Oil marketers profits face strain on static petrol prices

In the fourth quarter ended March 2022, an interesting trend was visible across the downstream oil marketing companies. These companies like IOCL and HPCL, which have already declared their results have seen top line growth but the bottom line has shrunk.

On the one hand, the sales were boosted by the high crude prices and robust gross refining margins (GRMs). On the other hand, profits suffered due to marketing margin pressure. 
 

Where did the marketing margin pressure come from?

For that one needs to understand the petrol and diesel pricing formula in India. Unlike in the past, petrol and diesel pricing are free to be changed on a daily basis.

However, these are inflationary items and hence remain extremely sensitive. In the event of a sharp rise in global crude prices, the OMCs don’t increase the price of petrol and diesel at will. Here government consent comes into play.

It is estimated that the 3 OMCs viz. IOCL, BPCL and HPCL lost a combined Rs.17,000 crore between November and March due to static petrol and diesel prices. During this period, the price of crude was up by over 80%.
 

That means the OMCs were paying market prices to procure the oil but were selling at static prices. This was necessitated due to the slew of state elections, where the government did not want to adopt an inflationary stance.

Normally, when the crude prices go up, the OMCs can either pass on the costs to the end consumer or they can absorb the additional cost. In the latter case, it directly hits their profit numbers. At one point of time, the average price of procurement of oil was nearly $29 more than the price at which they sold to consumers.

It was this gap that created the huge bottom line pressure on the oil marketing companies in the March 2022 quarter. BPCL will announce its results on 25th May, but the story may be almost the same.

These OMCs have a strong refining franchise and marketing franchise. Lower price of sale would result in lower revenue yield on sale of petrol and diesel. However, this was more than compensated by the sharp improvement in the gross refining margins (GRM) during the quarter. For IOCL, the GRMs were more than $11/bbl.

In addition, higher crude prices also result in inventory translation gains for the oil refining business. It must be remembered that high GRMs would be ephemeral as once the cost of procurement of crude also goes up, the gross refining margins would automatically taper.

Hence, going ahead these OMCs would have no choice but to increase the market price of petrol and diesel in proportion. If the companies continue their current policy, then they would need to effect gradual increases in prices over a prolonged period of time.

At a policy level, it is not just about the profits of OMCs but also about the impact on growth and inflation. According to a study done by EY India, the current increase in the crude basket could result in a 70-100 bps fall in GDP growth plus a 100 basis points accretion in inflation.

The question is how long the prices of crude remain at current elevated levels because the 3 OMCs are now losing nearly $70 million or Rs.540 crore on a daily basis. That is a huge loss to be borne by the OMCs on a daily basis.