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* As OMCs stopped changing auto fuel prices since 6 th Apr’22, they made an average loss of INR0.68/10.1/lit on petrol/diesel till Dec’22. However, a sharp decline in benchmark prices after that has resulted in gross marketing margins improving to INR9.0/INR11.8 per liter as of May’23.

* Although Singapore GRM (SG GRM) declining to USD3.3/bbl in 1QFY24’td (v/s USD10.8/bbl in FY23) should impact refining performance, our calculations suggest that to compensate for 1USD/bbl decline in SG GRM, gross marketing margins for auto-fuels needs to rise by INR0.65/INR0.59/INR0.42 per liter for IOCL/BPCL/HPCL .

* The current dip in oil prices makes a strong investment case for OMCs. However, any rise in oil prices or cut in retail prices poses a big threat to this thesis.

* HPCL should benefit the most from strong marketing margins; however, it continues to suffer from rising debt and projected execution risk. Hence, we maintain our neutral rating on stock. We reiterate our BUY rating on IOCL, valuing it at 0.9x FY25E P/BV and neutral rating on BPCL, valuing it at 1.2x FY25E P/BV.

Demand concern overshadows the impact of oil production cuts

* OPEC+ has been very proactive in ensuring high oil prices. It has cut oil production by 2mnbopd effective Nov’22 citing uncertainties around global economic and oil market outlook, followed by an additional 1.66mnbopd cut starting May’23.

* Despite these production cuts, Brent has declined below USD75/bbl over the past few days v/s USD93.1/bbl in Oct’22 when the first round of production cut was announced. The decline can be attributable to demand concerns amid rising interest rates and banking crises in the US and Europe.

* Declining crude prices bode well for OMCs, with gross marketing margins at INR9.0/INR11.8 per liter currently (v/s INR2.2/-INR5.9 per liter in FY23) for petrol/diesel. However, we caution that the next OPEC+ meeting is to be held on 4th Jun’23 and further production cuts might cause a spike in oil prices, thus impacting marketing margins adversely. Alternatively, with upcoming state and general elections, the OMCs may cut retail prices, thereby reducing their marketing margins.

Marketing segment gains to offset weak GRMs

* While marketing margins have been improving, concerns have started emerging on the refining segment as SG GRM has declined sharply to ~USD3.3/bbl during 1QFY23’td from USD10.8/bbl in FY23. IOCL has the highest exposure to refining among OMCs and it will be the most hit by declining GRMs.

* However, the SG GRM appears to have bottomed out and is likely to rebound to its long-term mean of USD5-7/bbl. We assume a GRM of USD5/bbl for IOCL and HPCL and USD5.5/bbl for BPCL in FY24-25E.

* Additionally, our calculations reveal that to compensate for 1USD/bbl decline in SG GRM, gross marketing margins for auto-fuels needs to increase by INR0.65/ INR0.59/INR0.42 per liter for IOCL/BPCL/HPCL. Hence, we expect marketing segment gains to offset weak GRMs, if margins stay at current levels.

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