We see near-term headwinds for RIL’s core businesses from (i) lower refining margins, (ii) subdued chemical margins and (iii) a sharp decline in KG D-6 production. Value creation from RIL’s new projects is 3-4 years away and will depend on (i) assumptions of conversion margins and (ii) incremental gas production. We revise our rating on the RIL stock to Reduce from Sell after the recent sharp correction. An out-of-turn gas price increase is the key risk to our view.
We expect subdued refining margins over the next 12-18 months given our cautious outlook on the refining cycle due to (i) large net additions to global refining capacity and (ii) weak oil demand resulting from a global slowdown. Singapore complex margins have declined to break-even levels currently from $3.8/bbl in mid-October led by a sharp contraction of spreads for petrol, diesel and ATF. We highlight that these products contribute 65-70% of product slate for RIL’s refineries. There has been a $4/bbl dip in refining margins since mid-October; this is partly mitigated by a $1/bbl increase in the light-heavy differential.
The margins for key polymers remained weak in recent quarters, closer to their lowest levels in a decade. Though we have assumed lower petrochemical margins for RIL in FY2013-14, we do not rule out downside risks to our assumptions given continued weakness in global downstream demand.
We see downside risks to the management guidance on FY2013-15 production from KG D-6 block noting the recent sharp decline in (i) gas production to 24 mcm/d currently from 30 mcm/d in H1FY13 and (ii) oil and condensate production to 6.8 kb/d from 10.7 kb/d in H1FY13. A reversal of decline in production from a revised development plan for the producing fields and incremental production from approved satellite fields is unlikely before FY2016-17e. Development work may also be delayed further due to the ongoing issues with the government on (i) gas pricing, (ii) scope of the CAG audit and (iii) cost recovery. On the positive side, the government may allow a price rise before April 1, 2014; we model $7/m BTU starting April 1, 2014.
Assumptions behind the earnings model
Refining margins: We model FY2013e (estimates), FY2014e and FY2015e refining margins at $8.5/bbl, $8.3/bbl and $8.3/bbl. We expect refining margins to be subdued over the next 12-18 months led by (i) net additions of 2.8 mn b/d to global refining capacity in CY2013-14e, (ii) 0.4m b/d of hike in OPEC