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Indian refiners; slippery track ahead

Monday, November 15, 2010
By Manik K. Malakar

Fuel -crude through to refined - is an obvious driver of the Indian economy, literally so…But the companies that operate in this sphere are going through a bad patch, mainly due to various geopolitical factors. Thus Gross Refining Margins (GRMs) of most of the domestic refining companies have been under pressure.   
“The Indian crude oil refinery sector is passing through a period of weak refining margins,” says K. Ravichandran, Senior Vice-President and Co-Head Corporate Sector Ratings, ICRA. Also global factors will play their part in the fortunes of the sector. Oversupply and lesser demand for petroleum products will also put pressures on the sector. In the short term, at least the Gross Refining Margins of domestic oil companies will be under pressure on the back of low refining margins globally.
But there is some good news for the sector: domestic demand. “With regard to the marketing segment, recent measures by the Government such as deregulation of oil prices, increase in prices of all four sensitive products and intent to deregulate diesel prices in the near term are positive to the credit risk profiles of the Public Sector Oil Marketing Companies,” said Ravichandran. The four sensitive products that he was referring to included Motor Spirit, High Speed Diesel, LPG and Superior Kerosene Oil for the Public Distribution System.  
Also of the same view is Alok Deshpande of Elara Capital. “Indian petrol demand grew at an average of eight per cent annually between 2000 and 2009 after an average annual growth of 7.2 per cent between 1995 and 2000,” he noted. Industry experts predict that in the next five years demand will grown by four to six per cent on an annual basis.
The Indian aspirational demand for automotives will also contribute to the demand for fossil fuels. India currently has 15 million vehicles – a figure that is expected to shoot up to 45 million units by 2020. This translates to an increased demand for petrol which accounts for only 9.3 per cent of total demand vis-à-vis 16 per cent for China.
However, while fossil fuel demand by the automotive sector is important, the oil companies are seeking other avenues for growth and diversification, especially that of distribution of gas to India’s major metros. Thus, BPCL is through stakes in various companies, into gas distribution in the National Capital Region and also for some districts of North Gujarat. IOC has similar ventures, again in various collaborations, for UP and HPCL has in JV format, gas distribution projects in Andhra Pradesh and Madhya Pradesh. ‘ICRA expects the domestic refineries to play a larger role in the CGD (City Gas Distribution) sector, as the regulator Petroleum and Natural Gas Regulatory Board has planned to cover over 200 cities in the coming years, where CGD owner will be selected through a bidding process,’ the ICRA team noted.       
The recovering economic scenario also means that now more people are travelling and thus flying. So demand for ATF (Aviation Turbine Fuel) has recovered in the 2009-10 period, vis-à-vis a fall in demand in the 2008-09 periods. This uptrend is expected to continue.  
For diesel demand grew at an average of 7.3 per cent between 2006 and 2009. a good growth from the 1.2 per cent between 2001 and 2006. Going forward demand is expected to average four to five per cent beyond calendar year 2010. Translated into figures there would be a demand for approximately 75 million metric tonnes (MMT) by 2015 from the current 56 MMT.  
Crude prices to date in Calendar Year 2010 have basically remained range bound in the band of 70 to 88 dollars per barrel. Analysts feel that crude will continue to trade in this price band at least for the next 12 months.
Incidentally, the refining capacity for crude in India is set to increase. Elara Capital holds that India has the potential to become a ‘Refining Hub’ for Asia. In the Asia Pacific region India today has 15 per cent of the refining capacity compared to eight per cent in 1998 and 12 per cent in 2005. A number of upcoming projects such as Indian Oil’s Paradip Refinery, as also the Reliance Refineries at Jamnagar will only boost India’s refining capability. “Thus, to sum up, India is well on its way to become a refining hub in Asia in the current decade,” reports Deshpande of Elara.
Refining Picks
Essar Oil : Buy; Target Price Rs. 180.
We believe that Essar’s current valuations largely neglect the upside that may emerge in Essar’s E&P portfolio and reserves.
MRPL : Sell; Target Price Rs. 70
We feel MRPL’s current valuations are extremely rich with very high earnings expectations.
Chennai Petroleum: Accumulate; Target Price Rs. 280
CPCL looks under-valued despite favouring lower GRMs due to CPCL being a comparatively simpler refiner.
Compiled by Alok Deshpande of Elara Capital.

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