Religare Research: RIL, IOCL, BPCL, HPCL, GAIL and PLNG are our top BUYS while Cairn and OIL are our top SELLS

Crude at USD 65/bbl, Buy OMCs and gas stocks
We are positive on the domestic oil and gas sector as we believe that there is a
high possibility of crude oil prices retreating to USD 65/bbl in the medium term
(next 9-12 months). Bleak global macroeconomic fundamentals and a material
impact of fuel efficiency/replacement on demand will be the key factors pulling
down crude prices. Supply, however, would continue to remain robust, backed
by improving OPEC spare capacity and supply from non-OPEC/unconventional
sources. With refining margins set for a gradual recovery (on higher utilisation
rates globally), domestic reforms imminent and the intact divestment story, we
believe that oil OMCs (IOCL, BPCL and HPCL) are the best bets in the space to
play against lower oil prices.
On the gas front, India will continue to face a deficit situation with demand
exceeding incremental domestic supplies. This unmet demand is expected to be
satisfied by imported LNG. We therefore see a case for higher domestic gas
prices ahead. To capture India’s robust gas story, we like RIL among upstream
players and GAIL and PLNG in the midstream space.
Oil prices to settle at USD 65/bbl in the medium term: Demand is likely to
remain subdued in medium to long term due to 1) the austerity drive restricting
consumption in OECD countries, 2) sharpened focus on fuel substitution (natural
gas, bio-fuel) by oil importing nations, 3) high possibility of economic slowdown
in China (~50% of incremental demand) and 4) launch of fuel-efficient vehicles
(hybrid/electric vehicles). On the other hand, the outlook for supply is improving
due to 1) good spare capacity with OPEC (5.5mbopd), 2) an expected increase in
Iraq’s production levels during the next decade (2.4mbopd to ~9mbopd) and 3)
higher supply coming in from unconventional sources (Brazilian pre salt
deposits, Canadian oil sands, Venezuelan heavy oil). Our view is further
supported by the high OECD inventory levels and a weakening contango.
Refining margins to improve, but only gradually: Higher demand for refined
products with limited increase in refining capacity over the next 2-3 years will
push up global operating rates and hence improve margins gradually. Also,
higher production of heavy oil will maintain the light–heavy crude differential,
benefitting complex refiners like RIL.
Reform story looks imminent with divestment in sight: As the government shows
clear signs of bringing reforms in the sector to improve its fiscal position and to
strengthen its case for divestment in ONGC & IOCL, there is a strong possibility of
implementation of diesel de-regulation in the next 4-6 months. With a gradual
increase in cooking fuels likely to take place over next 2-3 years, the issue of underrecoveries
will also be largely resolved and make OMCs the biggest beneficiaries.
Gas – demand to outstrip supply: With RIL guiding for stable production at KG
D6 (60mmscmd in the next 12-15 months) on one hand and domestic demand
remaining robust on the other, gas consumers would have to resort to imported
LNG to satisfy unmet demand. As the market gets more receptive to higher gas
prices, we expect domestic supplies to fetch higher prices. This may lead to the
introduction of a gas pool pricing mechanism in the near future, benefitting gas
producers like RIL and midstream players like PLNG, GAIL and GSPL.
Sector call positive, BUY RIL, OMCs and gas stocks: In our energy portfolio, RIL,
IOCL, BPCL, HPCL, GAIL and PLNG are our top BUYS while Cairn and OIL are
our top SELLS.