Indian oil marketing companies' gross refining margins (GRMs) will take longer than previously expected to recover, which increases the downside risks to the stand-alone credit profiles (SCPs) of Hindustan Petroleum Corp Ltd (HPCL) and Bharat Petroleum Corp Ltd (BPCL), while headroom for Indian Oil Corp Ltd (IOC)'s SCP remains limited. However, Fitch Ratings says its expectation of stronger marketing margins during financial year ending March 2021 (FY20-21) moderates the risk.
According to the ratings agency, the three companies' continued capex and demand for dividends from their main shareholder, the Indian State, will also put pressure on their financial profiles. The issuer default ratings (IDR) of the three companies are driven by linkages to the State, which remain intact.
Marketing margins of the three oil marketing companies' (OMCs) increased significantly during first quarter (1Q) of FY20-21 and boosted earnings before interest, taxes, depreciation and amortization (EBITDA) compared with 4QFY20.
"Marketing margins rose despite a hike in excise duty on auto fuels, as the fall in crude oil prices was not fully passed on to consumers. Despite lower petroleum product sales, we expect the OMCs' FY21 marketing profit to benefit from high marketing margins in 1QFY21 and price increases to partly cover investments for complying with new emission standards," Fitch says.
In contrast, the ratings agency says, the OMCs' refining throughput and domestic petroleum product sales both fell by around 25% in 1QFY20-21 from a quarter earlier, when the coronavirus-related lock-down started. Export sales increased by 4%, but was not enough to offset weak domestic sales as exports form only 5%-8% of overall sales.
Fitch says it expects volumes to gradually improve over the rest of FY20-21 as lock-down measures are relaxed, with full-year volumes down by 10%-15%. We expect demand to gradually improve to pre-coronavirus levels in FY21-22 as the economy recovers.
Refining profits were hurt by GRMs that were around break-even levels and lower utilisation rates. Fitch says, "We expect the OMCs' GRMs to average $1-1.5 per barrel in FY20-21 given the weak macroeconomic environment and high product inventories. We expect a gradual recovery in GRMs over FY21-22-FY22-23 to $4.5-5.5 per barrel as low global margins lead to consolidation in the refining industry, and fuel losses and processing costs decrease. However, our GRM estimates are still below the peak during the previous low in crude prices over FY16-FY17-18."
IOC's 1QFY20-21 consolidated EBITDA rose to Rs63 billion from Rs0.8 billion in 4QFY20, as record marketing margins offset GRM of -$1.98 per barrel. GRM excluding inventory losses was higher at $4.27 per barrel. IOC's reported petrochemical EBITDA (typically 10%-15% of total) increased by 53% from a quarter earlier, reflecting the better environment for naphtha crackers. 1QFY20-21 refining volumes of 12.9 million tonnes (mnt) and marketing volumes of 16.5mnt decreased by 25% from 4QFY19-20.
HPCL's higher share of earnings from marketing activities than peers, and high marketing margins helped offset its negligible GRM of $0.04 per barrel, including implied inventory gains of $0.9 per barrel. As a result, 1QFY20-21 consolidated EBITDA improved to Rs41 billion from a loss of Rs6 billion in 4QFY19-20. HPCL's 1QFY20-21 marketing volume fell by 20% to 7.6mnt, while refining throughput of 4.0mnt fell by 13% as HPCL's reduction in refinery run rates in response to falling demand was limited by its larger marketing exposure. HPCL's marketing volumes are nearly twice that of its refining, the ratings agency says.
Strong marketing margins drove up BPCL's 1QFY20-21 consolidated EBITDA to Rs43 billion from Rs6 billion in 4QFY19-20. Low standalone GRM of $0.39 per barrel was in line with the industry trend, but weakness in refining profitability was cushioned by the strong GRM at its Numaligarh refinery. 1QFY20-21 refining throughput of 5.1mnt and marketing volumes of 8.3mnt fell by 39% and 26%, respectively.
Fitch says it expects IOC's net leverage to weaken to around 6.0 times in FY20-21, before improving to less than 3.5 times from FY21-22 as industry conditions improve, supported by its economies of scale, better complexity of its refining assets than peers, and diversification across refining, marketing and petrochemicals.
It says, "We expect HPCL's net leverage, including proportionate consolidation of subsidiary HPCL-Mittal Energy Ltd (HMEL), to remain above levels appropriate for its SCP over FY21 and FY21-22, given weak industry conditions and ongoing capex, before improving to around 4.0 times from FY22-23, on better industry conditions and commissioning of new capacities. Any downward revision in HPCL's SCP can lead to a downgrade of HMEL's rating, given the support, while HMEL's SCP has some headroom despite weaker GRMs.
"We expect BPCL's net leverage, including full consolidation of Bharat Oman Refineries Ltd, to deteriorate to levels well above where we would consider revising the SCP downwards over FY20-21-FY21-22, before improving to around 3.0 times from FY22-23," the ratings agency concludes.