OIL MARKETING COMPANIES: Fall in Crude Prices may Hit Growth

Under-recoveries, ad-hoc subsidies and a spurt in interest costs impacted the June 2011 quarter numbers of state-run oil marketing companies — Indian Oil, BPCL and HPCL. Although, the companies ended up in the red, stocks of these companies have remained buoyant thanks to falling oil prices and renewed hopes on clarity in policy. However, this may be just a case of irrational exuberance once again.
The three oil marketing companies have generated 1-4% returns since the last week of July 2011, despite the global stock market crash that led to a 13% fall in BSE Sensex. And that too, after the fall in the past couple of trading sessions following negative numbers for the June 2011 quarter.
A 20% fall in global crude oil prices was the key reason, while reports of follow-on public offer, or FPO, of ONGC and Indian Oil revived hopes regarding clarity on subsidy-sharing mechanism, which has remained ad-hoc so far.
These stocks could, however, be entering a correction phase. Oil prices have rebounded nearly 8% in the last couple of days as global equity markets recovered a bit. But clarity on subsidy-sharing remains elusive. “Any near-term decline in oil prices is positive for OMCs, but we continue to believe that for these companies to emerge as long-term investment ideas, clarity is needed on deregulation and (subsidy) sharing mechanism,” a research by Nomura said.
The losses of OMCs in the June 2011 quarter were despite the support from the government as well as upstream petroleum PSUs. However, the OMCs were forced to bear nearly a third of the quarter’s under-recovery, compared with less than 10% in FY11. The government’s decision to share a lower burden was possibly driven by the expected reduction in under-recoveries in the later half of FY12, following price hikes and tax cuts implemented in the past week of June 2011. A key failure of the three OMCs was their inability to generate healthy refining margins for the quarter, when their private sector peers did exceedingly well.
A10% fall in crude oil prices during the June 2011 quarter left these companies with inventory losses weighing heavily on refining profits. A sharp jump in interest burden and a fall in other income, too, were responsible for higher losses.
Overall, the June quarter numbers of the three OMCs hold little to support their strong market performance of late.