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Under-recoveries to haunt the sector
Geo-political risks have caused a sharp escalation in crude
prices (21% increase QoQ), that are currently hovering at
US$120/bbl (Brent). However, refining margins soared
during the quarter led by strong petroleum product prices.
Earthquake and tsunami in Japan led to a loss of refining
capacity (about 1.4mbpd) which strengthened the refining
margins further. Domestic gas production has tapered
down due to poor performance of RIL’s KGD6 block,
leading to higher dependence on LNG imports thus
boosting the volumes of the LNG re-gasification players. On
the back of higher crude prices and healthy refining
environment, we expect Q4FY11 to be beneficial for the
private players (Cairn and RIL). However, the higher crude
prices are expected to lead to higher under-recoveries with
subsequent impact on OMCs, upstream companies and
Government finances.
Geopolitical risk causes crude to soar by 21% QoQ:
Crude prices surged by 21% QoQ averaging ~US$105/bbl
(Brent) during the quarter. Brent crude (currently stands at
about US$120/bbl) is at its two and half year high, primarily
driven by the tensions in the Middle East and North African
countries. We believe, Cairn India would be a direct
beneficiary of higher crude prices.
Expanding product cracks boosts refining margins:
Petroleum product prices have outstripped the increase in
the crude prices with diesel and jetkero crack spreads
expanding by over 40-43% QoQ. Reuters Singapore
complex GRMs averaged to US$7.4/bbl (34% increase
QoQ). We believe higher GRMs will benefit RIL along with
other domestic refiners.
Under-recoveries to cross over Rs1.0tn in FY12E: With
soaring crude prices and expanding product cracks, we
foresee a possibility of under-recoveries breaching the
Rs1.0tn mark in FY12E. Higher under-recoveries signal a
serious threat to the earnings of the OMCs as well as the
upstream companies. Subsidy discounts for the upstream
companies would rise with rising contribution from the
government through cash/ oil bonds. However, to contain
the under-recoveries, we do not rule out a diesel price hike
(may be Rs2-3/lit.) by the government in FY12E.
Crude continues rally
Since October 2010, we have seen a consistent rise in crude oil prices. During Q4FY11 Brent
averaged to US$105/bbl compared to US$87/bbl in Q3FY11. This sequential increase of ~21% was
primarily caused by geo-political tensions in the Middle East and North Africa (MENA) which was
further aggravated by the earthquake and tsunami in Japan. Despite lower demand post the winter
season, the political events in MENA region led to an uncertainty of crude supplies, resulting in oil
prices heading northwards
Distillate demand boosts GRMs
Yet another strong quarter for the refiners as the Reuters Singapore complex GRMs witnessed a
whopping ~34% sequential increase. GRMs averaged at US$7.4/bbl during Q4FY11 which almost
doubled from the beginning of the year when Q1FY11 GRMs averaged at US$3.7/bbl.
Post the earthquake and tsunami in Japan, the shut down of refineries (about 1.4mbpd) led to
reliance on petroleum product imports (primarily diesel) to meet the fuel demand. This propelled
the rise in petroleum product prices especially diesel, as a result of which diesel cracks spiked to
~US$25/bbl during mid-March 2011. GRMs during the same period breached US$10/bbl mark
(reached a high of US$11.2/bbl). Gasoline, diesel and jetkero prices increased by 17%, 21% and 22%
respectively in Q4FY11 (QoQ). We expect GRMs to sustain in short term as the US summer driving
season is approaching, during which fuel demand usually remains high.
Crude differentials support complex margins
The Arab light-heavy and sweet-sour spreads also contributed to the complex GRMs. The Arab
light -heavy spreads showed a sequential increase of 30% averaging at US$4.0/bbl. The WTI-WTS
sweet-sour spreads widened even further which stood at US$4.1/bbl during Q4FY11 v/s US$2.7/bbl
in Q3FY11 (sequential increase of over 48%).
Higher naphtha prices compress petchem cracks
During Q4FY11, the naphtha prices increased by ~15% sequentially. However, the petchem prices
did not reverberate to the input price rise, resulting in compressed petchem cracks during the
quarter. HDPE-Naphtha spreads declined by ~15% sequentially in Q4FY11. PP-Naphtha,
PP-Propylene spreads also witnessed decline during the same period.
Under-recoveries expand
Economic and political pressures restricted the government from raising prices of regulated
petroleum products. In such a scenario where crude prices and product cracks are expanding, the
under-recoveries are bound to go up. We expect total under-recoveries for Q4FY11E to jump to
Rs336bn and for FY11E Rs806bn. If crude prices continue to stay high, we believe the
under-recoveries would breach Rs1.0tn in FY12E.
Due to expanding crack spreads, the under-recoveries on diesel, kerosene and LPG have remained
at higher levels during Q4FY11. As of now (1st week of April) loss on gasoline, diesel, kerosene and
LPG is close to Rs5/litre, Rs17/litre, Rs29/litre, and Rs250/cylinder (14kg) respectively.
The final subsidy sharing formula for FY11E will be decided within next few weeks; however, we
expect it to follow the historic trend.
BPCL (Rating – Hold; Target Price – Rs604)
Positive GRMs environment is likely to aid the Indian refiners among which BPCL is likely to
report average GRMs of US$5.5/bbl. Also, sequential rise in crude oil prices is expected to earn
inventory gains for the company.
We believe the losses made during Q4FY11 would be totally compensated by upstream (1/3rd of
the total) and government (the rest, through oil bonds/ cash) (BPCL under-recoveries for
Q4FY11 – Rs74.4bn).
Cairn India Ltd (Rating – Buy; Target Price – Rs409)
Rise in crude oil prices from about US$90/bbl in the beginning of the quarter to about
US$115/bbl towards the end of the quarter are likely to benefit cairn during the quarter.
Production from Mangala is expected to be slightly lower than 125,000bpd due to disruption in
pipeline operations during the quarter which resulted into lower production for about a week.
GAIL (Rating – Buy; Target Price – Rs568)
GAIL’s transmission volumes are likely witness marginal uptick due to import of spot LNG
cargoes both by GAIL as well as PLNG.
Higher polymer and petchem prices are likely to support GAIL’s petchem segment performance
during Q4FY11. However, due to higher under-recoveries incurred by the OMCs during the
quarter, GAIL is expected bear higher subsidy burden (Q4FY11 subsidy burden-Rs8.7bn) which
is likely to dampen the performance.
LPG transmission and natural gas trading segments are expected to report stable performance
on a sequential basis.
Gujarat State Petronet Ltd. (Rating –Buy; Target Price – Rs127)
GSPL’s transmission volumes are expected to remain stable on a sequential basis, as lower
transmission of RIL KG D6 volumes is likely to be compensated by transmission of spot LNG.
Transmission tariffs are likely to remain at about Rs800/’000scm which would be lower on a
sequential basis.
Gujarat Gas (Rating –Buy; Target Price – Rs449)
GujGas’ distribution volumes are likely to remain stable on a sequential basis, with imported
LNG coming at higher cost.
The company is likely to enjoy the benefit of higher realisations from all the three segments i.e.
industrial retail, CNG and PNG. However, due to higher priced imported LNG, the operating
margins are likely to decline thus impacting the performance of the quarter.
HPCL (Rating – Hold; Target Price – Rs358)
Positive GRMs environment is likely to aid the Indian refiners among which HPCL is likely to
report average GRMs of US$5.2/bbl. Also, sequential rise in crude oil prices is expected to earn
inventory gains for the company.
We believe the losses made during Q4FY11 would be totally compensated by upstream (1/3rd of
the total) and government (the rest, through oil bonds/ cash) (HPCL under-recoveries for
Q4FY11 – Rs74.0bn).
IGL (Rating – Buy; Target Price – Rs346)
IGL is likely to report marginal CNG volume growth of about 2% on a sequential basis on the
back of healthy car conversion rate and PNG volume growth of about 3% on the back of
expended network.
The company is also likely to benefit from higher CNG prices which were increased to Rs29.0/kg
from January 1, 2011 onwards from earlier Rs27.75/kg. However, the company is likely to face
margin pressure due to higher LNG prices. Also, capitalisation of assets is likely to attract higher
depreciation and interest charge.
IOCL (Rating – Hold; Target Price – Rs336)
Positive GRMs environment is likely to aid the Indian refiners among which IOC is likely to report
average GRMs of US$6.5/bbl. Also, sequential rise in crude oil prices is expected to earn
inventory gains for the company.
We believe the losses made during Q4FY11 would be totally compensated by upstream (1/3rd of
the total) and government (the rest, through oil bonds/ cash) (IOC under-recoveries for Q4FY11
– Rs186.6bn).
ONGC (Rating – Buy; Target Price – Rs367)
ONGC’s crude oil production is likely to be lower due to lower production from Mumbai
offshore and Assam.
Higher subsidy burden is likely to eat away all the upside from higher crude prices. We estimate
ONGC’s subsidy sharing to more than double on a sequentially to Rs90.5bn which is expected
to reduce ONGC’s net realisation to US$52.9/bbl.
Oil India Ltd. (Rating – Buy; Target Price – Rs1,626)
OIL’s crude and natural gas production is likely to remain flattish on a sequential basis.
However, higher subsidy sharing is likely to impact the profitability for OIL. We estimate OIL’s
subsidy sharing at Rs11.7bn translating into net realisation of US$66.5/bbl during Q4FY11.
Petronet LNG (Rating – Buy; Target Price – Rs156)
PLNG once again is likely to report strong performance backed by healthy spot LNG volumes.
PLNG’s long-term contracted volumes are expected to decline marginally on a sequential basis
as Q3FY11 witnessed higher volumes which covered a backlog for Q1FY11 and Q2FY11.
With 5% escalation in re-gasification margins from January 1, 2011, PLNG’s blended
re-gasification margins are likely to jump to about Rs33/mmbtu during Q4FY11 thus elevating
the profitability.
Reliance Industries (Rating – Hold; Target Price – Rs1,106)
Strong improvement in benchmark Singapore complex GRMs is likely to impact profits of RIL in
Q4FY11. We expect RIL to report US$10.0/bbl in the quarter compared to US$9.0/bbl in the
previous quarter.
Petchem prices jumped further during Q4FY11, however feedstock costs (naphtha) increased
more than the product prices. Hence, even though the petchem prices were stronger, we
believe the petchem margins would decline sequentially, hampering the petchem
performance.
Lower KG D6 gas production at about 51mmscmd during Q4FY11 is likely to affect RIL’s
performance
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Under-recoveries to haunt the sector
Geo-political risks have caused a sharp escalation in crude
prices (21% increase QoQ), that are currently hovering at
US$120/bbl (Brent). However, refining margins soared
during the quarter led by strong petroleum product prices.
Earthquake and tsunami in Japan led to a loss of refining
capacity (about 1.4mbpd) which strengthened the refining
margins further. Domestic gas production has tapered
down due to poor performance of RIL’s KGD6 block,
leading to higher dependence on LNG imports thus
boosting the volumes of the LNG re-gasification players. On
the back of higher crude prices and healthy refining
environment, we expect Q4FY11 to be beneficial for the
private players (Cairn and RIL). However, the higher crude
prices are expected to lead to higher under-recoveries with
subsequent impact on OMCs, upstream companies and
Government finances.
Geopolitical risk causes crude to soar by 21% QoQ:
Crude prices surged by 21% QoQ averaging ~US$105/bbl
(Brent) during the quarter. Brent crude (currently stands at
about US$120/bbl) is at its two and half year high, primarily
driven by the tensions in the Middle East and North African
countries. We believe, Cairn India would be a direct
beneficiary of higher crude prices.
Expanding product cracks boosts refining margins:
Petroleum product prices have outstripped the increase in
the crude prices with diesel and jetkero crack spreads
expanding by over 40-43% QoQ. Reuters Singapore
complex GRMs averaged to US$7.4/bbl (34% increase
QoQ). We believe higher GRMs will benefit RIL along with
other domestic refiners.
Under-recoveries to cross over Rs1.0tn in FY12E: With
soaring crude prices and expanding product cracks, we
foresee a possibility of under-recoveries breaching the
Rs1.0tn mark in FY12E. Higher under-recoveries signal a
serious threat to the earnings of the OMCs as well as the
upstream companies. Subsidy discounts for the upstream
companies would rise with rising contribution from the
government through cash/ oil bonds. However, to contain
the under-recoveries, we do not rule out a diesel price hike
(may be Rs2-3/lit.) by the government in FY12E.
Crude continues rally
Since October 2010, we have seen a consistent rise in crude oil prices. During Q4FY11 Brent
averaged to US$105/bbl compared to US$87/bbl in Q3FY11. This sequential increase of ~21% was
primarily caused by geo-political tensions in the Middle East and North Africa (MENA) which was
further aggravated by the earthquake and tsunami in Japan. Despite lower demand post the winter
season, the political events in MENA region led to an uncertainty of crude supplies, resulting in oil
prices heading northwards
Distillate demand boosts GRMs
Yet another strong quarter for the refiners as the Reuters Singapore complex GRMs witnessed a
whopping ~34% sequential increase. GRMs averaged at US$7.4/bbl during Q4FY11 which almost
doubled from the beginning of the year when Q1FY11 GRMs averaged at US$3.7/bbl.
Post the earthquake and tsunami in Japan, the shut down of refineries (about 1.4mbpd) led to
reliance on petroleum product imports (primarily diesel) to meet the fuel demand. This propelled
the rise in petroleum product prices especially diesel, as a result of which diesel cracks spiked to
~US$25/bbl during mid-March 2011. GRMs during the same period breached US$10/bbl mark
(reached a high of US$11.2/bbl). Gasoline, diesel and jetkero prices increased by 17%, 21% and 22%
respectively in Q4FY11 (QoQ). We expect GRMs to sustain in short term as the US summer driving
season is approaching, during which fuel demand usually remains high.
Crude differentials support complex margins
The Arab light-heavy and sweet-sour spreads also contributed to the complex GRMs. The Arab
light -heavy spreads showed a sequential increase of 30% averaging at US$4.0/bbl. The WTI-WTS
sweet-sour spreads widened even further which stood at US$4.1/bbl during Q4FY11 v/s US$2.7/bbl
in Q3FY11 (sequential increase of over 48%).
Higher naphtha prices compress petchem cracks
During Q4FY11, the naphtha prices increased by ~15% sequentially. However, the petchem prices
did not reverberate to the input price rise, resulting in compressed petchem cracks during the
quarter. HDPE-Naphtha spreads declined by ~15% sequentially in Q4FY11. PP-Naphtha,
PP-Propylene spreads also witnessed decline during the same period.
Under-recoveries expand
Economic and political pressures restricted the government from raising prices of regulated
petroleum products. In such a scenario where crude prices and product cracks are expanding, the
under-recoveries are bound to go up. We expect total under-recoveries for Q4FY11E to jump to
Rs336bn and for FY11E Rs806bn. If crude prices continue to stay high, we believe the
under-recoveries would breach Rs1.0tn in FY12E.
Due to expanding crack spreads, the under-recoveries on diesel, kerosene and LPG have remained
at higher levels during Q4FY11. As of now (1st week of April) loss on gasoline, diesel, kerosene and
LPG is close to Rs5/litre, Rs17/litre, Rs29/litre, and Rs250/cylinder (14kg) respectively.
The final subsidy sharing formula for FY11E will be decided within next few weeks; however, we
expect it to follow the historic trend.
BPCL (Rating – Hold; Target Price – Rs604)
Positive GRMs environment is likely to aid the Indian refiners among which BPCL is likely to
report average GRMs of US$5.5/bbl. Also, sequential rise in crude oil prices is expected to earn
inventory gains for the company.
We believe the losses made during Q4FY11 would be totally compensated by upstream (1/3rd of
the total) and government (the rest, through oil bonds/ cash) (BPCL under-recoveries for
Q4FY11 – Rs74.4bn).
Cairn India Ltd (Rating – Buy; Target Price – Rs409)
Rise in crude oil prices from about US$90/bbl in the beginning of the quarter to about
US$115/bbl towards the end of the quarter are likely to benefit cairn during the quarter.
Production from Mangala is expected to be slightly lower than 125,000bpd due to disruption in
pipeline operations during the quarter which resulted into lower production for about a week.
GAIL (Rating – Buy; Target Price – Rs568)
GAIL’s transmission volumes are likely witness marginal uptick due to import of spot LNG
cargoes both by GAIL as well as PLNG.
Higher polymer and petchem prices are likely to support GAIL’s petchem segment performance
during Q4FY11. However, due to higher under-recoveries incurred by the OMCs during the
quarter, GAIL is expected bear higher subsidy burden (Q4FY11 subsidy burden-Rs8.7bn) which
is likely to dampen the performance.
LPG transmission and natural gas trading segments are expected to report stable performance
on a sequential basis.
Gujarat State Petronet Ltd. (Rating –Buy; Target Price – Rs127)
GSPL’s transmission volumes are expected to remain stable on a sequential basis, as lower
transmission of RIL KG D6 volumes is likely to be compensated by transmission of spot LNG.
Transmission tariffs are likely to remain at about Rs800/’000scm which would be lower on a
sequential basis.
Gujarat Gas (Rating –Buy; Target Price – Rs449)
GujGas’ distribution volumes are likely to remain stable on a sequential basis, with imported
LNG coming at higher cost.
The company is likely to enjoy the benefit of higher realisations from all the three segments i.e.
industrial retail, CNG and PNG. However, due to higher priced imported LNG, the operating
margins are likely to decline thus impacting the performance of the quarter.
HPCL (Rating – Hold; Target Price – Rs358)
Positive GRMs environment is likely to aid the Indian refiners among which HPCL is likely to
report average GRMs of US$5.2/bbl. Also, sequential rise in crude oil prices is expected to earn
inventory gains for the company.
We believe the losses made during Q4FY11 would be totally compensated by upstream (1/3rd of
the total) and government (the rest, through oil bonds/ cash) (HPCL under-recoveries for
Q4FY11 – Rs74.0bn).
IGL (Rating – Buy; Target Price – Rs346)
IGL is likely to report marginal CNG volume growth of about 2% on a sequential basis on the
back of healthy car conversion rate and PNG volume growth of about 3% on the back of
expended network.
The company is also likely to benefit from higher CNG prices which were increased to Rs29.0/kg
from January 1, 2011 onwards from earlier Rs27.75/kg. However, the company is likely to face
margin pressure due to higher LNG prices. Also, capitalisation of assets is likely to attract higher
depreciation and interest charge.
IOCL (Rating – Hold; Target Price – Rs336)
Positive GRMs environment is likely to aid the Indian refiners among which IOC is likely to report
average GRMs of US$6.5/bbl. Also, sequential rise in crude oil prices is expected to earn
inventory gains for the company.
We believe the losses made during Q4FY11 would be totally compensated by upstream (1/3rd of
the total) and government (the rest, through oil bonds/ cash) (IOC under-recoveries for Q4FY11
– Rs186.6bn).
ONGC (Rating – Buy; Target Price – Rs367)
ONGC’s crude oil production is likely to be lower due to lower production from Mumbai
offshore and Assam.
Higher subsidy burden is likely to eat away all the upside from higher crude prices. We estimate
ONGC’s subsidy sharing to more than double on a sequentially to Rs90.5bn which is expected
to reduce ONGC’s net realisation to US$52.9/bbl.
Oil India Ltd. (Rating – Buy; Target Price – Rs1,626)
OIL’s crude and natural gas production is likely to remain flattish on a sequential basis.
However, higher subsidy sharing is likely to impact the profitability for OIL. We estimate OIL’s
subsidy sharing at Rs11.7bn translating into net realisation of US$66.5/bbl during Q4FY11.
Petronet LNG (Rating – Buy; Target Price – Rs156)
PLNG once again is likely to report strong performance backed by healthy spot LNG volumes.
PLNG’s long-term contracted volumes are expected to decline marginally on a sequential basis
as Q3FY11 witnessed higher volumes which covered a backlog for Q1FY11 and Q2FY11.
With 5% escalation in re-gasification margins from January 1, 2011, PLNG’s blended
re-gasification margins are likely to jump to about Rs33/mmbtu during Q4FY11 thus elevating
the profitability.
Reliance Industries (Rating – Hold; Target Price – Rs1,106)
Strong improvement in benchmark Singapore complex GRMs is likely to impact profits of RIL in
Q4FY11. We expect RIL to report US$10.0/bbl in the quarter compared to US$9.0/bbl in the
previous quarter.
Petchem prices jumped further during Q4FY11, however feedstock costs (naphtha) increased
more than the product prices. Hence, even though the petchem prices were stronger, we
believe the petchem margins would decline sequentially, hampering the petchem
performance.
Lower KG D6 gas production at about 51mmscmd during Q4FY11 is likely to affect RIL’s
performance
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