Refining gains push stock prices higher

MUMBAI: Stocks from the refining space have performed well of late. Most of them are up between 22% and 36% in the last one month. The key reason for this surge is the recent rise in gross refining margins (GRM), led by the shutdown of refineries globally. Improved visibility in refinery margins has also played positively. Additionally, a strong rupee, lower burden of subsidy for oil marketing companies for 2006-07 (to Rs 4,000 crore from Rs 12,000 crore in 2005-06), expectations of strong fourth-quarter results are seen in positive light, particularly for PSU companies.

Coming to refinery shutdowns, as many as 12 refineries in Europe and the Middle East, with a combined capacity of 2.192 million tonnes, had shut down (partially and or fully) between January 1, 2007 and May 1, 2007. And another 18, with 2.863 million tonne combined capacity, are scheduled to shut between now and December 2007. The reasons for the shutdown are different and the period ranges between 10 and 40 days. But its impact on GRMs has been clearly visible and to the benefit of refining companies. The other aspect helping domestic companies is the rising rupee, which makes imports (crude oil) cheaper but also makes exports less remunerative.

The recent surge in price of crude oil, the key input for refineries, from $64-65 to $69-70 a barrel may however shave off a big part of the gains. With too many factors having changed, the impact will vary.

Arpit Sikka, analyst with Batlivala & Karani, is of the opinion that the effect of rupee appreciation would lower the bottom line of companies. “An appreciation in the rupee by 10% from Rs 45 to Rs 40 per dollar will lead to a negative impact on refining margins. Crude price increase would also have a negative impact on the margins.”

Although standalone refining companies like Chennai Petroleum and Bongaigaon would gain from higher refinery margins, Sikka is of the view that Reliance Industries is likely to benefit the most because of its technical advantage and since  it does not have to share the subsidy burden unlike the public sector refiners.

Another analyst with a foreign brokerage has a slightly different view. While he maintains that refining margins will be negatively impacted by the appreciation in the rupee since the net realisation in rupee terms would be lower, his take on the PSU refiners varies.

Since most PSU refiners sell in the domestic markets, the end price is fixed. They are integrated players for whom the raw material price declines as the rupee appreciates and output price remains fixed and hence, rupee appreciation has a positive impact on PSU refiners. Indian Oil Corporation (IOC) is expected to enjoy favourable effects of higher margins as it has the highest refining capacity among Indian companies.

On the other hand, Reliance will benefit from economies of scale. Its complex refinery also helps it achieve higher GRMs. For Q4 2006-07, RIL’s GRM stood at $13 per barrel as compared to benchmark Singapore GRM of $6.8. The higher GRMs, ability to process cheaper crudes and increased output in Q1 2006-07 should benefit Reliance.

Says Amitabh Chakraborty, president, equity, Religare Securities: “GRM is an outcome of the kinds of crude a company buys and also the complexity of the company’s refineries viz. ability to process heavy crude. For example, Chennai Petroleum will clock a lower GRM as compared to RIL.” Overall, he expects RIL to be among beneficiaries.

But since the company exports nearly 60% of its refining products (valued $11.3 billion in FY07), the appreciation in the rupee is likely to have partly offset the gains in refinery margins. But another positive aspect is that owing to a shutdown in May 2006, in Q1 last year, RIL’s overall utilisation was 91%. This year, it is likely to be higher at 100%, which means an additional 0.75 million tonnes of output.

As far as sustainability of high refinery margins is concerned, general market perception is that the refining cycle will continue for the entire year, though some also believe this is a momentary phenomena and may see some softening once this seasonal strength goes away. For the time being though, things look good for the refining companies.