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Energy: Is the optimism justified?

Sep 22, 2004

After a mixed 1QFY05 performance by the energy stocks, the last one-month has seen major gains (in stock prices) across the energy spectrum with standalone refineries being the major gainers. Oil-marketing companies too have been trading amidst strength. Let us now analyze as to what are the factors that led to these gains:

Aug-04 Sep-04 (%) change
CPCL 143.0 173.5 21.3%
BRPL 62.5 72.3 15.6%
IOC 385.7 442.5 14.7%
GAIL 173.1 197.3 14.0%
BPCL 340.1 366.7 7.8%
HPCL 314.0 336.7 7.2%
  • Government policies: At the end of 1QFY05, the government raised the prices of petrol, diesel and LPG and at the same time announced major excise duty cuts. This allowed energy companies some breathing space after a loss-making 1QFY05 (IBP witnessed a net loss while other marketing companies witnessed profit erosion). Further, in August, the government's major announcements regarding customs and excise duty cuts have resulted in a recovery in profits. Also, major duty cuts in LPG (liquefied petroleum gas) and kerosene led to reduction in under-recoveries suffered by the oil marketing companies. As a result, 2QFY05 results are expected to be better.

  • Strong growth in demand: During the first half of the fiscal year, the energy sector has witnessed strong growth in demand. To put things in perspective, diesel sales (constitutes nearly 40% of the petro-products basket) improved by nearly 12% while petrol sales grew at a rate of 9% YoY. At the same time, it is to be remembered that the industry had witnessed negative growth in these products during the last fiscal. Strong growth in LPG sales and the growing aviation sector have helped the sector recover from the 1QFY05 price freeze. Further, production of petroleum products grew at nearly 13% during 1QFY05.

  • Better capacity utilization: Uptrend in international crude prices backed by strong demand for petro-products led to robust refining margins. As a result, major refineries operated at more than 100% of their rated capacities, thus yielding the benefits of high refining margins. Also, better capacity utilization is likely to benefit the refineries in the coming period as a result of economies. We believe this trend is likely to continue in the medium term. Also, oil-marketing companies have stepped on the accelerator to increase capacities of their refineries so as to ride on the higher margins cycle.

We believe the 2QFY05 has proved to be better than expected as far as industry volumes are concerned. Although, marketing margins have remained subdued, strong refinery margins have more than compensated for that loss. Integrated companies such as HPCL, BPCL and IOC are likely to be the major beneficiaries while Reliance Industries, which operates a standalone refinery at Jamnagar, has found it difficult to market its products in the domestic markets with offtake from the oil marketing companies declining by nearly 50% YoY. All in all, we believe the stock prices have already factored in these numbers and to that extent, some of the stocks seem to have stretched valuations in the short term, although long-term prospects for the industry in a growing economy look bright.

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