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Raghuvir Srinivasan

Global oil consumption is showing an increasing trend, with projections of about 9 per cent growth in demand for this calendar year.

OIL STOCKS are at the forefront of the current market rally. Be they upstream stocks, such as Oil and Natural Gas Corporation (ONGC) and Gail India, or downstream ones, such as Bharat Petroleum (BPCL) and Hindustan Petroleum (HPCL), oil stocks have gained handsomely in the last three months. The scale of appreciation, that ranges from 25 per cent (BPCL) to 100 per cent and above (Kochi Refineries, Bongaigaon Refinery), gives an indication of the following that these stocks command.

What are the prospects for these stocks going forward? Are they still on the upcurve or have they run up too much too soon? By far, the biggest positive factor driving these stocks is the sharp rise in global oil prices in the last two months. Oil prices, which dipped after the Iraq war, have staged a smart turnaround and are now trading in the $28-30 band per barrel.

Rising oil prices translate into higher revenue and earnings for upstream major, ONGC. The company's revenues per barrel of oil produced will rise in tandem with global prices even as the cost of production remains static. In other words, the incremental revenues go straight towards beefing up ONGC's already fat bottomline.

According to the company's own estimate, every dollar of rise in global oil prices will add Rs 900 crore to ONGC's revenues. Any surprise then that the stock is the darling of the bourses today? Remember, even at the height of its problems following the copter crash at Mumbai High, the ONGC stock stood remarkably steady.

For downstream companies, higher oil prices generally mean better refining margins, apart from the prospect of inventory gains. Refining margins have been particularly good in the current oil price rally, as product prices have run up faster than oil prices. In other words, the delta between product prices and crude oil price is quite large now, which means that refining companies gain disproportionately higher prices for their products. Besides, they stand to make handsome profits through inventory gains as well.

This is one reason why the likes of Chennai Petroleum, Kochi Refineries and Bongaigaon Refinery have run-up sharper than HPCL, BPCL or IOC, all of which are refining and marketing companies.

Now, when debating the prospects for these stocks, we have to find an answer to the crucial question of where global oil prices are headed. There are indicators to support the view that oil prices could remain buoyant in the $26-30 band through the end of this calendar year. On the demand side, global oil consumption is showing an increasing trend, with projections of about 9 per cent growth in demand for this calendar year. If the presently incipient signs of a turnaround in the US economy persist, demand can only grow further in the near term.

On the supply side, Iraqi oil appears still a while away from adding to supplies and the OPEC appears in no mood to raise its own production. Besides, the northern hemisphere countries will, starting end-October, begin stocking up on oil ahead of the winter.

This will only support firm price trends. Unless something drastic happens, the current outlook for oil prices appears to be one laced with firm undertones. This should be good news for the oil companies that are already looking at bountiful bottomlines for the second quarter ended-September. So does this mean that investors should go all out to acquire these stocks now?

It would pay to proceed with caution, especially in the case of the twins up for privatisation, HPCL and BPCL. These two appear to be driven more by the privatisation theme than their fundamentals.

Though the due-diligence process has begun for HPCL, legal hurdles remain to be crossed before the company can be privatised. As for BPCL, it seems unlikely that the company will be privatised in the next one year as elections are round the corner. It may be dangerous for investors to acquire these two stocks in the absence of any firm indications on the privatisation front.

As for pure refining stocks, Chennai Petroleum appears to be priced fully at current levels but there could be some upside still left in Kochi Refineries. Bongaigaon Refinery seems to have turned into an operator-driven stock that has run up too sharply for comfort given its fundamentals.

The company is turning around with better crude availability thanks to IOC and with fiscal concessions from the government. Yet, the current valuations seem to be on the higher side especially in the absence of confirmed news on the sale or lease of its petrochemicals facilities.

Indian Oil has gained about 15 per cent since it went ex-bonus a couple of weeks ago and prospects for major upside from current levels appear low at the moment.

The other big stock, ONGC, has seen a sharp rally in the last fortnight appreciating 18 per cent. The stock is undergoing a re-rating and could yield further returns to those who stay with it.

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