OIL & GAS: September GRM down 22% MoM; 2QFY11 average up 14% QoQ; Outlook continues to remain weak- Regional benchmark Singapore GRM fell 22% MoM in Sept-10 to US$3.6/bbl from US$4.6/bbl in Aug-10. Average 2QFY11 GRM at US$4.2/bbl is up 14% QoQ (US$3.7/bbl in 1QFY11) and 31% YoY (US$3.2/bbl in 2QFY10).
- September month weakness is primarily driven by weakness in gasoline cracks which fell to US$6.6/bbl from US$7.5/bbl in August 2010. End of the US driving season and very high inventory levels have resulted in lower gasoline cracks.
- Strong QoQ GRM performance is led by improvement in middle distillates (diesel and kerosene/ATF) and fuel oil, while YoY increase is led by middle distillates.
- Middle Distillates to be the savior for refiners: Strong gasoline cracks in 1HCY10 prompted refiners to increase throughput. However, due to lack of demand support, markets were oversupplied resulting in significantly high inventory levels and eventual fall of cracks in the recent months. On the other hand, middle distillates initially improved by some recovery in economy are now witnessing higher cracks with the advent of approaching winter season.
- Mixed trend in light-heavy differentials: Light-Heavy crude differentials remain largely flat during the quarter. Arab light-heavy differential increased ~5% while WTI-Maya decline ~13% QoQ in 2QFY11. Nevertheless, the differentials are significantly up from Jan-09 to Feb-10 period. In 2QFY11, Arab light-heavy differential averaged US$2.8/bbl (v/s US$2.7/bbl in 1QFY11 and US$1.7/bbl in 2QFY10) while WTI-Maya differential stood at US$8.5/bbl (v/s US$9.8/bbl in 1QFY11 and US$5/bbl in 2QFY10). Improving light-heavy spreads augurs well for complex refiners like RIL.
- GRM outlook continues to remain weak: Refining business is currently facing overcapacity led by large new capacity coming online (~1.6mmbbl/d in 2010 and 2011) as against slower than expected growth. Many uneconomical refiners (~2mmbbl/d) have already shutdown over the last 2 years; however, further closures are facing difficulties owing to political pressures and energy security issues in some countries. Unless there are major refinery closures and the global economy remains strong, we expect refining margins to remain subdued.
- GRM sensitivity: Every US$1/bbl change in GRM impacts FY12E EPS by 8% for RIL (Rs6/sh), 39% for MRPL (Rs1.7/sh) and 63% for CPCL (Rs17/sh).
- Our assumptions for RIL: 1) We model average gas production of 60mmscmd for FY11 and in FY12; 2) Well-head gas price of US$4.2/mmbtu. 3) We continue to factor in tax holiday on KG-D6 gas profits; and 4) GRM of US$7.6/bbl in FY11 and US$8.5/bbl in FY12.
- Valuation and View: We have a Neutral rating on RIL, Sell on MRPL and Buy on CPCL.
Refining margin and crude differential trends (US$/bbl)
RIL: Earnings and valuation summary
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