Worries around OMCs appear to be overdone?

1. Worries around OMCs appear to be overdone?

2. In sync with historical trends, govt may look to reduce excise duty to curtail impact of rising crude oil prices, believe analysts Stocks of oil marketing companies (OMCs) namely Indian Oil Corporation (IOC), Bharat Petroleum Corporation (BPCL) and Hindustan Petroleum Corporation (HPCL) have lagged the S&P BSE Sensex since December 9 as the Opec and non-Opec nations agreed to cut crude oil production by 1.2 million barrels of oil equivalent per day from January 1, 2017. These stocks have fallen anywhere between 2-6 per cent in this period versus a per cent fall in the Sensex. While crude oil prices have come off by 0.6 per cent to $53.25 a barrel in this period, most analysts expect this metric to surge going forward and touch $60 a barrel levels. Rising crude oil prices are negative for OMCs as they may not always be in a position to pass on this hike and it is also likely to result in higher working capital requirements. But the fears around these stocks could have been overdone. Historical evidence suggests that the government has deployed excise duty as an efficient tool to reduce the burden of rising crude oil prices on both the OMCs as well as the end consumers. The trend is likely to continue this time around as well, estimate analysts. "We believe at $60 a barrel, excise duty rollbacks are likely, and possibly VAT cuts too. These cuts would be structurally positive for OMCs and reduce the risk of adverse marketing margins," says Sabri Hazarika of PhillipCapital. Though the jury is out on whether the government would bear the entire burden of oil price increase, even a partial support on this front would aid OMCs. "If the government bears the entire brunt of the increase in oil price by cutting duties so as to leave the final retail selling price (RSP) unchanged, it could suffer a revenue loss of 0.5 to 0.7 per cent of GDP for oil between $60-65 a barrel," estimates Suhas Harinarayanan of JM Financial. If the government shares half of this burden, he believes it could lead to a revenue loss of 0.32 to 0.45 per cent of GDP. In an unlikely scenario of the OMCs passing on the entire price increase to the end consumers, retail petrol and diesel prices could surge 16-19 per cent over December 1, 2016, estimate analysts. This scenario though seems highly unlikely as the government has asked the OMCs to raise prices in a protracted manner. An important change for OMCs is announcement of 0.75 per cent discount on sale of petrol and diesel via cards and e-wallets implying a hit of Rs 0.4 to 0.5 per litre on these fuels. "This move is not necessarily margin dilutive, as OMCs can offset the earnings hit through higher margins given the pricing freedom. It could introduce quarterly volatility in marketing earnings, as actual margin realisations would depend on the share of digital payments," writes Sanjay Mookim of Bank of America Merrill Lynch in a recent report.

3. For now, it seems that the recent stock price correction seems to ignore some of the positives for the OMCs. One, consumption demand continues to grow at a healthy clip in India with demonetisation adding fuel to the consumption fire. Second, de-regulation of kerosene and LPG prices since July have led to an increase of 18 per cent and 4 per cent respectively in their prices. Third, reduced under-recoveries burden on the OMCs will aid their profitability. "We see budgeted subsidy available for FY17 at Rs 17,000 crore; hence, about Rs 18,500 crore of projected under-recoveries would largely be managed," adds Hazarika. Lastly, higher oil prices could lead to inventory gains (in the short term at least) and boost gross refining margins of the OMCs. In this backdrop, most analysts are positive on the three companies. HPCL is a direct play on crude oil prices, potential upsides from the exploration and production activities could further aid BPCL's prospects. IOC too stands to benefit from ramped up capacities at its Paradip refinery kicking in. Article By: -Business Standard