In Focus: Don't Slip on Oil | Value Research Investors should not get carried away by the current rally in oil marketing cos
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In Focus: Don't Slip on Oil

Investors should not get carried away by the current rally in oil marketing cos

Indian oil marketing companies have recorded a sharp spurt on the bourses since July this year. As the prices of global crude came down from $78.4 barrel in July to $59 barrel at present, share prices of Indian Oil Corporation (Idirect Code: INDOIL) have registered an increase of 29.87 per cent, HPCL (27.19 per cent) (Idirect Code: HINPET) and BPCL (17.04 per cent) (Idirect Code: BHAPET).

However, investors in this sector should exercise restrain and should not get carried away by the exuberance of the current rally in the oil marketing companies on the bourses. Investors need to be cautious while deciding on fresh investments in these companies, as hopes of a sharp operational turnaround in the near-term seems to be far fetched. Some of the points that need to be considered are Losses still prevalent in 3 out of 4 major products. At the current prices, the oil marketing companies have started making money in petrol retailing but are still making losses in diesel, kerosene and LPG sales. In spite of a recent fall in diesel prices from $82 per barrel to $72 per barrel and LPG prices from $550 per tonne to $475 tonne, these companies are still losing money, although the quantum of losses have gone down. The international price of kerosene has remained firm and has not shown signs of softening. Unless crude oil prices fall to $50-52 barrel levels for a sustainable period, these companies will continue making operational losses (excluding oil bonds).

Falling gross refining margins. The woes of these companies have been compounded by a sharp fall in gross refining margins in the last quarter. A part of the reduced under-recoveries will be thus offset by lower profits from the refining business. Refining margins have fallen by 30-40 per cent over the last quarter for most of the major players since product prices have fallen faster than crude oil prices.

Upcoming state elections: Six states are slated to go for Assembly elections next year. The government is unlikely to increase the prices of politically sensitive goods such as kerosene and LPG in such a scenario. On the contrary, should oil prices crash further, there is a possibility that prices of petroleum products may be reduced thus capping the upside for these companies. So the chances of reduction in under-recoveries by increasing prices of goods are remote and the companies will have to continue bearing the same.

Threat of reduction in oil bonds. For 2005-06 average crude oil price was $60 per barrel and the under recoveries were around Rs 39,000 crore. The government had issued oil bonds worth Rs 11,500 crore to the marketing companies in order to bail them out. In first quarter of 2006-07, total under-recoveries were about Rs 17,000 crore due to a surge in oil prices (YTD $69.3/bbl). The government has announced oil bonds of Rs 28,000 crore for the current year on expectations of Rs 72,000 crore under-recoveries. The first tranche of these bonds worth Rs 5,000 crore was issued on October 16. Any sharp reduction in the under-recoveries can result in the government reducing the quantum of oil bonds support. On the positive side, Indian refinery stocks are available at very attractive levels on replacement cost basis. However, unless the fundamental and structural issues related to their under-recoveries are addressed, their performance will always be subject to factors not within their control. We believe the recent sharp jump in share prices of the oil marketing companies has discounted the positive developments and investors should adopt a wait and watch strategy.

Source: Idirect

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