.5 a barrel, $15.3 a barrel and $12.44 a barrel, respectively, in the March quarter, according to analysts.

The weak refining outlook is also prompting analysts to cut earnings estimates. Citi has cut FY24 Ebitda (earnings before interest, tax, depreciation and amortization) estimates by 12%, 8%, and 22% for BPCL, HPCL and IOCL, respectively, as they lowered their GRM forecasts and raised marketing margin forecasts. OMCs expect FY24 gross margins at $7-7.5 a barrel against earlier estimates of $10-10.5 a barrel. Blended gross marketing margins (post-freight) on petrol and diesel are estimated at 2.25 a litre versus 1.5 a litre earlier.

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