Petrol and diesel prices are unlikely to be increased despite firming raw material costs because of upcoming general elections next year, Moody's Investors Service said.

Three state-owned fuel retailers -- Indian Oil Corporation (IOC), Bharat Petroleum Corporation Ltd (BPCL) and Hindustan Petroleum Corporation Ltd (HPCL) -- which control roughly 90 per cent of the market, have kept petrol and diesel prices on freeze for a record 18 months in a row.

This is despite the raw material (crude oil) cost surging last year, leading to heavy losses in first half of 2022-23 fiscal year before easing oil prices propelled them to profitability.

International oil prices have firmed up since August, leading to margins of three retailers turning negative again.

"High crude oil prices will weaken the profitability of the three state-owned oil marketing companies in India -- IOC, BPCL and HPCL," Moody's said in a report.

"The three companies will have limited flexibility to pass on higher raw material costs by increasing the retail selling prices of petrol and diesel in the current fiscal year because of upcoming elections in May 2024." The OMCs' marketing margins -- the difference between their net realized prices and international prices -- have already weakened significantly from the high levels seen in the quarter ended June 30, 2023 (1Q fiscal 2024). Marketing margins on diesel turned negative since August while margins on petrol have narrowed considerably over the same period as international prices increased.

"The increase in raw material costs comes after the price of crude oil jumped around 17 per cent to more than USD 90 per barrel in September, from an average of USD 78 a barrel in 1Q fiscal 2024," Moody's said. "An extension in production cuts by the Organization of the Petroleum Exporting Countries (OPEC) of around 1 million barrels a day until December 2023, combined with Russia's extended export cuts of around 300,000 barrels a day over the same period have driven oil prices higher." Nonetheless, high oil prices are unlikely to be sustained for long as global growth weakens, it said.

"The decline in the OMCs' marketing margins has been mitigated to some extent by the increase in gross refining margins (GRMs). The benchmark Singapore GRMs have improved since June in part due to continued growth in liquid fuels consumption in the region as well as planned refinery outages which constrained the supply of petroleum products in the region," it said.

The ratings agency expected GRMs and international prices of transportation fuels to moderate in subsequent quarters as concerns over China's economic slowdown dampen demand while supply increases as refineries come back online after the completion of scheduled maintenance activities.

"Although a smaller gap between international and domestic prices will reduce marketing losses for the OMCs, their overall profitability will remain weak as retail selling prices will likely remain unchanged," it added.

After very strong earnings in April-June quarter, OMCs' operating performance is expected to weaken over the next 12 months as oil prices remain at current elevated levels.

"Still, the three companies' fiscal 2024 (April 2023 to March 2024) earnings will remain strong and higher than historical levels, even if crude oil prices remain at current levels of USD 85 per barrel to USD 90 a barrel in the second half of fiscal 2024.

"This is attributable to the OMCs' exceptionally strong earnings in 1Q fiscal 2024. The three companies' EBITDA in the first quarter alone was close to their average annual EBITDA for the last few years," Moody's said, adding the OMCs will start incurring EBITDA losses in the second half of fiscal 2024 if crude oil prices increase to around USD 100.

Strong marketing margins for petrol and diesel drove the robust operating performance in 1Q fiscal 2024.

OMCs' net realized prices on sale of diesel and petrol have largely remained unchanged since April 2022 even though feedstock costs had declined steadily. The price of Brent crude declined to USD 78 per barrel (bbl) in 1Q fiscal 2024 from USD 112 in 1Q fiscal 2023.

Among the three OMCs, IOCL and BPCL are better positioned to withstand any further increase in crude oil prices, compared to HPCL, the rating agency said, adding the difference in the OMCs' capacity to absorb an increase in feedstock costs stems from the difference in their business profiles.

IOCL's and BPCL's larger-scale operations and a high degree of integration between their refining and marketing segments allow them to weather the impact of adverse changes in the operating environment. IOCL's presence in petrochemicals and pipelines also reflects its business diversification. Meanwhile, HPCL's smaller scale and a higher dependence on its marketing operations make it more vulnerable to any unfavourable price movements.

"Strong earnings in 1Q fiscal 2024 and lower crude oil prices compared with fiscal 2023 have reduced the OMCs' working capital requirements and allowed them to reduce their borrowings over the past few months. As a result, we expect leverage, as measured by debt/EBITDA, for all the three companies to remain well positioned compared with the rating thresholds through fiscal 2024. This is despite capital spending and shareholder payments remaining high and rising crude oil prices resulting in increased working capital requirements in the period," it said.

Meanwhile, the Indian government's Rs 30,000 crore in capital support for the oil marketing sector announced in the budget earlier this year will boost cash flows for the OMCs and partially cover their capital spending needs. To this effect, IOCL and BPCL have already announced rights issues to the government.

Moody's said it has however not factored this into its projections as the timing and quantum of such proceeds remain uncertain at this time.

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