Indian Oil & Gas Sector-Refining & Marketing Domestic petroleum products demand growth at multi-year highs; outlook healthy for the medium term

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1 Indian Oil & Gas Sector-Refining & Marketing Domestic petroleum products demand growth at multi-year highs; outlook healthy for the medium term K. Ravichandran Prashant Vasisht Anoop Bhatia Sai Krishna Abhishek Dafria Ankit Patel June 2016

2 What s inside? I. Executive Summary II. Trends & Outlook Global Refining Industry Domestic Refining Industry Export of Petroleum Products Under-recovery Petroleum Products Marketing III. IV. Industry Outlook Aggregate Financial Performance V. Company-wise Update on a. Indian Oil Corporation Limited b. Bharat Petroleum Corporation Limited c. Hindustan Petroleum Corporation Limited d. Reliance Industries Limited e. Mangalore Refinery and Petrochemicals Limited f. Chennai Petroleum Corporation Limited Annexure Annexure-I: Trends in Crude Oil Prices, Light-Heavy Differentials and Crack Spreads ICRA Limited P a g e 2

3 INDIAN REFINING & MARKETING INDUSTRY Domestic petroleum products demand growth at multi-year highs; outlook healthy for the medium term Industry Review June 2016 Executive Summary Demand of petroleum products reported growth of 10.9% (YoY) in FY2016 on the back of high growth rates in consumption of petrol (14% YoY growth), naphtha (23%), ATF (10%), and pet coke (22%) Domestic demand growth at 10.9%, the highest level since 2000, on the back of improving economic activity and lower crude oil prices India s petroleum products demand increased to MMT in FY2016 from MMT in FY2015, registering a growth of 10.9% (YoY), the highest level since This kind of demand growth was the highest in the last two decades and was on a much larger base. The total petroleum products demand growth in FY2016 was more than double the cumulative average growth (CAGR) level of 4% (achieved during FY ) in line with high growth in consumption of petrol, naphtha, LPG, petcoke and bitumen, along with a material improvement in growth in diesel demand. Except kerosene and lubricants, almost all petroleum products reported a healthy increase in consumption in FY2016. The high demand growth is primarily driven by economic recovery and acceleration in demand on the back of lower crude oil prices. The impact of lower crude oil prices is reflected by the fact that the demand of products like naphtha and FO, with overall decline in consumption by 2.3% pa and 7.9% pa during FY2005-FY2015, reported an increase of 20.9% (YoY) and 11.9% (YoY) during FY2016. The increase in demand of these products was high as they replaced a part of the costlier long-term RasGas LNG consumption. Demand outlook positive for the medium term; albeit recovery in prices of crude oil and petroleum products along with availability of cheaper LNG to moderate the growth rates in coming years The demand for petroleum products is expected to be materially higher than the long-term average over the medium term, following prospects of increased economic activity and low prices of crude oil and petroleum products, incentivising the consumers in different segments to switch over from alternate fuels. However, the recovery in crude oil prices may lead to certain moderation in growth rates from the current high levels. Besides, lower prices of LNG as compared to liquid fuels may moderate growth rates for products like naphtha in the near to medium term. GURs to be ~Rs billion in FY2017 at crude oil prices of US$45-50/bbl Post significant fall in FY2016, GURs may increase moderately in FY2017 with recovery in oil prices The gross under-recoveries (GURs) of public sector oil marketing companies (OMCs) declined by 64% (YoY) to ~Rs. 274 billion (including cash reimbursement under DBTL) in FY2016 from Rs. 763 billion in FY2015 in line with lower Indian Basket crude prices at US$46/bbl in FY2016 against US$84/bbl in FY2015, partly offset by depreciation in INR/US$ to ~65.4 in FY2016 from ~61.1 in FY2015. ICRA projects GURs of OMCs to increase to ~Rs. 355 billion for FY2017 (estimated at average Indian basket crude oil price of US$50/bbl and INR/US$ of 68.5 for FY2017). Indian Basket crude oil prices have largely remained around US$40-50/bbl over the last couple of months. Although soft level of crude oil prices and deregulated prices of auto-fuels would lead to materially lower under-recoveries on sensitive petroleum products (LPG and kerosene) in comparison to past high levels seen till FY2015; the same are expected to be higher in FY2017 as compared to FY2016. If average crude oil prices remain low, the under-recoveries may be flat (around Rs billion for Indian Basket crude oil price ranging from US$40- ICRA Limited P a g e 3

4 Executive Summary 45/bbl. Further, there could be a downside to GURs if the GoI reduces the household income threshold for domestic LPG subsidy from the current level of Rs. 1 million per annum. Direct benefit transfer for kerosene could materially reduce subsidies; however, implementation a major challenge On January 1, 2016, the GoI announced that the subsidy on Superior Kerosene Oil (SKO or kerosene) distributed through the Public Distribution System (PDS) will be directly transferred to the bank accounts of consumers under the Direct Benefit Transfer for Kerosene (DBTK) in line with DBT for LPG. The DBTK, on a pilot basis in 26 districts, is aimed at reducing the leakage of kerosene, which is widely believed to be high as it is used for adulteration of auto-fuels (especially diesel) due to significant price differential between auto-fuels and subsidised kerosene prices (for instance, retail selling price of SKO (PDS) and HSD are currently at Rs /litre and Rs /litre respectively in Mumbai, effective from June 1, 2016; whereas retail price of unsubsidised kerosene is Rs /litre, which is close to the diesel price). The scheme was planned to be implemented with effect from April 1, 2016; however, the same has faced delays due to issues related to bank accounts of beneficiaries and linking of the same with Aadhar numbers. The estimated savings from DBT for kerosene could be sizeable (at around 30-40% of total under-recoveries on kerosene with country-wide implementation); however, the implementation of the same is a major challenge as the kerosene distribution has been through PDS, handled by the respective state governments, unlike LPG, which is directly sold by the Central Government-owned OMCs. High LPG demand growth and recovery in crude oil prices to push up GURs LPG demand and level of crude oil prices would be key drivers of subsidies in the future Along with global crude oil and LPG prices, LPG (domestic) demand growth has a significant impact on LPG subsidies. Despite cancellation of fake domestic connections and lower diversions, LPG (domestic) demand reported a healthy growth of 7.1% (YoY) in FY2016, although at much lower rate than 11.3% for FY2015. The LPG demand growth is driven by fresh connections (20.33 million fresh connections and million DBCs in FY2016) and lower LPG prices, as compared to alternative fuels. Future growth of LPG (domestic) is expected to be robust with the efforts of the GoI to increase penetration of LPG (domestic) to replace other harmful cooking fuel like coal, wood etc. The same, however, may lead to an increase in LPG subsidy burden in the ensuing years. Significant increase in crude oil supplies from Iran, change in OPEC s stance towards production level, significant geo-political events and cut back in supplies by high cost shale oil players would be key sensitivities for oil prices. Light-sweet and heavy-sour crude differentials declined in Q4 FY2016 Light-heavy differentials increased from US$ 2.9/bbl in Q2 FY2016 to US$ 3.2/bbl in Q3 FY2016 The light-sweet / heavy-sour differentials declined to US$2.8/bbl in Q4 FY2016 as against US$3.2/bbl in Q3 FY2016 due to higher production of light grades of crude oil and higher cracks of fuel oil. The ability of complex refiners to leverage the price differential between light-sweet and heavy-sour crudes to earn higher GRMs vis-à-vis relatively simpler refiners increases with the widening in the differential. ICRA Limited P a g e 4

5 Executive Summary Crack spreads declined across the barrel (except gasoline) in Q4 FY2016 vis-à-vis Q3 FY2016 Demand growth of petroleum products expected to remain moderate due to slowdown in China and the EU Crack spreads decline across the barrel (except gasoline) in Q4 FY2016 Crack spreads declined across the barrel (except gasoline) in Q4 FY2016 vis-a-vis Q3 FY2016. Naphtha crack spreads declined in Q4 FY2016 vis-à-vis Q3 FY2016 but remained healthy and increased in FY2016 vis-à-vis FY2015 due to strong demand for gasoline blending and from the petrochemical sector. Gasoline crack spreads increased in Q4 FY2016 vis-à-vis Q3 FY2016 and in FY2016 vis-à-vis FY2015 due to healthy demand from India, China and the US due to low retail prices and strong passenger vehicle sales. In the middle of the barrel, gasoil cracks declined in Q4 FY2016 over Q3 FY2016 and in FY2016 over FY2015 owing to supply overhang with higher exports from China and additional supplies from new refineries. Jet/kero crack spreads declined in Q4 FY2016 as against Q3 FY2016 and in FY2016 as against FY2015 due to higher supply from existing refineries who maintained high capacity utilisation levels to capture gasoline margins and an additional supply from new refineries. At the bottom of the barrel fuel oil increased in Q4 FY2016 vis-à-vis Q4 FY2015 and in FY2016 vis-à-vis FY2015 due to healthy bunker demand and lower supply from Russia owing to higher domestic demand and high export tax. With the international prices of crude oil recovering from US$39/barrel as on March 31, 2016 to about $50/barrel as on June end, GRMs of domestic refineries are expected to be healthy in Q1 FY2017, buoyed by inventory gains. Global supply additions, net of closures, likely to match demand growth Globally, GRMs are expected to remain healthy in the medium term due to global refinery capacity additions, net of closures matching the growth in demand. The demand growth of petroleum products is expected to remain moderate due to economic slowdowns in China and the EU. Delays in commissioning of some of the proposed projects and closure of unviable refinery capacities would support GRM levels over the medium term. A higher-than-expected closure of unviable refinery capacities could provide additional uplift to the GRMs. However, the light-heavy differentials, which aid the GRMs of complex refineries, are expected to remain moderate in the medium term on account of the completion of complex refineries and conversion projects that are likely to result in increased demand for heavy and sour crudes. The profit metrics of domestic refiners will continue to be sensitive to the fluctuating value of the Indian Rupee (INR) against the US Dollar (USD), inventory gains/losses arising from volatility in crude prices, and import duty protection levels. GRMs expected to remain healthy with demand growth matching global capacity additions Outlook for domestic refining and marketing industry is stable The medium term outlook for GRMs is stable in line with expectation of demand growth matching supply addition globally. Low crude oil prices could continue to support the demand growth despite modest global economic prospects and accordingly crack spreads of most of the products are expected to remain healthy. Additionally, any recovery in crude oil prices may also lead to inventory gains for the refiners. The marketing margins are expected to be healthy due to lower prices of petroleum products apart from anticipated healthy demand growth due to improving economic activity in the country. The oil marketing companies are likely to continue to share low or nil burden in gross under-recoveries on sensitive petroleum products, which are anticipated to be at moderate levels. Apart from brownfield expansion/debottlenecking projects, the new investments in the sector are still in planning stages. The investment in auto-fuel retailing is the major area of interest for private companies in the near to medium term. ICRA Limited P a g e 5

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