India’s Gross Refining Margins on crude oil processing may decline by 40-50% this year due to narrowing discount on Russian oil

The Gross Refining Margin (GRM) for Indian crude oil processors is likely to decline by 40-50 percent in the financial year 2024-25 due to the narrowing discount on oil imports from Russia. India’s huge dependence on imported crude oil coupled with rising domestic demand on the back of post-pandemic economic recovery, is likely to keep the oil import bill elevated. The GRM is calculated as the difference between the total value of petroleum products coming out of the oil refinery (output) and the price of the raw material.

According to a Care Ratings report released on Wednesday, Indian Oil Marketing Companies (OMCs) posted record high GRM at an average of US$16-18 a barrel on crude oil processing in the financial year (FY) 2022-23 due to a substantial discount on the import of Russian crude. However, the GRM of Indian refiners gradually moderated to an average of US$10-12 a barrel in FY2023-24 which was largely in line with market expectations.

Care Ratings forecast the GRM for India refiners may remain at US$6-8 a barrel for the current financial year i.e. 2024-25 due to a sustained decline in the discount offer on the Russian crude oil. This moderation was on the back of a narrowing discount on Russian crude along with a reduction in product cracks. The GRM of Indian players, however, continued to remain reasonably higher than the benchmark Singapore GRM of US$6.7 a barrel for FY2023-24 (US$10.77 a barrel for FY2022-23).

In FY23, Indian refiners experienced an extraordinary period characterized by all-time high GRMs. These exceptionally high GRMs were primarily influenced by disruptions in the demand-supply dynamics triggered by the outbreak of the Russia-Ukraine war in February 2022. Geopolitical factors played a significant role, leading to an increased supply of cost-effective Russian crude oil to India. Simultaneously, the cessation of natural gas supply from Russia to Europe resulted in a substantial rise in diesel cracks, further enhancing the GRMs for Indian refiners.

The subsequent normalization of diesel cracks and contraction in discount available on Russian crude led to moderation in GRM in FY24 to an average of US$10-12 a barrel. However, the GRMs of Indian refiners consistently outperformed the benchmark Singapore GRMs, reflecting the evolving dynamics of their business operations.

Growing Russian import
India relies on imports to meet nearly 88 percent of its total crude oil needs. The contribution of Russian crude in India's import portfolio was less than 2% before the outbreak of the Russia-Ukraine war. However, the geopolitical dynamics stemming from this conflict led to a significant increase in the share of cost-competitive Russian crude oil in India's overall crude oil supply, jumping to around 35 percent in FY2023-24.

The share of Russian crude in India’s total crude oil imports reached a nine-month high level of 40 percent in April 2024. Despite the shrinking Ural-Brent differential over the last few months and fresh sanctions imposed by the United States, the share of Russian crude oil import increased as offtake from China remained subdued and Russian refining infrastructure is partially impaired by Ukraine drone attacks, thereby making higher crude oil volumes available for India’s refiners. Going forward, the share of Russian crude oil in India’s total imports is expected to remain sizeable at more than 30 percent as long as arbitrage is available for Indian refiners.

Global economic growth influences oil prices
Crude oil prices are strongly influenced by the global economic outlook, the supply of oil managed by the Organisation of the Petroleum Exporting Countries (OPEC) and allies (OPEC+), and other geopolitical factors. The price of crude oil experienced an upward trajectory in FY2021-22 as the impact of the Covid-19 pandemic receded and demand rebounded. However, the conflict between Russia and Ukraine from February 2022 caused crude oil prices to reach record levels in the first half of FY2022-23, with the benchmark Brent futures for the near month deliver on the New York Mercantile Exchange (Nymex) hitting the record high of US$127.98 a barrel on March 8, 2022.

Crude oil prices continued to slide subsequently as global consumption of crude oil declined owing to a global slowdown with the sluggish recovery of the Chinese economy, interest rate hikes, and inflationary pressures. However, in August 2023, and April 2024 there was a surge in crude oil prices due to production cuts announced by OPEC+, mainly Russia and Saudi Arabia. Geopolitical factors including tension in the Middle East are also keeping the crude oil prices firm.

Marketing margins under stress
Elevated crude oil prices could not be passed on to Indian customers due to stagnant retail prices resulting in loss from marketing operations of OMCs in the first half of FY2022-23. Marketing margin started improving from October-December 2023 onwards with a reduction in crude prices and stable retail prices of petrol and diesel. However, with the surge in crude prices in the latter part of July-September 2023 which closed at US$96 a barrel at the quarter end, and retail prices being unaltered, the marketing margin witnessed a moderation in the second half of FY 2023-24. Despite this, the overall marketing margin for FY2023-24 witnessed a substantial jump over FY2022-23 aided by relatively lower crude prices and stable retail prices. Significantly higher marketing profit offset the reduction in GRM in FY2023-24.

The marketing margin is expected to moderate substantially in the April-June 2024 quarter with the recent price cut for petrol and diesel by Rs 2 per litre from mid-March 2024. The crude prices are also on an increasing trend since the start of calendar year 2024 barring some reduction in between. Crude prices are expected to have an upward bias in the near term on the back of the strained geopolitical situation.

Improving the credit profile of Indian refiners
During FY2023-24, India’s oil refining companies processed 261.55 million metric tonnes (MMT) of crude oil, surpassing their aggregate installed capacity of 256.82 MMT as on March 31, 2024 (vis-à-vis last year’s processing of 255.23 MMT on a capacity of 253.92 MMT as on March 31, 2023). This high capacity utilization is primarily attributed to robust domestic and export demand for key refined products.

Richa Bagaria, Associate Director at CareEdge Ratings, stated, “The availability of relatively cost-competitive Russian crude, a substantial post-pandemic surge in refined product demand, and geopolitical disruptions leading to higher demand for Indian refined products from European nations have collectively contributed to Indian refiners consistently achieving significantly higher GRMs than the benchmark Singapore GRMs over the past four years ended FY2023-24. Consequently, this has led to an improvement in the credit profile of Indian refiners.”

Echoing a similar response, Hardik Shah, Director at CareEdge Ratings, said, “While FY2022-23 and FY2023-24 were exceptional years for Indian refiners, FY2024-25 is expected to witness some normalcy with moderation in refining and marketing margins. Expected refining margin of S$6-$8 a barrel in FY2024-25 with full utilization of refining capacities are still expected to be decent when compared with pre-Covid years and it provides adequate headroom to absorb any potential shocks in marketing margin during the year.”

Operating profit up
Despite moderation in GRM in FY2023-24, the operating profit of oil players jumped multi-fold in FY2023-24 over FY2022-23 due to higher marketing margin. Even though average crude oil prices were reduced in FY2023-24 from FY2022-23, the retail price of Motor Spirit (MS) / High-Speed Diesel (HSD) was unchanged since April 2022 which resulted in a higher marketing margin in FY2023-24.

Meanwhile, the decision of Russia and other OPEC+ nations to extend the voluntary cut in crude oil production by 2.2 million barrels per day till mid-2024 and geopolitical factors including Middle-East disturbance, has somewhat limited the decline in crude oil prices despite sluggish global demand prospects, high interest rates, and inflationary pressures. OPEC+ had, in April 2023, announced a 1.657 million bpd of crude oil production cut to support the energy prices in the international market.


DILIP KUMAR JHA
Editor
dilip.jha@polymerupdate.com