Refining margins improve but nothing to get excited about yet

Oil refining margins have been weak in recent quarters. Still, some comfort can be derived from the sequential improvement in the benchmark Singapore gross refining margin (GRM). According to ICICI Securities Ltd, Singapore GRM has increased by about 11% to $3.54 per barrel so far in the June quarter compared to the March quarter.

The quarter-on-quarter rise is driven entirely by a 2.2 times sequential jump in petrol cracks to $8.2 per barrel, said ICICI Securities in a report on 10 June, adding: “All other product cracks are down quarter-on-quarter.”

For a refiner, GRM is realization from turning a barrel of crude oil into finished products.

Sure, the improvement in overall Singapore GRM is encouraging, but investors should not get carried away just yet. That’s because the measure still remains drastically lower on a year-on-year basis.

Plus, it’s not as if the overall refining outlook is bright. For one, demand outlook is relatively subdued at a time when large global refining capacity additions are expected. China, a key market, is not giving respite either. Chinese gasoline exports are expected to remain high on account of growing refining capacity and tepid domestic demand, pointed out Nitin Tiwari, an analyst at Antique Stock Broking Ltd.

Needless to say, a weaker refining margin environment won’t bode well for refining firms. For Reliance Industries Ltd (RIL), many analysts have clipped their refining margin estimates over the course of FY19. For instance, Kotak Institutional Equities’ refining margin assumption for FY20 was $10.1 per barrel after Q4 FY19 results. This measure was at $12.1 per barrel after Q1 FY19 results. The broker has factored in near-term weakness in refining margins, which may be followed by gains from implementation of the International Maritime Organization’s (IMO’s) 2020 rules for marine fuels and a gradual ramp up of RIL’s petcoke gasifiers.

In that backdrop, investors will have to closely watch whether GRMs improve when IMO’s new regulations come into effect in 2020. These require ships to use oil with lower sulphur content, which in turn is expected to boost diesel demand, boosting refining margins.

However, should these gains not fructify and the current muted GRMs persist, investors can expect further cuts in RIL’s refining margin estimates going ahead.
Source: LiveMint