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Favorable energy prices and margins to support OMCs/upstream earning

* We note that despite perceived volatility in energy prices and margins, key parameters for Indian OMCs and upstream companies are steady and we do not foresee any risk of core earnings downgrade. We do not anticipate major inventory losses for OMCs in Q3FY22.

* For OMCs, benchmark GRMs in Q3 are up at USD5.5-6.0/bbl with a steady outlook till Mar’22. Accounting marketing margins on auto-fuels have risen to ~Rs9/ltr as prices have been frozen for ~50 days. Diesel volumes have been a drag but would not impact much.

* For upstream, Brent prices remain steady at USD70/bbl+ despite the omicron threat, as the demand-supply balance is favorable. However, with the winter pushing up European gas prices, we now estimate APM in Apr’22 to more than double to USD6.5/mmbtu+ GCV.

* We believe, after the recent correction, valuations look attractive. The election overhang could emerge by Jan’22-end amid polls in Punjab and UP but will last only for a month. Retain Buy on ONGC, Oil India, IOCL and BPCL, upgrade HPCL to Buy from Hold.

GRMs hover at mid-cycle range; auto-fuel margins up at ~Rs9/ltr: Singapore benchmark margins, after rising to the recent peak of USD8/bbl+, currently stand at the USD5-6 range, which is a mid-cycle level and implies steady earnings for OMCs. Our checks suggest forward cracks are steady till Mar’22 on the back of global recovery, despite the omicron threat and slower demand growth in India. After the last reduction in excise duty and VAT, OMCs have kept petrol/diesel prices largely unchanged for ~50 days now. As Brent corrected from its peaks of almost USD90/bbl to USD70-75/bbl, gross marketing margins expanded and current accounting margins stood at a high of ~Rs9/ltr for petrol/diesel. If OMCs could maintain such margins till Jan’22-end, they could report Q4 average margins above normative levels despite major elections in Punjab and Uttar Pradesh in Feb-Mar’22, unless oil prices spike.

Brent overall stable, but recent winter surge to lift APM further: Brent saw volatility, with prices falling by almost USD20/bbl from the recent peaks due to omicron fears and the release of strategic reserves by major oil consumers amid rising OPEC+ output. Nevertheless, prices remain above USD70/bbl due to a deficit market and a sharp spike in global gas prices. We see limited downside risk to our USD75/70 per barrel assumptions for FY22/23. However, APM (domestic) gas prices would cross our estimate of USD4.5/mmbtu GCV in Apr’22, as the recent spike in NBP prices implies that the next revision will be to USD6.5/mmbtu+. Steady oil prices and higher-than-expected gas prices bode well for ONGC and Oil India. For every USD1/mmbtu change in APM price, ONGC/Oil India’s FY23 standalone EPS will change by Rs2.4/Rs4.5 per share, or 10%/12%.

Reiterate Buy on ONGC, Oil India, IOCL and BPCL; upgrade HPCL from Hold to Buy: We retain Buy on ONGC, Oil India, IOCL and BPCL and upgrade HPCL from Hold to Buy due to the recent correction in stock prices. We note that the delay in BPCL’s disinvestment is a dampener, though the valuation remains attractive.

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