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Brent dips to 70s; OMCs gain margins; upstream not as bad

Benchmark crude oil prices have corrected ~15% over the last 15 days to ~USD65-70/bbl (WTI-Brent), led by macro weakness on account of nearing OPEC+ production ramp-up, weak Chinese demand outlook, and muted US economic data. Benchmark refining margins are also down to low-single digit. Chinese oil demand is perceived to be affected by a weak domestic scenario and shift to alternates. US oil demand seems reasonable while Indian crude demand is fairly stable at 3-4% YoY growth in CY24TD. We believe near-term volatility could persist in oil prices with tapering of OPEC+ production cut being a major bearish factor, although demand environment can be supported by lower pump prices, strategic restocking, and a global interest rate cut cycle. Nevertheless, we believe Brent could de-rate to a USD70-80/bbl range from a USD80-90/bbl range earlier. Consequently, our average Brent assumption for FY25E/26E/27E could be down from USD85/bbl each to USD80/75/75, though we have kept it unchanged for now.

Indian Oil & Gas sector sees a mixed impact from lower oil prices with upstream, petchem, and gas sector being affected negatively from lower realizations, deltas, and adverse economics, whereas oil downstream and retailing and lubes should gain from better margins and volumes (if prices are cut). However, against a USD70/bbl Brent, upstream stock (ONGC and Oil India) correction of ~15% during this period seems excessive, given that they were earning only USD75/bbl due to windfall taxes. Hence, we retain our estimates and even at USD70/bbl Brent, SA (standalone) EPS cut would be 6-9%, therefore vs CMP we remain constructive, maintaining our BUY ratings on ONGC and OIL. For OIL, a USD2/bbl drop in NRL’s book GRM results in a 2% annual decline in its consolidated EPS.

We believe there are expectations of a retail price cut in auto-fuels for OMCs (IOCL, BPCL, and HPCL) amid the upcoming state elections. While we do not rule out the same, the model code of conduct for J&K and Haryana is on for a month. There could be a cut only toward Diwali and before Maharashtra election’s model code of conduct, which could be Rs2/ltr each for petrol and diesel and possibly coupled with an equivalent increase in excise duty. However, during the next one month OMCs can earn supernormal marketing margins, covering LPG under-recoveries and inventory losses to a large extent. We estimate implied Q2FY25E gross marketing margins at Rs9.7/8 per liter for petrol/diesel vs Rs4.7/3.8 in Q1 and a normative range of Rs3.5-4 each.

USD75/bbl Brent in H2FY25, and a Rs4/ltr margin impact from price cuts and excise hikes could still yield Rs5-7/ltr of margins, which is healthy. Based on current Aramco contract prices, system-level LPG under-recoveries could amount to ~Rs300bn by FY25-end, though being a controlled item, a one-time subsidy from GoI is also expected. While Aramco propane-butane for September is steady, futures leading up to Mar-25 is indicating a steady decline given the lower oil prices offsetting seasonality. We reiterate our BUY rating on HPCL, BPCL, and IOCL. While BPCL is fundamentally the strongest, HPCL’s Vizag expansion and modernization project is expected to fully complete this month, and from Q3FY25 GRM uptick can be seen if stabilization is successfully completed. IOCL stock has relatively underperformed HPCL and BPCL recently, but it does have a higher inventory loss risk.

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