Petroleum minister's clarification on not interfering with auto fuels pricing is a relief

After an unconfirmed media flash suggested the possibility of downstream PSUs being asked to absorb higher crude prices by the government, the petroleum minister clarified on not changing the market-driven pricing mechanism of auto fuels on a knee-jerk basis. The clarification does provide some relief, as any such intervention would have reversed the significant benefits of a critical reform for oil PSUs and more importantly, the nation, at large.

Fuel prices may moderate a bit as US refineries ramp up operations post disruptions

The petroleum minister also suggested that fuel prices may moderate as the temporary impact from hurricane disruptions in the US normalizes, a point that we also agree with. We note that 27-41% of incremental domestic retail prices of diesel and gasoline since July 1 was contributed by a jump in global product cracks, a portion of which will likely moderate in the near term as the US refineries ramp up operations. However, around 45-56% of incremental retail prices can be attributed to a recovery in global crude prices from then low levels, which is unlikely to reverse, in our view.

The government's intent to retain higher duties despite a sharp jump in fuel prices...

Recent media articles suggest that the government does not intend to cut excise duties on auto fuels despite a sharp increase in global product prices as well as domestic retail prices over the past few months. The retail price of diesel in India is near historical peak levels, as the government continues to retain higher excise duty despite near-90% jump in global product price since the last change in excise duty on February 1, 2016; we highlight that the current global price of diesel is still ~40% below the earlier period of peak retail prices in India. The situation in gasoline prices is not much different.

...rules out marketing margins expansion even with a reasonable crude price and exchange rate

The government's intention to retain higher excise duties despite a sharp increase in retail prices of auto fuels does rule out any possibility of expansion in marketing margins for OMCs even in the current environment of a reasonable crude price and exchange rate. Any further increase in global crude/fuel prices and/or depreciation of Rupee against the US dollar, with latter definitely a possibility, may worsen the situation, as the government will be required to manage both fiscal balance and inflation scenario.

Another reason for marketing segment to be not accorded higher valuation multiples

The above apprehensions provide another reason to not accord higher valuation multiples to the marketing profits of OMCs, besides our earlier-highlighted concerns on fungibility of cash flows across segments-robust cash generation from marketing segment gets deployed in relatively lower-return businesses of refining, petchem or even upstream. We reiterate our negative stance on BPCL, HPCL and IOCL with relative preference for the latter given reasonable valuations.

Source : Equity Bulls

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