Stock has risen at a time of Singapore GRM fall

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Published: July 23, 2018 1:18:33 AM

Reliance Industries’ (RIL’s) stock price is up 17% from lows in end-May’18 whereas Reuters’ Singapore gross refining margin (GRM) has plunged by 25% from May’18 level hit by both demand and supply factors.

IEA in its 2018 OMR estimates demand jump of 1m b/d in CY20 to reverse in CY21-CY23 and shift to very low sulphur fuel oil.

Reliance Industries’ (RIL’s) stock price is up 17% from lows in end-May’18 whereas Reuters’ Singapore gross refining margin (GRM) has plunged by 25% from May’18 level hit by both demand and supply factors. However, implementation of the International Maritime Organisation’s (IMO) decision to cap sulphur in marine fuels to 0.5% from 3.5% w.e.f. Jan’20 is estimated to boost global diesel demand by 1.0-2.0m b/d, and hence diesel cracks and GRM, in CY20. Most experts estimate diesel demand to remain elevated even beyond CY20. However, IEA in its 2018 OMR estimates demand jump of 1m b/d in CY20 to reverse in CY21-CY23 and shift to very low sulphur fuel oil (VLSFO).

Also, surge in diesel demand is likely to boost oil prices, which may trigger a global slowdown and limit GRM strength to just CY20; diesel consumption is already declining/slowing down in the US, China and India. We introduce our FY21 EPS estimate (up 27% y-o-y) based on RIL’s GRM at $15/bbl and raise our target price by 5% to Rs 1,104 (3% upside). However, we downgrade the stock to Hold from Add pending more clarity on near-term concerns and on medium-term upsides in refining. We are assuming free cashflow generation from FY19, non-materialisation of which is also a risk.
Estimate Jul’18-TD RIL’s GRM at $6.1/bbl as diesel and petrol cracks hit multi-month lows and light-heavy crude spreads contract

We estimate RIL’s Q1FY19 GRM to be at a 7-quarter low of $10.1/bbl; GRM would have been lower but for inventory gains. We estimate RIL’s GRM in the first two weeks of Q2FY19 at just $6.1/bbl due to decline in diesel and petrol cracks to 13-24 month lows respectively. Cracks have been hurt by: (i) rising Chinese petrol and diesel exports, (ii) US refinery utilisation being at 17-year highs and (iii) fall in US and Chinese diesel consumption and slowdown in US and Indian petrol consumption growth in Q2CY18-TD vs in Q1CY18. Fuel Oil (FO) cracks on the other hand are at a 9-month high, which has meant RIL’s crude mix discount to Dubai crude is at a 4-month low; FO cracks have been boosted by fall in Venezuelan heavy oil output, fall in Russian exports, strong Middle East demand, and potential loss of Iranian FO exports.

Boost to diesel cracks from change in marine fuel sulphur specs appears imminent, but not without risk IEA in its 2016 OMR estimated 2m b/d of demand to shift from high sulphur fuel oil (HSFO) to marine gasoil (MGO) in CY20. However, in 2018 OMR it estimates: (i) 1 m b/d of demand shift each to MGO and VLSFO from HSFO in CY20, and (ii)1m b/d demand shift from MGO to VLSFO over CY21-CY23. Another headwind may be in the shift-away from diesel cars in Europe after the Volkswagen scandal and Feb’18 German court ruling that allows municipalities to ban diesel cars in inner cities.

EY expects share of diesel cars in sales, which had plunged to 31% in early-CY18 from 51% in CY15, to fall to 25% in CY18. IEA believes some of the 4.5m b/d refining capacity shut globally in the five years to CY18 may be restarted if they can produce low sulphur marine fuel and have ready access to markets needing such fuel; in recent weeks two such projects in US Virgin Islands and Wilhelmshaven in Germany have been announced.

Raise TP, but downgrade to Hold
RIL’s share price is up 8% from Rs 996 on 27-Apr’18 when its Q4FY18 result was announced. Share price had corrected to Rs 916 on 30-May’18. RIL’s current share price at Rs 1,076 is up 17% from levels on 30-May’18. Petrol cracks in Jul’18-TD at $7.2/bbl are at a 24-month low despite the recovery over the past two weeks. Diesel cracks in Jul’18-TD are at a 13-month low of $11.9/bbl.

RIL’s GRM down 10% in last two weeks
Our estimate of RIL’s GRM has declined by $0.6/bbl from $6.7/bbl to $6.1/bbl over the past two weeks. During the same period, Singapore GRM has rebounded by $1.2/bbl. RIL’s GRM has declined despite rise in weighted average product cracks of its slate by $0.7/bbl (from $2.5/bbl to $3.2/bbl) due to contraction in discount of its crude mix by $1.4/bbl from $5.3/bbl to $3.9/bbl.

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