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Demand a worry, but OMCs poised for another leg up

* Re-iterate Buy on ONGC and Oil India despite oil price-related risks: In Jun’24, we highlighted the potential risks to ONGC and Oil India’s crude realization assumption of USD 73-74/bbl in our report titled “Oil price outlook: Has the crude oil party peaked?” Since then, the lower crude price momentum has led to corrections of 9% for ONGC and 18% for Oil India over the past four weeks. The International Energy Agency (IEA) has continued to moderate its demand assumptions for both CY24 and CY25, even as supply risks continue to mount. However, following the recent corrections, we believe that both ONGC and OINL are now pricing in the realization-related risks. Hence, we reiterate our BUY rating on both these stocks.

* Refining margin weak but likely to bottom out: The Singapore GRM in 1HFY25YTD has averaged only USD3.6/bbl, reflecting the effects of a subdued oil demand environment. However, key product inventories globally remain at the lower to mid-range of the last five years. We anticipate limited downside for refining margins from current levels as we approach the seasonally stronger winter months.

* Marketing margin outlook remains robust; OMC profitability likely to remain strong: Against the backdrop of weak crude oil prices and a range-bound refining GRM environment, the outlook for marketing margins remains strong. We believe the risk of a substantial retail price cut for MS/HSD before the upcoming key state elections is overstated. Instead, the central government may urge individual states to reduce state taxes to provide relief to consumers. While OMCs appear to be trading at the higher end of the historical range, street earnings estimates are building in only INR3-4/lit marketing margin (current margins are above INR10/lit).

Demand and OPEC+ spare capacity multi-year overhangs

* In its latest monthly oil market report, IEA reiterated that: 1) the oil demand outlook remains soft at 900/950kb per day in CY24/CY25; and 2) oil supply is set to rise 2.1mb/d in CY25, assuming voluntary cuts remain in place. IEA increased its OPEC+ supply growth marginally by 140kb/d for CY25.

* Demand estimate dips marginally: IEA has reduced its global oil demand estimate to 900/950kb per day in CY24/CY25 (marginally below the previous estimate). According to the IEA, global oil demand growth continues to slow down, with an increase of 800kb/d in 1HCY24, amid muted demand from China.

* The persistent weakness in oil demand, as per the IEA, is due to a contraction in Chinese consumption, an expanding EV fleet, and an improvement in vehicle efficiency. Crude oil imports hit a 22-month low in Jul’24, as demand for industrial fuels and petrochemical feedstock was weak.

* Key OPEC players raise production in Aug’24: According to IEA, Iran, Kuwait, Saudi Arabia, and the UAE increased their oil production by ~1.5-2.0% each MoM in Aug’24, leading to 300kb/d increase in oil production and an equivalent reduction in spare capacity. Kuwait, the UAE, and Saudi Arabia together still account for 77% of the OPEC+ spare capacity. With the reversal of voluntary cuts from Dec’24, these four countries together shall add ~1.8mb/d oil production over the current levels by Dec’25.

* Non-OPEC supply remains robust: The IEA expects global oil supply to report a lower-than-estimated increase of 660kb/d for CY24 (vs. 730kb/d rise estimated previously). This reduction is primarily attributable to outages in Libya and the US Gulf. OPEC+ production is projected to decline 810kb/d in CY24 (vs. 760kb/d decline estimated previously). In CY25, global supply is estimated to rise 2.1md/d (+1.9mb/d est. in Aug’24), as non-OPEC+ output is expected to rise 1.6mb/d.

* Our oil price assumption down 12% vs. the US EIA: We are modeling oil prices of USD75/bbl in both FY25 and FY26, but we believe risks to a lower oil price curve continue to mount given the strong non-OPEC supply response in CY25 and beyond.

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