Why HPCL is more vulnerable to fuel price cuts than peers

These fears have come true with the government announcing a price cut of ₹2 per litre for petrol and diesel. This is the first cut in prices since May 2022, signaling an end of the high marketing margin period during the nine-month ended December (9MFY24) that oil marketing companies (OMCs) have enjoyed so far.

It may be a coincidence that Bharat Petroleum Corp. Ltd (BPCL) stock also hit a lifetime high on the same day as HPCL shares and started sliding, but its fall from the peak has been curtailed to 18%. Indian Oil Corp. Ltd (IOC) has also moved in tandem with a 22% slide from the high. 

Even so, HPCL’s relative underperformance does not make it appealing compared to peers if one has a more positive view on refining margin vis-à-vis marketing margin.

While the gross refining margin (GRM) per barrel is not affected by the recent fuel price cut, it does squeeze the gross marketing margin (GMM). From consumers’ point of view, the fuel price cut may not appear to be substantial as it is less than 3% of the prevailing prices in most states. However, there could be a significant adverse impact on the profits of oil marketing companies (OMCs) whose gross earnings include GRM as well as GMM.

Since the cut was announced in March, the Q4FY24 numbers will have a negligible impact, but FY25 numbers could be more adversely impacted. For example, HPCL sold 3,463 crore litre of petrol and diesel in FY23, as per its annual report. 

The cut in retail fuel price flows straight to profit before tax (PBT) as there is no corresponding change in the cost structure, leading to a potential annual hit of ₹6,926 crore. For perspective, this is 44% of HPCL’s consolidated PBT during 9MFY24. The same parameter for BPCL and IOCL works out to about 26% and 30% of 9MFY24 consolidated PBT, respectively.

Adding to the woes, HPCL not only has the lowest GRM but also the lowest refining capacity among all the OMCs. The company is taking steps to increase its refining capacity to 45 million tonne by FY28 from 29 million tonne in FY23. This will be achieved through a combination of brownfield and greenfield capacity additions.

While that augurs well, this time around, GRM is unlikely to provide succor when GMM is being compressed. Notably, the base of GRM is already high, as OMCs benefited from higher margin on lower-priced crude due to the discounts offered in the wake of the Russia-Ukraine war. 

Those discounts are normalizing now. For instance, HPCL’s average GRMs in FY23 stood at $12 a barrel, a huge jump from $7 a barrel in the previous year. The trends are similar for BPCL and IOC. As per the International Energy Agency, the global spare capacity of refining is expected to be low. This may keep GRMs globally on a firm footing, but it may not push the GRM to FY23 level given the far higher benefit of discounted crude back then.

Given all this, HPCL is facing a double whammy, making it the most vulnerable among peers to the hit on marketing margin following the cut in retail fuel price. The best period for HPCL versus peers, therefore, may not be on the horizon anytime soon.