OIL & GAS: Glut in refining suppresses GRMs
– Singapore (SG) GRM shot up during 2QFY20 due to rise in petrol and FO cracks, averaging USD6.3/bbl for the quarter. Continued demand weakness combined with normalization of FO supply resulted in SG GRM declining to USD4.1/bbl and USD1.7/bbl in Oct’19 and Nov’19 YTD, respectively, from USD7.6/bbl in Sep’19.
– We estimate that a total of 2.6mnbopd of refining capacity came online in 2019 against incremental demand of 0.8mnbopd (revised down from 1.1mnbopd at the start of the year).
– In the absence of global recovery, we anticipate that GRMs would remain suppressed for a few more months in lieu of incremental refining capacity addition.
Refiners add to the glut
– At the beginning of 2019, IEA forecasted incremental demand of 1.4mnbopd of oil consumption; it was revised down to 1.0mnbopd in their latest report.
– At the start of 2019, IEA anticipated incremental capacity addition of 2.6mnbopd while our research shows that the said capacity has already come up. Even though it is less than IEA’s forecast, it is much ahead of the incremental oil demand.
– To make matters worse, Chinese teapot refineries have ramped up their utilization rate to ~67% vis-à-vis 61% in Oct-Nov’18 as the country increased crude oil import quotas for the former in 2019.
– The higher capacity addition in 2019 is also a response to the higher diesel demand post-implementation of IMO 2020.
IMO 2020 boost to GRM – a mirage!
– With incremental demand for 2.0mnbopd of diesel as a result of IMO 2020, it was anticipated that diesel cracks would jump sharply. Most also believed that GRMs would spurt.
– On the contrary, our belief was that although diesel cracks might improve, there would be no commensurate demand for the higher production of other refinery products. As a result, GRMs may not improve. However, refiners would still benefit through higher utilization of their assets.
– Despite IMO just 50 days away, diesel cracks have failed miserably to revive in line with the street expectation of USD25-30/bbl (link) (~USD11/bbl for Nov’19 YTD v/s USD14/bbl in 2QFY19). More importantly, the forward curve for diesel depicts an incapacitated scenario of a mere USD14-16/bbl.
– We believe that as low GRMs persist, higher cost refiners would close their operations and SG GRM would revert to the long-term average of USD5-6/bbl.
Valuation and recommendation
– Our preference stays with IOCL, which has the most diversified EBITDA profile; 35% of IOCL’s EBITDA comes from refining. Its free cash flow is estimated to be INR15/share for FY20-21.
– We reiterate Buy recommendation for HPCL. However, we also note the company’s rising net debt and project execution as risks to our call.
– BPCL has outperformed the Nifty by ~40% on hopes of privatization (since Aug’19). We believe that there are too many complexities involved here, which may not be solved by FY20-end.