India Ratings and Research (Ind-Ra) expects continued subdued crack spreads in both gasoil and gasoline will impact the overall gross refining margins (GRMs) of Indian oil marketing companies (OMCs), though they have healthy complexity and low operating costs per barrel. Gasoil and gasoline are the two key products of Indian refiners, accounting for around 65% of their product slate. While OMCs have been consistently increasing their pipeline capacity to reduce transportation costs and venturing into new business segments such as petrochemical and city gas distribution to diversify its revenue streams, Ind-Ra believes that the refining and marketing segment would continue to dominate the overall profitability in the near term. With expectations of subdued recovery in GRMs and continuance of healthy marketing margins, Ind-Ra believes that marketing segment would be the principal contributor to OMCs’ profitability in FY22.

The weak crack spreads would continue to be driven by the global destruction of transportation fuel demand, led by various travel restrictions imposed due to the COVID-19 pandemic. Though there has been an improvement in crude prices, the crack spreads have not improved and the capacity utilisation of refineries remain lower than pre-COVID levels (North America refineries capacity utilisation; March 2021: 77.6%, March 2020: 85.6%). In a weak demand environment, a fresh capacity addition of 3mbpd of refining capacity (largely concentrated in Asia and middle-east region) is also likely to come onstream in the next two years, leading to continued pressure on GRMs. Refiners, to mitigate the impact of lower crack spreads on gasoil and gasoline, have resorted to investments in downstream capacity and refinery bottom of the barrel upgradation through large refinery capital expenditures. However, continued low GRMs would have a significant financial impact on the less complex refineries who might be forced to shut down if capital and operating structures do not justify viable operations. 

  

Note: Indian Oil Corporation Ltd (IOCL, IND AAA/Stable), Hindustan Petroleum Corporation Limited (HPCL, IND AAA/Stable) and Bharat Petroleum Corporation Limited (BPCL)


The profitability of OMCs is a function of i) refining segment profitability including the inventory gain/loss on crude and finished products, ii) marketing segment profitability and iii) profitability of other segments such as pipeline and petrochemicals.. Historically, marketing segment profitability has largely remained stable, predictable and had high EBITDA to cash flow from operations, given low net working capital requirements. Over FY15-FY18, IOC’s marketing EBITDA averaged about INR70 billion, while over FY19-FY21 when refining profitability was subdued, the marketing segment EBITDA would average around INR185 billion. 

Given the sharp drop in crude prices seen towards end-March 2020, the three OMCs had a combined refining inventory loss of INR206.8 billion during FY20. However, with the recovery in crude prices during 9MFY21 to USD50/bbl (FYE20: USD32/bbl; refer Figure 5), OMCs had a refining inventory gain of INR52.6 billion (9MFY20: INR9.4). Ind-Ra expects such inventory gains to continue in 4QFY21, led by 31% qoq increase in crude prices to USD65.6/bbl. This  was led by a combination of i) vaccine rollout led growth, ii) continued production cuts by OPEC+ members (Saudi Arabia continuing with the 1million barrel per day (mbd) production cut in April), and iii) a temporary reduction of around 2mbd production of US crude due to the cold weather storm. Ind-Ra expects the crude prices to range between USD60-65/bbl during FY22, as a function of the gradual reduction in the production cuts by OPEC+ and stabilising US crude production. Hence, Ind-Ra sees limited possibility of further inventory gains during FY22. Amid this and subdued GRMs, the burden of lifting the EBITDA level profitability would hinge upon the marketing segment. 




Marketing Margins - Strong Pillar of OMCs’ Credit: The marketing segment behaves like a toll road and ensures stable cash flows to OMCs as profitability is linked to volume throughput and the per unit margin. Given the volume hit in the marketing segment owing to the travel restrictions anticipated at the beginning of FY21, OMCs kept a higher marketing margin leading to healthy absolute profitability. Despite a 15% yoy decline in marketing volumes to 109 mmt during 9MFY21, growth in OMCs’ marketing EBITDA was led by around 70% yoy increase in net marketing margins to INR3.8 per litre and higher inventory gains (9MFY21: INR60.8 billion, 9MFY20: INR8.4 billion). Ind-Ra expects that marketing margin to remain healthy in the range of INR2-3/litre during FY22. This would ensure i) sufficient cash flow from operations with OMCs to meet high capex requirements, ii) cash available to support dividend and buybacks and iii) strong valuation to the disinvestment programme of one of the large OMCs. 

improvement in OMCs’ Credit Metrics:
OMCs’ credit metrics recovered to pre-COVID levels (FY19) levels during   9MFY21 (Interest coverage: 9MFY21: 13.4x, FY20: 1.8x, FY19: 9.1x; Net Leverage: 2.4x, 11.0x, 2.1x) largely led by the combination of a reduction in interest rates and overall debt (9MFYE21: INR1,278 billion, FYE20: INR2,014 billion), resulting from i) lower subsidy receivables (INR105 billion, INR331 billion) and lower capex (INR313 billion, INR547 billion. Ind-Ra expects the FY21 credit metrics to have sustained 4QFY21 levels, supported by i) a continued recovery in demand, ii) healthy marketing margins, iii) low subsidy receivables, and iv) inventory gains led by the steep increase in crude prices in 4QFY21.

 




SOLICITATION DISCLOSURES

Additional information is available at www.indiaratings.co.in. 

Ratings are not a recommendation or suggestion, directly or indirectly, to you or any other person, to buy, sell, make or hold any investment, loan or security or to undertake any investment strategy with respect to any investment, loan or security or any issuer.

DISCLAIMER

ALL CREDIT RATINGS ASSIGNED BY INDIA RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTPS://WWW.INDIARATINGS.CO.IN/RATING-DEFINITIONS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE WWW.INDIARATINGS.CO.IN. PUBLISHED RATINGS, CRITERIA, AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. INDIA RATINGS’ CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE, AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE CODE OF CONDUCT SECTION OF THIS SITE.

Analyst Names

  • Ankur Rustagi

    Senior Analyst
    India Ratings and Research Pvt Ltd DLF Epitome, Level 16, Building No. 5, Tower B DLF Cyber City, Gurgaon Haryana 122002
    0124 6687261

    Vivek Jain

    Director
    +91 124 6687249

    Media Relation

    Ankur Dahiya

    Manager – Corporate Communication
    +91 22 40356121