PL Sector Report: Oil & Gas - Sector Update – Fall of the last bastion?

Oil & Gas - Swarnendu Bhushan - Co-Head of Research, Prabhudas Lilladher Pvt Ltd

Sector Update – Fall of the last bastion?

We remain cautious on PNGRB’s decision to implement common carrier for product pipelines due to the challenge it poses for OMCs. OMCs own ~90% of marketing infrastructure including pipelines, marketing terminals and depots. While pipelines constructed under bidding process already have provisions for common carrier, older pipelines are still lacking behind. Overall utilization of product pipelines at 68% in FY23 does present an opportunity to other interested parties including private players. Pipelines provide the cheapest method of transportation, as next best coastal is ~46% costlier while roadways are even twice as costly. In addition to the cost of creating new infrastructure, uncertainty of obtaining right of using land for laying pipelines remains a key challenge limiting expansion of private players in product retailing. However, post implementation of unified tariff of natural gas pipelines, we expect PNGRB to open petroleum product pipelines, a step that may sound like fall of the last bastion for OMCs.

Although HPCL/BPCL/IOCL are trading at 0.9/1.2/0.8x FY24 PBV, a look at their long term valuation charts suggests that they could still correct from here. More importantly, the common carrier access of product pipelines may result in sustained de-rating of these stocks even lower. We reiterate ‘HOLD’ rating on HPCL/BPCL/IOCL with TP of Rs263/353/97 valuing at 0.8/1.1/0.8x FY25 PBV.

Almost all marketing infrastructure owned by OMCs: India has total ~22,500km of product pipelines and ~5,000km of LPG pipelines, almost all owned by OMCs. There are 310 marketing terminals/depots, 91% of which are owned by OMCs. Out of 283 aviation fuel stations, 89% are owned by OMCs and 90% of 87,458 retail outlets are also owned by OMCs. Pipelines are the most critical part of the supply-chain as their construction takes long time. Just to share a perspective, Kochi-Bangalore gas pipeline has still not been completed even after a decade of commissioning the Kochi LNG terminal.

Common carrier access could break the oligopoly: Private players have largely remained at bay (6-7% market share in sale of petrol/diesel in FY23) given 1) pricing interventions in petrol and diesel resulting in non-competitive environment, and 2) high cost plus time involved in laying marketing infrastructure alongside risk associated with it. However, at times OMCs have bled in terms of losses in marketing segment due to inability to pass on high cost to consumers, over a longer period of time; they have shown resilient profits. The common carrier access in product pipelines, could thus, lower the entry barrier for private players, thereby challenging dominance of OMCs over a period of time.

Marketing margins losses continue: Average HPCL and BPCL returns have under-performed Nifty by 15/7/6% in past 3/6/12month, while IOCL’s performance has given 8% underperformance against Nifty in 3 months (overperformed 3/16% in 6/12m) due to inability of raising retail prices amidst rising crude oil prices. As per our calculation, the gross marketing margin on petrol and diesel stand at Rs5.5lit and loss of 3.8/lit respectively in Sep’23 compared to Rs10.6lit/10.2/lit in 1QFY24 and Rs8.4/2.7/lit in 2QFY24YTD.

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