Refineries: Some key factors… - Views on News from Equitymaster

Helping You Build Wealth With Honest Research
Since 1996. Try Now

  • MyStocks


Login Failure
(Please do not use this option on a public machine)
  Sign Up | Forgot Password?  

Refineries: Some key factors…

Aug 10, 2006

In the previous articles, we highlighted the business model and financial performance of HPCL and BPCL. Taking the same theme forward, we now move on to analyzing the historical valuation of the two companies. However, before we do that a short tutorial on key factors that affect the performance of a refining company is in order. How to identify the refining companies:

Capacity utilisation: Refineries procure crude from various sources and refine it into petroleum products, thus earning profit on refined products. Higher capacity utilisation leads to lower fixed cost per unit of refined products (though the fixed cost is not significant part of the total cost). Lower demand for end products pushes the refining capacity utilisation lower. Thus, higher utilisation generally leads to higher margins. All the refining companies have been enjoying good capacity utilisation in recent times due to global refining capacity crunch.

Gross refining margins: Refining is primarily a margin-based business in which a refiner's goal is to optimize the refining processes and yield of all products in relation to feedstock used. GRMs are the major indicators of a refinery's operational efficiency. Gross refining margins (GRMs) are weighted average prices of petroleum products minus cost of crude and other feedstock. Here, weights beings volumes of products sold. GRMs are usually measured in terms of USD per barrels. Upturn in refining margins signal increase in the profitability of the refineries. GRMs for the Indian refineries are benchmarked to Singapore GRMs, (current pricing policy at the refinery gate level is trade parity pricing, 80% import parity pricing and 20% export parity pricing). Currently, refineries in India enjoy better GRMs than the benchmarked Singapore ones (refineries of similar configuration are considered) on account of duties and tariffs that get added to the product prices. Going forward, these GRMs are likely to reduce as Indian refineries build up capacities for the export markets where the final prices will not be inclusive of duties and tariffs. Thus, while profit may improve in absolute terms, GRMs might witness some downward movement.

Complexity of the refineries: Complexity of refinery can be understood as the processing ability of the refinery. Petroleum products are classified into three distillates- light, middle and heavy. Given the fact that light and middle distillate products trade at a premium to heavy distillates. The refineries, which have the capability to convert the heavier fractions into lighter one, by using catalytic converters and crackers, can earn higher margins as compared to that of simple refineries with only distillates. Reliance Industry, which has superior complexity vis-a-vis PSU refiners, earns higher GRMs.

Also, refineries with higher complexity have the ability to handle sour crude. There are two types of crude oil in terms of sulphur content- sweet crude oil and sour crude oil. Sweet oil in comparison to sour crude is trading at premium in the international markets due to greater difficulty in processing sour crude. However, if the refinery can improve configuration of its plant to process the sour crude oil by way of increased complexity, it can manage to get above average refining margins by producing similar products, albeit with a lower cost of crude. Thus, the type of crude can impact GRMs and ultimately the profitability of refining companies.

Location of the refinery: Refinery situated near the coast and also near the source of crude has obvious advantage over the inland refineries owing to reduced transportation costs. Also, the regulatory issues have a say the refining margins due to geographical presence. BPCL has a sole refinery in Mumbai while HPCL has a major portion of its refining capacity in Mumbai. Refineries established in Mumbai attract a 3% cess on crude oil. Thus the GRMs of HPCL and BPCL take a hit due to this cess. IOC on the other hand, also has refineries in the north- east region where excise duty exemption is provided, which in turn boosts the GRMs. .

Efficiency on crude procurement front: Crude requirement of Indian refineries is majorly fulfilled through imports. This exposes them to the exchange rate risk Refineries with strong crude trading desk that looks into purchases, hedging and sourcing of the crude oil will be able to earn higher margins on account of superior sourcing expertise.

Equitymaster requests your view! Post a comment on "Refineries: Some key factors…". Click here!


More Views on News

Sorry! There are no related views on news for this company/sector.

Most Popular

How the 8-Year Cycle Can Help Identify Multibaggers (Fast Profits Daily)

Sep 11, 2020

This is how you can apply the greed and fear cycle in the market to pick stocks.

Why We Picked This Small-cap Stock for Our Hidden Treasure Subscribers (Profit Hunter)

Sep 17, 2020

This leading household brand will profit big time in a post covid world.

This Could Be the Best September for Auto Stocks (Profit Hunter)

Sep 11, 2020

Here's why I think this month could be a great for auto stocks.

What Do the Charts Say About Buying Smallcaps Now? (Fast Profits Daily)

Sep 18, 2020

Everyone seems to be excited about buying smallcaps now...but is it the right thing to do? What do the charts tell us? Find out in this video...


Covid-19 Proof
Multibagger Stocks

Covid19 Proof Multibaggers
Get this special report, authored by Equitymaster's top analysts now!
We will never sell or rent your email id.
Please read our Terms


Sep 24, 2020 01:43 PM