Lower oil price gains could be capped for OMC

The average price of Brent crude fell to around $70 a barrel in September from more than $80 in August. However, companies face uncertainty over a possible government cut in retail fuel prices, which would limit their profits.

But first, why are oil prices falling?

Interestingly, oil is down about 20% since peaking above $90 a barrel in April. Subdued demand prospects, especially from China, have weighed on prices. Adding to the woes is the expectation that the Organization of the Petroleum Exporting Countries and its partners (OPEC+) will phase out their additional voluntary production cut of 2.2 million barrels per day (mbpd) from December.

The International Energy Agency (IEA) has estimated that the global oil market will see a surplus of 1.8 mbpd in 2025, down from 0.1 mbpd in 2024 and a deficit of 0.2 mbpd in 2023. Accordingly, oil price estimates have been lowered. For instance, ICICI Securities Ltd expects FY25 crude to average below the FY24 average of $83 per barrel. The brokerage has lowered its FY25/FY26 Brent crude oil estimates to $80/85 per barrel, down from $85/87 per barrel earlier.

As for OMCs, their integrated margin (refining and marketing) is expected to increase on the back of strong marketing margins even as weaker crude oil has significantly depressed refining margins.

Gross margins on gasoline and diesel sales for the September quarter to date (Q2FY25-TD) are ₹7.3 liters and ₹5.2 liters, compared to ₹3.9 liters and ₹Analysts at Kotak Institutional Equities in a report dated September 12 indicated that the price was expected to reach $3.50 per litre in the first quarter of fiscal 2025.

“With frozen retail prices of petrol/diesel/LPG (around 80-85% of OMC sales), overall integrated margins are rising with lower crude oil prices,” the broker said. “Based on current crude oil prices of ~$70/bbl, integrated margins are at $29-30/bbl for petrol/diesel (versus average $15-20/bbl) in FY18-23,” Kotak analysts said in a report.

Silencer

Sure, a possible retail price cut is a looming threat. The negative impact could be limited if the cut remains in the range of around ₹2 per litre. Emkay Global Financial Services has forecasted that the combined EBITDA for the three OMCs would grow by over 50% in Q2 FY25 from Q1 levels, assuming a Brent crude oil price of USD 75 per barrel and a reduction in fuel prices by ₹2 per litre. Ebitda stands for earnings before interest, taxes, depreciation and amortisation.

Hindustan Petroleum Corp. Ltd (HPCL) earnings could rise further in H2FY25 as Vizag expansion and modernisation is expected to be completed this month. ICICI Securities does not expect earnings per share to take a material hit provided retail price cuts are within a reasonable range ₹2-3 per liter.

OMCs are making significant investments to reduce their exposure to oil price volatility, especially in the downstream petrochemical segment. Indian Oil Corp. Ltd (IOC) invests ₹61,000 crore to set up a petrochemical complex in Orissa, its largest investment in a single location so far. IOC expects its petrochemical capacity to increase to 14 mtpa by FY30 from the current 4.3 mtpa, and petrochemical intensity to increase to 15% from 6.1%. Petrochemical intensity is the percentage of crude oil processed to produce petrochemicals.

Bharat Petroleum Corp. Ltd (BPCL) estimates that the intensity will increase to 8% by FY2029 with two new petrochemical projects at Bina and Kochi. Over the next five years, BPCL and HPCL have planned a combined capital expenditure of around ₹1.7 trillion and ₹75,000 crore, respectively. Of course, the potential profits from these projects may take some time to reflect in the results of these companies.