Oil & Gas: MODI-fied environment

5 Dec 2023 , 10:20 AM

The macro environment for OMCs is turning favourable with benign oil (prices down 9% MoM), recovery in GRMs (up 35% MoM) and auto-fuel margins. Given the favourable state election results, risk of steep cuts in auto-fuel prices is less. So, earnings recovery in OMCs should continue; valuations are compelling and analysts of IIFL Capital Services like them the most in the sector. Stability in LNG prices bodes well for GAIL and other CGDs. Meanwhile, recovery in GRMs also places RIL favourably. 

Favourable macro environment: 

The macro environment is turning favourable for downstream companies, evident in the benign Brent, which is down 9% MoM. A runaway increase in prices is not the base case, given the OPEC+ meeting outcome (cuts lower than anticipated). Meanwhile, SG GRM rose by 35% to US$5.3/bbl in November vs US$3.9/bbl in October, driven by a strong recovery in gasoline and fuel oil cracks. However, diesel and ATF cracks exhibited weakness. Petrochemical delta across the chain remains weak (down MoM), as the supply is expected to exceed demand. Analysts of IIFL Capital Services forecasts for RIL, GAIL, etc., take into account such weakness. Stability in LNG prices also augurs well. 

Improving outlook:

Subsequent to 2QFY24 earnings, Street has upgraded earnings for OMCs by 30-60%. Analysts of IIFL Capital Services see steep upsides to these earnings, as macro environment remains favourable. Moreover, with the key state elections concluding with an outcome favourable to the ruling party, risk of steep cuts in auto-fuel prices has lowered. Firm outlook on economic activity should support POL consumption at a time when marketing margins are marking a comeback. Analysts of IIFL Capital Services would progressively monitor ONGC’s gas production at KG basin, where it has guided to scale up production to 10mmscmd by FY25. 

OMCs best-placed:

Valuations across PSUs are attractive: 5-11% dividend yields and 4-7x FY25 P/E even in a normalised operating environment; analysts of IIFL Capital Services like OMCs the most, given the scope for further earnings upgrade; GAIL, PLNG can benefit along with CGDs, if LNG is stable.