This, however is not base case scenario, as possibility of steep price cut remains high, which can offset some/all of such gains; the valuations are already pricing in such scenario. Upstream is a good defensive allocation (8-9% dividend yield), while RIL can surprise on upside if Brent-Ural differential holds.
OPEC cut ineffective?
Despite the production cut by OPEC, Brent oil prices have remained range-bound. Recovery in Iranian oil exports could be one of the reasons. The MS, HSD, ATF cracks are up 10-31% MoM, supporting recovery in benchmark SG GRMs (up 30% MoM to US$5/bbl), as China consumption recovers. Warmer-than-expected weather in EU is supporting LNG (up 3% MoM). The petchem delta across the chain is weak as of now, due to calibrated recovery of demand in china, and may strengthen in H2 if recovery holds up.
Economics of Russian oil
Share of Russian oil in the Indian basket is ~25% in FY23 (<1% earlier); the landed cost of oil is US$9 10/bbl < Brent, and benefits refiners (PSU/private) as its share increases. Opaque disclosures, volatile spreads and risk of steep price cuts on auto-fuels, which may offset such gains on aggregate P&L, presents challenge in building in such gains in the earnings forecasts. And to that extent, there is a good scope for OMCs in particular to surprise on earnings. As of now, analysts at IIFL Capital Services have assumed normalized scenario for forecasting FY24/25 earnings, and base oil at US$75/bbl.
OMCs trade cheap – pricing in risks
If bonanza from Russian oil sourcing were to hold, and auto fuel prices unchanged, OMCs will report highest ever earnings in FY24; this however is not the base case scenario, where analysts can build in normal marketing margins and GRMs mirroring SG benchmark. Their valuations are cheap, and price in risks of steep price cuts; CGDs, which will need to match up auto fuel pricing, will also see margin compression in H2, which is not priced in yet. RIL can surprise on earnings, if scenario holds in FY24/25.
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