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OPEC+ has announced additional “voluntary” cuts of 2.2mmbpd for 1QCY24 to maintain balance in oil markets. However, excluding a) extension of Saudi Arabia and Russia’s existing voluntary cuts of 1.3mmbpd and b) reduction of Russia’s fuel exports by 0.2mmbpd, the effective additional crude output cut is 0.7mmbpd. Further, as it is a voluntary cut, and not a formal cut, there is likely to be some scepticism on its actual implementation. We still believe the strong pricing power of OPEC+ will continue to support Brent crude price at ~USD 80/bbl, which is the fiscal break-even crude price for Saudi Arabia. This price is a sweet spot for ONGC/Oil India. We maintain BUY on ONGC (TP INR 225) and Oil India (TP INR 355) given the strong 6-8% dividend play and also because CMP is discounting ~USD 55-60/bbl net crude realisation. However, the market’s optimism on OMCs will depend on whether crude sustains below ~USD 80/bbl. OMCs’ valuations are trading at their historical average (FY24 P/B at 1.0x for HPCL/IOCL and 1.4x for BPCL) after the recent rally.

? OPEC+ announces additional “voluntary” cuts of 2.2mmbpd for 1QCY24; however, taking past announcements into account, effective additional crude output cut is 0.7mmbpd: OPEC+ has announced additional “voluntary” cuts of 2.2mmbpd for 1QCY24 to maintain stability in the oil markets. The countries that have agreed to these additional voluntary cuts are Saudi Arabia (1,000kbpd), Russia (500kbpd – 300kbpd of crude and 200kbpd of oil product exports), Iraq (223kbpd), UAE (163kbpd), Kuwait (135kbpd), Kazakhstan (82kbpd), Algeria (51kbpd), and Oman (42kbpd). These cuts are over and above June’2023 agreement whereby OPEC+ extended its output cuts until end-CY24 — Exhibit 5. However, the 2.2mmbpd cuts include a) extension of the existing voluntary cuts of 1.3mmbpd by Saudi Arabia (1.0mmbpd) and Russia (0.3mmbpd); this was originally valid till end-CY23, and b) reduction of Russia’s fuel exports by 0.2mmbpd. Hence, the effective incremental voluntary crude output cut is 0.7mmbpd, and it is by OPEC+ countries other than Saudi Arabia and Russia. Further, given that it is a voluntary cut, and not a formal cut, there is likely to be some scepticism on its actual implementation. The next OPEC+ meeting scheduled for 1st Jun’24.

? OPEC+ output cuts to keep oil market in deficit in 1QCY24; likely to support Brent ~USD 80/bbl: OPEC+ output cuts are likely to keep the oil market in deficit in 1QCY24. We still believe OPEC+ will continue to use its strong pricing power to support Brent crude price ~USD 80/bbl, which is the fiscal break-even crude price needed by Saudi Arabia (Exhibit 7). The pricing power of OPEC+ has got strengthened over the past 2-3 years due to: a) US oil production continuing to be at ~13.2mmbpd (vs. pre-Covid peak of ~13.1mmbpd) as US shale investors have become disciplined in capital investment (Exhibit 9-10), and b) OPEC+ having shown strong ability to cut output (by ~10mmbpd) in early CY20 to offset the ~10% decline in global oil demand post Covid. Moreover, OPEC+ has enough headroom to cut output by another 2-3mmbpd to offset any macro-related risk to global oil demand growth. Hence, we believe the new normal for Brent crude price may be ~USD 80/bbl (except in the event of a global macro shock). This is a departure from the pre-Covid normal price of around USD 60-65/bbl, which was driven by marginal cost of US shale oil production.

? Moderation of global oil demand growth in CY24 may cap sharp rise in oil prices: IEA expects CY23 global oil demand growth to be strong at ~2.4mmbpd (at 102mmbpd) due to post-Covid recovery in the Chinese economy. But it sees demand growth moderating in CY24 to 0.9mmbpd (at 102.9mmbpd) due to rise in penetration of electric vehicles, efficiency gains and macro headwinds. This is likely to limit the sharp rise in oil prices.

? ONGC/Oil India key beneficiaries of high crude price: We maintain BUY on ONGC (TP INR 225) and Oil India (TP INR 355) given strong dividend play (of 6-8%) and also because CMP is discounting ~USD 55-60/bbl net crude realisation (Exhibit 21-22). Our TP, on the other hand, is based on USD 65/bbl net crude realisation, and various changes in windfall tax that suggest the government is fine with ONGC/Oil India making a net crude realisation of ~USD 75/bbl. Brent crude price of USD 75- 80/bbl is a sweet spot for ONGC/Oil India as it improves visibility for net crude realisation of USD 75/bbl by eliminating the risk of ad hoc fuel subsidy burden.

? Optimism on OMCs will be contingent on crude sustaining below ~USD 80/bbl: The market’s optimism on OMCs will depend on whether crude sustains below ~USD 80/bbl. After the recent rally, OMCs’ FY24 P/B valuations (at ~1.0x for HPCL/IOCL and 1.4x for BPCL) are trading at their historical average. At spot Brent price and actual product cracks, OMCs’ gross auto-fuel marketing margin has risen to +INR 6.4/ltr (vs. historical margin of +INR 3.5/ltr) and gross auto-fuel integrated margin has gone up to +INR 15.2/ltr (vs. historical margin of +INR 11.4/ltr) - Exhibit 23.

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