Barring shares of Reliance Industries Ltd, stocks of other listed oil companies in India have lagged the markets so far in 2018. State-run oil companies were bogged down by regulatory risks. Oil marketing companies (OMCs), for instance, bore the brunt of the government asking them to sacrifice a portion of their marketing margins in early October. Since then, OMCs’ valuations have dropped meaningfully. OMCs are Bharat Petroleum Corp. Ltd (BPCL), Hindustan Petroleum Corp. Ltd (HPCL) and Indian Oil Corp. Ltd.
On the other hand, fears of oil subsidy sharing cast their shadow on shares of upstream oil companies, Oil and Natural Gas Corp. Ltd (ONGC) and Oil India Ltd. For the Reliance stock, better-than-expected performance of its telecom and retail businesses—Reliance Jio Infocomm Ltd and Reliance Retail—helped valuations.
So what will the coming year bring? Here are the key factors:
Oil prices: This is a significant variable. Shares of upstream companies will take cue from oil prices. Now, “higher the oil price, the better it is” could easily have been the mantra for oil producers. In India, it’s a different ball game. The sooner oil prices start to inch upwards by a good margin, subsidy sharing concerns emerge for state-owned oil producers. As mentioned earlier, this is one of the reasons that weighed on the sentiments for the two stocks this year, although things have eased with the recent drop in crude prices.
Refining margins: Benchmark Singapore gross refining margin (GRM) is currently much lower than the average of $6.1 a barrel seen in the September quarter. For a refiner, GRM is realization from turning every barrel of crude oil into finished products. Unfortunately, the outlook isn’t getting better over the near-to-medium term. That’s because global net refining capacity addition is expected to surpass global refined products demand growth in 2019. Analysts expect a relatively softer refining margin environment in the first half of the year.
However, towards the end of next year, some strengthening in refining margins can be expected owing to the compliance with International Maritime Organisation’s new norms for sulphur content used by ships. Demand for low sulphur diesel/middle distillates globally is expected to get a boost, in turn resulting in better product cracks.
Marketing margins: According to ICICI Securities Ltd, marketing margins on petrol and diesel is estimated to be flat or higher year-on-year in 2019. Needless to say, much also depends on where crude prices are and what government policy is adopted.
The government: For state-run oil companies, the government that comes to power next year will be critical. As ICICI Securities says in its 2019 outlook, “We believe that strength and hue of the government that comes to power in May 2019 after elections would influence the earnings outlook and stock performance of OMCs and ONGC.” A strong government will likely mean stable and reasonable auto fuel marketing margins, and reforms to reduce LPG and kerosene subsidy, the broker added.
Reliance Jio, Reliance Retail Key for RIL
For the Reliance stock, performance of its telecom and retail businesses—Reliance Jio and Reliance Retail—remains a key measure to track. How refining margins fare will also be consequential. At Reliance, though, valuations are rich even as earnings, free cash flow and return on capital employed may lag Street estimates despite impressive momentum in telecom and retail, pointed out analysts from Jefferies India Pvt. Ltd in a 17 December note.
