The sustained strength of marketing margins (MM) and recovering demand for petroleum products is supporting the profitability of India's oil marketing companies (OMCs) against weak gross refining margins (GRM), thereby lowering downside risks for their credit metrics, Fitch Ratings says.

Petroleum product sales at Indian Oil Corporation Ltd (IOC), Bharat Petroleum Corporation Limited (BPCL) and Hindustan Petroleum Corporation Limited (HPCL) surged by 22%-23% in the third quarter of the financial year ending March 2021 (3QFY21) from the previous quarter, with domestic transportation fuel demand recovering to near normal levels, barring aircraft fuel, and MMs on auto fuel sustained at above pre-pandemic levels.

However, reported GRMs dropped due to lower inventory gains and the improvement in underlying GRMs was limited by weakening product cracks and increasing crude oil prices. IOC reported a 3QFY21 GRM of USD2.2/barrel versus USD8.6 in 2QFY21, BPCL reported USD2.5 versus USD5.8 and HPCL reported USD1.9 versus USD5.1. However, core GRMs excluding inventory gains were lower at USD1.2 for IOC, USD1.2 for BPCL and negative USD1.0 for HPCL.

Fitch expects above long-term average MMs from FY22, which should aid GRMs in the short term, partly recover past refinery investments and fund new investments over the medium term. GRMs are likely to rise to around USD3.7-4.0/barrel in FY22 from USD2.0-2.5 in FY21 on a better demand-supply balance as the economy recovers.

Fitch forecast net leverage at IOC, as measured by net debt/EBITDA, to fall to below 3.5x and be adequate for its Standalone Credit Profile (SCP) of 'bb+' from FY21, as strong volume and MMs are supported by its petrochemicals diversification; its 3QFY21 segment EBITDA increased by 61% qoq to INR20 billion. IOC intends to maintain operational control of its pipelines even post part monetisation, should it choose to do so, given the pipelines' vital role in its integrated business model. IOC owns around 14,600km of crude and product pipelines.

Fitch expects BPCL's net leverage, including full consolidation of Bharat Oman Refineries Limited, to be lower over FY21-FY22 than our previous estimates, albeit slightly above the level where we would consider revising the SCP downwards. BPCL has finalised commercial terms to purchase Oman Oil Company's 36.62% stake in its Bina refinery for INR24 billion in cash. BPCL intends to sell its 61.65% stake in the Numaligarh refinery to a consortium led by Oil India Limited (BBB-/Negative) and the state of Assam during FY21, an important pre-condition for the government's planned BPCL divestment, which Fitch has not yet factored in.

Fitch expects HPCL's credit metrics, including the proportionate consolidation of subsidiary, HPCL-Mittal Energy Limited (HMEL, BB/Negative, SCP: b+) to remain above the levels appropriate for its SCP of 'bb' during FY22. HMEL's inclusion adds around 0.8x to HPCL's FY22 leverage, higher than our previous estimate of 0.6x; excluding HMEL would see HPCL's leverage at the same level as the negative sensitivity of its SCP.

Fitch's expectations are subject to the risks of persistently weak industry conditions or capex and shareholder returns that are higher than our forecasts.

Fitch believes the central or state governments may reduce fuel taxes to support affordability if crude oil prices remain at around USD60/barrel or continue to rise. The capacity to reduce taxes would be supported by the recovery in fuel sales and other government income sources, like the GST, to almost pre-pandemic levels. We believe state interference in fuel prices, if any, would be temporary and limited, as it could affect the government's plan to divest BPCL.