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Event update: Oil & Gas - Material changes likely if oil price sustains at US$60/bbl

EVENT – Brent falls to a 12M low

Brent crude fell to a 12-month (12M) low of US$59/bbl levels as on 26 Nov 2018, US$13/bbl below the average price of US$71.8/bbl over the last 12M. The price is >30% lower than the high of US$86/bbl seen on 3 Oct 2018. News reports attribute the fall to an oversupplied market and potential weakness in demand for global crude. We note OPEC (supplies ~35% of global oil supply) and key producers like Russia are once again contemplating production cut by 1-1.4mb/d to bring back the balance in the market, clarity on which will be seen after the next meeting slated to be held on 6 Dec 2018.

IMPACT: Material implications across our coverage universe

Sharp cut in Indian import bill, fuel subsidy: India currently has net imports of 4mb/d (~200mt). A US$15/bbl reduction in crude price (versus our estimate of US$75/bbl) will result in annualised savings of US$22bn in India’s crude import bill. We estimate net import bill to reduce to US$88bn at US$60/bbl crude versus US$110bn at US$75/bbl crude. The annual subsidy bill for LPG/Kero too would reduce materially, if crude were to sustain at US$60/bbl. If we assume product spreads of US$8/bbl for Kero and LPG discounts of US$15/bbl (average of last 12M) sustain, FY19E subsidy would be Rs230bn at US$60/bbl crude versus Rs478bn at US$75/bbl crude.

Marketing margins – OMCs get more leeway, customers to benefit as well: OMCs have seen fuel retail margins expand steadily post the surprising Re1/ltr hit taken in the beginning of Oct 2018, when gross margins slipped to less than breakeven EBITDA levels for both petrol and diesel. Current retail margins hover at >Rs5/ltr for petrol and >Rs4/ltr for diesel, with current prices (as on 19 Nov 2018) reflecting an average gasoline price of US$71/bbl and diesel price of US$87/bbl. With the decline in crude price, we expect the price of gasoline to reduce to US$68-69/bbl and that of diesel to decline to US$76-77/bbl. With margins expected to normalise at Rs3.5/ltr levels, retail prices can drop by Rs5/ltr for petrol and Rs6.1/ltr for diesel versus that seen on 19 Nov 2018. The fall should help support stronger demand for transportation fuels in FY20E.

Refining margins – uncertain prospects: Softness in crude price over FY18 was driven by oversupply concerns in the crude markets, even as product demand remained robust globally. This implies key product spreads and hence GRMs remained steady at US$6.5-7/bbl through FY18. However, recent weakness in crude prices has been accompanied by fears of a global slowdown in product demand as well (except for diesel, which is driven by imminent IMO regulations). Gasoline spreads as a result have fallen to a 5-year low of US$0.5-1/bbl, albeit in the recent week ending 23 Nov, spreads have improved to US$3.5/bbl. Benchmark GRMs therefore fell to US$5/bbl levels during this month. While medium-term prospects for demand and supply still indicate that GRMs could revert to historical levels of US$6/bbl over the next 12M, near term trends look negative for Indian refiners.

Gas – demand strength may get hit, margins to stay robust: For gas players, the reduction in effective LNG prices (prices have a 12-13% linkage to crude) is a material positive, with the accompanying softness in INR/USD also a positive for input costs. However, the sharp decline in crude also results in softer alternate fuels (Petrol/diesel/LPG/naphtha/FO), which can moderate the strong growth momentum seen in gas demand over the last 6 months. Long-term demand prospects for gas remain robust due to a structural push towards gas, but near-term demand could be weak due to lower competitiveness of gas versus alternate fuels.

VIEW: OMCs

We expect demand for petroleum products to pick up, coupled with stronger marketing margins if the current price environment sustains. This should help offset softer GRMs, making OMCs attractive at their current valuations. The crude price scenario remains volatile, with the upcoming 6 Dec meeting of OPEC and other key suppliers being key monitorable that would determine the direction of crude prices over the medium term. We remain cautious on OMCs as of now, and our positive stance on gas companies remains unchanged. We believe any near-term slowdown in demand growth is likely to be temporary, while margin strength would add to earnings. For the upstream players, the sharp decline in prices would be a negative, with Q3 earnings likely to show a sharp qoq decline for ONGC/OIL. We will revert with revised estimates for our coverage universe post the 6 Dec meeting, as we believe the outcome of the said meeting will drive the medium term direction for crude prices over the next 9-12M.