Downstream companies, particularly oil marketing companies in India, are better placed to benefit from structurally lower oil prices and from a growing ability to charge higher marketing margins, notes Goldman Sachs.
Nilesh Banerjee and team at Goldman Sachs in their May 18, 2015 research report titled: “India: Energy: Oil” predicts long-term Brent at US$55/barrel by CY20E.
Oil Prices: Cost deflation from triple drivers
The Goldman Sachs analysts point out that global oil markets are likely to witness triple supply drivers over the medium to long term viz.: (a) continued rise in U.S. shale productivity, (b) sustained OPEC growth and (c) new projects. The analysts believe these triple drivers would add to deflationary pressures.
As depicted in the following table, Goldman Sachs’ global Energy team anticipates Brent to drop to US$55/bl by CE20E vs. LT of US$70/bl earlier. However the analysts anticipate Brent to remain between US$58-65/bl during the CY15E-19E period, before dropping to their new long term forecast.
Banerjee and team anticipate under-recoveries will decline with lower crude prices. The following table captures the share of under-recovery among different stakeholders:
Moreover, the analysts note the government’s share of under-recoveries would also drop from Rs 1000 billion in FY 13 to Rs 450 billion by FY 18. They point out that such decline in under-recovery would aid in more public spending:
Banerjee et al. believe the lower long term oil price forecasts will not only imply a lower subsidy burden for the Indian government going forward, but will also offer more room for fuel pricing reforms – in both oil and natural gas.
In the natural gas space, the Goldman Sachs analysts anticipate a more realistic domestic gas pricing formula aligned with relevant international benchmarks vs the current formula that links Indian gas prices to that in gas-surplus economies like the U.S., Russia and Canada. Aided by lower oil price, they believe this new formula will continue to lead to low natural gas prices that will likely be acceptable to the regulated consuming sectors.
Downstream companies to benefit
The analysts note the structurally lower oil prices would benefit downstream (especially oil marketing companies) in particular over upstream. The reduction in oil prices will enhance their oil product demand and grow their ability to charge higher marketing margins. Moreover, the analysts believe at lower oil price, OMCs cash losses in LPG/Kerosene too would dwindle further, leading to further improvement in working capital cycle and lower interest costs. Accordingly, they have trimmed their EPS by up to 16% for upstream companies:
Keeping in mind lower oil prices, the GS analysts also trimmed their target price for E&P companies by an average of 10%:
The following table sets forth the Goldman Sachs analysts’ 12-month price target for various Indian companies, involved in E&P, refining and integrated oil firms: