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OMCs’ blended auto-fuel gross marketing margin (GMM) has risen to +INR 4.0/ltr vs. negative ~INR 6.8/ltr in 9MFY23 and above-historical GMM of +INR 3.5/ltr; this has been driven by fall of diesel cracks and some moderation in Brent crude price. At current refining/marketing margins, OMCs’ overall quarterly EBITDA run rate at ~INR190bn is ~25% higher than historical normalised quarterly EBITDA (of INR 150-155bn); also, OMCs’ earnings in 4QFY23E are estimated to be higher than historical normalised quarterly EBITDA. This should help OMCs to partly recoup the huge losses they incurred in 9MFY23; in the absence of government compensation, OMCs will take 8-10 quarters to recoup past losses at the current run rate. Our calculations suggest that OMCs incurred auto-fuel under-recovery of ~INR 750bn in 9MFY23; however, press reports say that OMCs have sought government compensation of ~INR 500bn (implying adjustment of ~INR 250bn for abnormal refining earnings). We believe the government will allow OMCs to earn above-normal GMM (of +INR 3.5/ltr) to recoup some of the past losses; in addition, the government’s FY24 budget estimate provides for capital support of INR 300bn to OMCs for emission-reduction-related capex. Hence, OMCs’ FY23 earnings will be contingent on any additional government compensation that may be announced before 4QFY23 results. We have a BUY rating on HPCL (TP of INR 260) and BPCL (TP of INR 390) on valuation grounds; however, we maintain HOLD on IOCL (TP of INR 80) given the company’s continued aggressive capex plans. OMCs are trading at attractive valuations: HPCL at 0.7x FY24 P/B, IOCL at 0.8x FY24 P/B and BPCL at 1.1x FY24 P/B. Optimism on OMCs will be contingent on crude sustaining below ~USD 80/bbl and the government giving them significant compensation for FY23 auto-fuel under-recoveries. Though there is valuation comfort, downside risk still exists if: a) OMCs’ auto-fuel under-recoveries rise again due to potential spike in crude price, and b) there is limited recovery of auto-fuel losses incurred by OMCs in 9MFY23.

* Blended auto-fuel GMM has risen to +INR 4/ltr on spot crude/product crack vs. negative INR 6.8/ltr in 9MFY23 and vs. historical GMM of +INR 3.5/ltr: Due to the fall in diesel cracks (to ~USD 21/bbl in the last few weeks vs. USD 35-40/bbl in the last 3-4 quarters) and some moderation in Brent crude price (to ~USD 83/bbl), OMCs’ GMM has risen to +INR 3.8/ltr on diesel and +INR 4.4/ltr on petrol; hence, blended GMM has increased to +INR 4.0/ltr (based on ~67% weight for diesel and 33% weight for petrol) vs. negative ~INR 6.8/ltr in 9MFY23 and above-historical GMM of +INR 3.5/ltr. Every USD 1/bbl decline in crude price helps to boost GMM by ~INR 0.5/ltr (or INR 72-75bn on an annualised basis based on annual auto-fuel sales volume of 145-150bn ltr) and vice versa; hence, OMCs’ break-even crude price for the marketing business is ~USD 83-85/bbl to earn a historical blended GMM of +INR 3.5/ltr (assuming spot product cracks) –

* At current refining/marketing margins, OMCs’ quarterly EBITDA at ~INR 190bn is ~25% higher than historical normalised quarterly EBITDA: At current refining margin (of ~USD 7.5/bbl due to normalisation of diesel cracks) and marketing margin (blended auto-fuel GMM at +INR 4.0/ltr), OMCs’ overall quarterly EBITDA run-rate at ~INR190bn is ~25% higher than historical normalised quarterly EBITDA (of INR 150-155bn); this should help to partly recoup the huge losses incurred in 9MFY23 – Exhibit 2. Similarly, OMCs’ earnings in 4QFY23E are estimated to be higher than historical normalised quarterly EBITDA – Exhibit 4. Hence, in the absence of government compensation, OMCs will take 8-10 quarters to recoup past losses at the current run rate. HPCL is a relatively bigger beneficiary of above-normal marketing margin given it is relatively more levered to marketing earnings (as its marketing to refining volume is 1.9x vs. 1.1x/1.3x for IOCL/BPCL) while IOCL was a relatively bigger beneficiary of the strong GRM witnessed in the last 3-4 quarters.

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