India Oil &Gas:Refining,on a firm wicket

Asian refining margins to remain above 10-year average.

    With global refined product demand outstripping capacity additions, YoY lowerrefined product inventory levels and benign Chinese exports, we remainconstructive on the Asian refining margin outlook, expecting refining margins(GRMs) of USD7.0/7.1/6.8/bbl for 2017/18/19 (vs. USD6.8/7.0/bbl previously).

    At over USD 7, Asian GRMs would be 11% above the last 10 years’ average.

    Over CY17-19 we estimate incremental refining capacity addition of only2.1mmbpd vs. incremental demand of 3.9mmbpd. Among the Indian refiners,we prefer stocks that enjoy valuation comfort, catalysts and earnings drivers.

    Our preferred picks: BPCL and Reliance Industries.

    Low inventory, benign Chinese export growth to support refining margins.

    Going into the Northern hemisphere winter, multi-year low inventory levels,especially for middle distillates, and slow growth in Chinese refined productexports should support refining margins at over USD 7/bbl. Gasoline andmiddle distillate inventories are running at close to two-year lows for this timeof the year, driven by strong demand and the hurricane impact in the US.

    Gasoline inventories are at 22.8 days of demand (last seen in 2014) and gasoilinventories at 33.1 days (last seen in 2015) in the US (Fig 10 and Fig 11). OECDmiddle distillate inventories are at 33.7 days (Fig 14), at the last five years’average. We also expect Chinese refined product export growth to be under0.1 mmbpd in CY18 and CY19 (0.04 mmbpd YTD CY 17).

    Capacity additions to lag supply growth.

    We now estimate net refining capacity adds at 0.4/0.8/0.8 mmbpd inCY17/18/19 v/s 0.6/0.7/0.5 mmbpd earlier (Fig 1). Globally, over the last 10years, average annual refining capacity additions have been at 0.9 mmbpd.

    However, supply from non-refinery sources (natural gas liquids – NGL, gas-toliquids– GTL, etc) of 0.4/ 0.5 mmbpd in CY18/ CY19 should partly offset theimpact of lower refining capacity adds. Most of the capacity expansion over2017-19 should be from projects in Asia.

    Demand to be robust over CY17-19.

    Deutsche Bank forecasts global oil product demand growth of 1.6/1.3/1.0mmbpd in CY17/18/19. We expect demand growth to continue to be driven bynon-OECD countries in Asia and the Middle East, with India and China the keydrivers. YTD 2017, India, OECD Europe, the US and China have contributed~1mmbpd of incremental demand (Fig 6).

    We prefer BPCL and Reliance Ind among the Indian refiners.

    We have raised our earnings estimates by 1%-4% and target prices by 2%-3%for Indian refiners, factoring the increase into our refining margin forecasts.

    Among the Indian refiners, we prefer stocks that enjoy valuation comfort,catalysts and earnings drivers. Our preferred picks are BPCL and RelianceIndustries. For BPCL, we expect an 11% EPS CAGR over FY17-19e, driven by alarger refining contribution from the Kochi refinery expansion, higher refinerymargins and marketing volume growth. Reliance Industries should benefitfrom the contribution from capacity expansion and revenue market sharegrowth in its telecom business.