Refining margins blow looms for RIL, Essar

The heat’s on oil refiners and marketers, and not just state-owned ones. If analysts are to be believed, even private players such as Reliance Industries (RIL) and Essar Oil have much pain to bear going forward.

Indeed, Morgan Stanley sees these two private companies hit by shrinking gross refining margins (GRMs) next fiscal.

“We are turning bearish on Asian refining margins and cut our GRMs forecast for Essar by 24% for 2013 and 21% for 2014, leading to earnings cuts of 31% for 2013 and 36% for 2014,” Morgan Stanley analysts Vinay Jaisingh and Rakesh Sethia said in a report on Friday.

According to the analyst  duo, Essar is expected to clock GRMs of close to $7 per barrel for 2013.

RIL, on the other hand, is expected to earn GRMs of $8.7 per barrel for 2012 and $8 per barrel in F2013/14, according to the international brokerage.

Cairn India appears to be the lone shining star in the oil and gas space, wrote Jaisingh and Sethia. “Increase in production due to swifter approvals; improved realisation due to weakening of rupee, and increasing free cash flow and attractive valuation are the factors that would benefit Cairn India.”

Downgrading their view on the oil and gas sector from ‘attractive’ to ‘cautious’, the analyst duo said that a negative outlook on refining and petrochemical margins and higher subsidy burden will bear heavy on the sector, especially on the government-owned oil companies.

An analyst with a leading domestic brokerage, in fact, sees Indian Oil, Bharat Petroleum and Hindustan Petroleum squeezed between higher under-recoveries and increasing refining capacity in Asia.

“It will be difficult for them to maintain the peak levels of GRMs achieved in 2011, when demand was still going strong and euro crisis had not crept into other markets. But now, the outlook is poor as demand has weakened and an impending overcapacity stares bluntly at the refining companies,” said the analyst, requesting anonymity.

The current Singapore GRM, which is an average of the refining margins of all major Asian refiners, is at $6.72 per barrel, down from a peak of $9.1 per barrel achieved in September. This was a level last seen during the 2007-08 refining up-cycles.

Refining margin is the difference between the price at which oil companies purchase crude from oil explorers and the price at which they sell the end product after refining the crude at their refineries. The process involves boiling the crude at high temperatures until it breaks into different products based on weight and properties. The refined products thus obtained include petrol, diesel, kerosene, LPG, furnace oil and naphtha.

Therefore, the earnings of any oil refiner depend largely on the gross refining margins that they are claiming in the market by selling the refined fuel.