Recovery in marketing margins, lower oil prices to restore OMC profitability in FY24: Moody's

State-owned Indian Oil Corporation (IOC), Bharat Petroleum Corporation Ltd (BPCL) and Hindustan Petroleum Corporation Ltd (HPCL) are likely to see weak earnings in current fiscal year despite fall in oil prices mainly because of losses they incurred on holding prices in the first half, Moody's Investors Service said on Tuesday. "As international oil prices cool on economic slowdown concerns, marketing losses will ease for the three state-owned refining and marketing companies, IOC, BPCL and HPCL.

"Still, overall earnings for fiscal 2023 ending on March 31, 2023 will be weak because of marketing losses in the first half, when net realized prices did not increase as much as international prices because of fuel price caps," it said.

The three oil marketing companies (OMCs) did not change prices beginning April 6 despite cost of raw material rising. This led to the three booking a combined loss of Rs 21,000 crore during April-September 2022.

The rupee's depreciation against the US dollar further hit profits as oil prices and a large portion of refiners' borrowings are in dollars, the rating agency said.

"A decline in crude oil prices from levels earlier in the current fiscal year will lower feedstock costs and improve profitability in the next few months.

"The three companies also benefit from the continued use of Russian crude oil, which is trading at a discount to Brent crude. Nonetheless, oil prices are likely to remain volatile over the next 12 months," it said.

An escalation of the Ukraine conflict or an increase in oil demand from China following its opening would push up prices and constrain the refiners' profits.

"The companies' credit metrics will improve as earnings rise and working capital requirements ease. The companies' debt levels increased between March 2022 and September 2022 as they funded EBITDA losses through incremental borrowings," it said.

Working capital requirements also rose significantly along with crude oil prices.

"As a result, the companies' credit metrics will remain weaker than rating downgrade triggers through March 2023," Moody's said.

It said increased regulatory uncertainty will weigh on rated companies' credit strength.

"Lack of clarity on fuel pricing in India is credit negative for the refining and marketing sector. If the companies continue to incur losses from fuel price controls and are not compensated by the government in a timely and predictable fashion, their fundamental credit quality will weaken," it said.

However, their final ratings will likely remain unchanged because of a high likelihood of extraordinary government support incorporated in their ratings, it added.

Moody's said it expects marketing margins to normalize only when the refining and marketing companies' net realized prices for petrol and diesel are allowed to freely align with international prices.

"This will likely happen only in 2024 after the conclusion of general elections in India," it said. "Significant marketing losses earlier in the year will drag on earnings for the three state-owned refining and marketing companies in fiscal 2023 ending on March 31, 2023."

Net realized prices for petrol and diesel, which account for almost 55-60 per cent of product sales for the three companies, did not increase at the same pace as international prices, resulting in EBITDA losses for the six months through September.

The recent decline in crude oil prices from levels prevailing earlier in the fiscal year is credit positive for the companies.

"If crude oil prices remain at or near current levels, profitability for the refining and marketing companies will improve over the next few months.

"Compared with an average crude price of USD 105 per barrel for the six months ended on September 30, 2022, average prices fell 16 per cent to around USD 89 a barrel for the quarter ended on December 31, 2022," it said.