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* Macro headwinds have intensified, narrowing the margin of safety across the Oil & Gas sector. INR depreciation (~6% YoY in 3QFY26) continues to weigh on OMC/CGD margins, partially offsetting benefits from softer crude prices. Refining margins, which spiked in Nov’25 (SG GRM averaged USD9.8/bbl, up 47%/63% MoM/YoY) amid supply dislocations and geopolitical risks, have moderated as planned maintenance concluded and incremental global capacity came onstream, limiting earnings upside from current levels. Additionally, Henry Hub (HH) gas prices rose sharply (up 52%/23% YoY/QoQ in 3QFY26), pressuring margins and diluting the benefit of structurally lower domestic gas costs.

* While sector stocks (excl. OMCs) have corrected meaningfully from recent peaks, current valuations still do not reflect maximum pessimism. Majority of the stocks trade near or above the LTA P/E or P/B, limiting the margin of safety. We also highlight that only MAHGL, IGL, and BPCL trade near their mean-1 SD valuation (P/E for CGDs; P/B for BPCL). HPCL, GAIL, and MAHGL are our preferred picks in the sector.

Excise tweak concerns resurface; marketing remains the preferred subsector Marketing has remained our preferred sub-sector over the last two years as: 1) Since Jun’24, we have maintained a negative view on crude oil prices (link); crude softness has helped OMCs report MS/HSD gross marketing margins above our estimates, 2) LPG under-recovery has declined sharply from INR100-170/cyl (FY25-1HFY26) to INR30- 50/cyl (3QFY26 avg). Recent investor pushback on OMCs has been driven by concerns over potential adverse excise duty adjustments as we head closer to the central government budget, given weak GST collection data (link). However, we believe a minor INR1-1.5/lit duty adjustment is unlikely to trigger a sharp de-rating for OMCs, given the otherwise strong earnings momentum.

Despite recent strength in diesel cracks, reiterate neutral on refining Despite recent strength in diesel cracks, we reiterate a neutral stance on refining over FY27-28, as expected net global capacity additions in CY26 (~1mb/d) are likely to outpace liquid demand growth (~0.7mb/d). Diesel cracks have already corrected from a high of USD30/bbl in Nov’25 to USD18/bbl recently, as planned/unplanned capacity under maintenance resumes operations. While we are positive on IOCL’s 25% refining capacity expansion by FY27’end, the timely commissioning of projects will be key to sustaining investor confidence and driving a re-rating. This aligns with guidance from Southeast Asian refiners (IRPC & Thai Oil), which expect Gasoline/Diesel refining margins to correct to USD9/16 per bbl in CY26 from USD14/24 per bbl in 4QCY25.

City gas distribution: USD/INR and HH price volatility key challenges; MAHGL most reliant on price hikes The benefit of lower gas costs (amid lower crude oil prices) has been partly offset by three headwinds: 1) 6% INR depreciation in 3QFY26, 2) sharp 52% YoY rise in HH prices in FY26’YTD, 3) continued APM de-allocation and, at times, new well gas shortage. According to reported data, GUJGA had the least HH exposure in 2QFY26 (2%), while MAHGL had the most (34%). With the revised unified zonal tariff effective from 1 Jan’26, IGL is expected to see an EBITDA margin uplift of INR0.9/scm, MAHGL is likely to face a margin contraction of INR0.3/scm, while GUJGA’s margins should remain largely unchanged. We believe that MAHGL would likely need price hikes to offset the impact of: 1) higher HH-linked gas cost (est. impact of INR0.3-0.4/scm); 2) Rupee depreciation (est. impact of INR0.7-0.8/scm); and 3) increase in Zone-1 tariff 

Rising dry-well costs; weak Brent price outlook keeps us negative on upstream Upstream remains our least preferred sub-sector despite ONGC/Oil India trading at/near LTA one-year rolling forward P/B. We are building in Brent oil prices of USD60/bbl in FY27/28 amid oil demand growth (IEA est.: 0.86mb/d), significantly trailing projected supply growth (IEA est.: 2.4mb/d). The potential for further production increases from OPEC+ presents an additional downside risk to our current oil price assumptions. We also see a heightened risk of earnings cuts amid rising exploration costs write-offs.

Our top picks – HPCL, GAIL, and MAHGL

HPCL: We continue to prefer HPCL among OMCs, given: 1) its high leverage towards marketing, which remains our preferred sub-sector, 2) the reasonable current valuation, 3) receipt of INR6.6b per month in LPG compensation over Nov’25-Oct’26, which will boost earnings, even as the sharp decline in LPG underrecovery to INR30-40/cyl currently, vs ~INR135/cyl in 1HFY26, improves blended marketing margins, and 4) mid-term auto-fuel marketing margin outlook remains robust amid a weak crude price outlook (USD60/bbl in FY27/28). Further, the startup of RUF and HRRL, coupled with sustained strength in diesel cracks, is expected to meaningfully boost refining earnings.

GAIL’s valuations have corrected sharply from their Sep’24 highs, and the stock now trades close to its historical average at ~1x one-year forward core P/B, offering limited downside, considering an attractive dividend yield and a robust FCF outlook. Further, the transmission tariff revision, effective from Jan’26, would raise the FY27E PAT by around 7%. Transmission volumes are also set to rebound in FY27 as the impact of multiple one-off disruptions in FY26 wanes, with a recovery in power and fertilizer offtake and normalization of floodimpacted supplies. Government initiatives to further rationalize natural gas (NG) taxation can be a significant long-term positive. Reiterate BUY with a TP of INR215.

We model MAHGL’s volumes to clock an 11% CAGR over FY25-28 and estimate an EBITDA margin of INR8.7-8.9 per scm during the period. While margins may face pressure in the near-term amid high HH prices, we believe this has already been factored into the current stock price. MAHGL currently trades at 10.1x FY28E SA P/E. We value MAHGL at 15x Dec’27 P/E, resulting in a TP of INR1,645. Reiterate BUY.

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