The sharp fall of 25 per cent in Brent crude oil prices to $21 a barrel over two days is not good news for domestic oil producers such as ONGC, Oil India and even Vedanta, the natural resources major, whose subsidiary Cairn India is involved in oil production and exploration, as well as Reliance Industries (RIL). Oil marketing companies (OMCs), too, will be hit in the short run, but they stand to gain if oil prices sustain at lower levels.
Globally, while there continues to be a demand-supply mismatch, with oil supplies exceeding demand, it has led to storage issues for crude. This was a key reason behind WTI crude oil May futures tumbling into negative territory, and Brent crude prices slipping to $25 levels on Monday, even as major oil producing countries have announced deep output cuts. On Tuesday (5.40 pm IST), Brent prices fell another 17 per cent.
“As storage becomes saturated, price volatility will remain exceptionally high in coming weeks,” observed analysts at Goldman Sachs, who add that production will soon need to fall sizeably to bring the market into balance.
With International Energy Agency already expecting demand for crude oil to drop by 23 million barrels per day, Ravindra Rao, VP- Head Commodity Research at Kotak Securities, too, feels that the selling might continue until the supply glut remains and demand doesn’t pick up.”
Not surprisingly, stocks of oil producers such as ONGC and Oil India were down by 5 – 7 per cent on the bourses. OMCs, too, corrected between 3.5 – 5.3 per cent. RIL, which had fallen over 6 per cent in intra-day trade, however, recovered to close with a decline of 0.67 per cent.
ONGC and Oil India will feel the maximum pinch of the decline in crude prices as it will hit their net realisations significantly. The cost of oil production for ONGC, including capex for maintaining output from oil fields, is close to $31 a barrel, while for Oil India it is $25-26 a barrel, according to analysts. Due to tumbling crude prices, these companies now stare at losses at the operating level, if the weakness persists.
For refiners like Reliance Industries (RIL), which is already seeing pressure in its refining segment’s profitability due to demand woes, the fall in oil prices also means that it may face inventory losses thereby pulling down its refining margins further, say analysts.
Though Reliance Industries clocks relatively higher gross refining margins or GRMs (compared to OMCs) due to its crude sourcing ability and complex refinery, its GRM was estimated to decline to $7.5 in the March quarter from $9.2 in Q3’FY20.
However, analysts say that RIL’s diversified business model places it ahead of peers.
State-run oil marketing companies (OMCs; Hindustan Petroleum, Bharat Petroleum and Indian Oil), too, will feel the heat on refining margins and likely report inventory losses. But, they would also benefit from the ongoing positive trend in marketing margins. Further, lower oil prices benefit OMCs as they need to pay less for imports, and hence, it lowers their working capital requirements.
For the refining industry, GRMs have been under pressure in the last couple of months due to weak demand. The benchmark Singapore GRM had averaged at $1.2 a barrel during March quarter, lower than $1.6 in previous quarter and less than half of $3.2 a barrel in year-ago period.
Meanwhile, post the inventory write-downs, OMCs will remain in a sweet spot in a low oil price environment. Currently, OMCs are earning net marketing margin of Rs 13 per litre, each on petrol and diesel. This will likely improve given the fall in oil prices. Analysts estimate that a $1 fall in crude prices lead to Rs 0.45 per litre improvement in net marketing margins on petrol and diesel. Yogesh Patil at Reliance Securities says that marketing margin will remain at all-time highs subject to no increase in excise duty after normalisation of petroleum product sales. Amongst OMCs, Bharat Petroleum remains his top pick. For these gains to accrue, it is also crucial that the economy bounces back fast, otherwise lower volumes will limit benefits for OMCs.