Best Oil & Gas Stocks To Buy Now To Profit From Low Crude Prices

Oil & Gas stocks

Event Update

OMCs best play in weak crude oil prices

Quick Pointers:

 Weak crude price likely to help marketing profitability make up for inventory loss and weak refining.

 FY21E OMCs earnings might increase by 48-66% on higher than base marketing margins. Lower refining margins to potentially hit earnings by 30%.

 Upstream companies and RIL will also be hit from weakening global economy and lower oil and gas realization.

Global crude oil prices have crashed to USD35/bbl on disagreement between OPEC and Russia on extent of production cuts in a weakening global economy. Higher production cuts over current levels of 2.1mbpd were expected to help balance oil markets. With no agreements, we expect oil prices to remain weak. The OMCs with high leverage to low crude oil prices are best placed especially HPCL and BPCL.

Our sensitivity suggests OMC profits are likely to increase by 48-66% from higher marketing margins (FY21 Rs4.5 vs Rs3.2 in base case) compared to ~30% lower profits from drop in refining margins (~USD2/bbl vs base case. RIL standalone FY21E PAT is likely to be down 14% from USD2/bbl lower GRMs (base USD10.5/bbl).

Also, the upstream companies PAT will be down by 22-58% for drop in crude oil realization to USD45 vs USD65/bbl in base case. Reiterate BUY on HPCL, BPCL and RIL as recent price correction already factors in drop in profits.

Disagreement in OPEC+ causes crude price meltdown:

Crude oil prices crashed to ~USD30/bbl on disagreement between OPEC and Russia to cut oil production by further 1.5mbpd from April till December 2020. This is over and above 2.1mbpd cuts already in force, to counter falling demand due to Covid-19 outbreak. With Aramco cutting the Official Selling Price (OSP) for next month by USD6-8/bbl to regain market share, the stage is set for all-out war between OPEC, Russian and US producers. We accordingly expect global crude prices are likely to remain weak, pending any agreement between producing nations.

HPCL, BPCL best placed to benefit from crude price fall: The OMCs are best placed to benefit from recent correction in crude oil prices led by higher marketing profits and lower fuel and oil losses (5-9% for the OMCs) even factoring in for inventory losses and muted refining profits. For Q4YTD average marketing margins were at ~Rs5/3.5/litre for diesel and petrol vis-à-vis Q3 average of Rs3/1.5/litre respectively, and we expect marketing profits to increase post sharp correction in crude oil prices. However, refining profits are likely to remain muted, in line with 9MFY20 average. Also, OMCs will report inventory loss given crude oil price correction.

HPCL, with high marketing leverage (9MFY20 market sales of 29MTPA vs refining volumes of 12MTPA) and no overhang of stake sale (post government stake sale to ONGC) is best placed while BPCL will also benefit from stake sale to potential global oil majors.

However, IOCL will have limited benefit as weak refining and petrochemicals profits coupled with high government share (overhang because of ETF sales) will be a drag in stock performance. OMC profits are likely to increase by 48-66% from higher marketing margins (FY21 Rs4.5 vs Rs3.2 in base case) compared to ~30% lower profits from drop in refining margins (~USD2/bbl vs base case.

RIL profitability is likely to be weak given weakness in refining and petrochemicals prices. We calculate 14% hit in FY21E profits from USD2/bbl lower GRMs to USD8.5/bbl. However, positive profit trend in telecom and retail is likely to provide downside support to earnings.

Upstream companies to be worst hit: Upstream companies, ONGC and Oil India will be worst hit from crude price fall. With crude oil and gas realization falling given worsening geopolitical concerns, profits will be impacted given limited production growth.