According to a report by JP Morgan, the profit earning capacity of government oil marketing companies (OMCs) is going to improve. According to the report, fuel marketing margins are increasing due to falling prices of crude oil. However, rising debt and uncertainty over fuel taxes may limit the long-term earnings prospects of the sector.
The report said that combined margins on sales of petrol and diesel from government refineries and fuel retailers are now above the level before the recent Middle East conflict. This increase is due to low prices of crude oil and low central excise duty. The outbreak of conflict in West Asia caused a surge in global oil prices, but retail pump rates in India remained largely stable and increased much less than the required increase. Even after petrol and diesel prices increased by Rs 7.50 per liter in May, retail pump rates were below cost.
Loss still high on LPG
JP Morgan said that our estimates for OMC’s combined margin on petrol and diesel are now higher than pre-war levels. Losses on LPG are still high, but this should also reduce soon with the fall in oil prices. Also said that huge inventory loss may impact the earnings in the first quarter (April-June) of the current financial year, but the profit should be better in the second quarter.
The report said that two things limit our enthusiasm about this improvement in margins: OMCs have accumulated significant debt in the last few months – which has impacted valuations, and a large part of the restoration of profitability is due to excise duty cuts. It is possible that the government may keep taxes low for some time – so that OMC can repay the loan. However, there remains a risk of excise duty increasing in future.
To avoid an immediate increase in retail prices, the government had reduced excise duty on petrol and diesel by Rs 10 per liter in March. When global oil prices return to pre-war levels and stabilize, the duty can be increased again.
Margin increased on petrol and diesel
Of the three state-owned OMCs – Bharat Petroleum Corporation Limited (BPCL), Indian Oil Corporation (IOC) and Hindustan Petroleum Corporation Limited (HPCL) – BPCL and IOC are expected to benefit the most in the near future if oil prices continue to fall. The brokerage estimates that the current combined margins of petrol and diesel for BPCL and IOCL are higher than pre-conflict levels, while margins for HPCL have largely returned to or even exceeded the levels before the recent surge in oil prices. This improvement reflects improved combined refining and marketing economics, even though standalone fuel marketing margins still remain below historical averages.
There will be pressure in the first quarter
An improved margin environment could support earnings from the second quarter, especially if crude oil prices remain below $80 per barrel and refining margins remain high. However, Q1 earnings are likely to remain under pressure due to inventory losses due to the recent decline in crude oil prices. Analysts also expect that the debt burden on the three oil companies may increase after suffering losses on sales of petrol, diesel and liquefied petroleum gas (LPG) in recent months. Although the loss on LPG is still huge, it is expected that this loss will be reduced due to the impact of low oil prices on this sector.
loss of revenue to the government
One of the main reasons behind the improvement in fuel margins has been the government’s decision to keep excise duty low, due to which OMCs have been able to pass on a larger share of retail fuel prices. Analysts estimate that the government has lost revenue of about Rs 1.8 lakh crore annually due to the cut in excise duty. This has raised questions over the sustainability of current profit levels. Analysts say the government may allow OMCs to maintain higher margins for some time to help reduce the debt accumulated during the recent losses (under-recovery). However, pressure to increase fuel tax may build again, especially because the government may have to spend more in the next two financial years.
When can we earn good money?
JP Morgan expects OMCs to earn good earnings in the December and March quarters if crude oil prices remain low, but has warned that it is difficult to say anything clearly about fuel marketing margins after financial year 2028. Therefore, the decision to invest in this sector will largely depend on the changes in crude oil prices and tax policy of the government, and in the current environment BPCL and IOC are being considered as better options.
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