New emission norms, higher utilisation to boost Reliance GRM

Reliance Industries, India’s largest company by net profit, may see an upward revision of its core refining business because of new ship-fuel emission norms and full utilisation of the pet-coke gasification project, which should together expand the gross refining margins (GRM).

Reliance’s GRM — the difference between crude oil costs and average selling price of refining products — could expand in the range $2-8 per barrel in the next two years. An expanding GRM suggests higher operating profits for the refining business, fetching superior EV/EBITDA multiple for the segment.

At present, the Street has assigned a multiple of around 6.5-7.5 for the refining business, which accounted for half of the total operating profit (EBIT) of the company in the past fiscal year and 40-45 per cent of the fair value computed by analysts.

The major trigger for GRM expansion could be better realisation on diesel, kerosene, and ATF — middle distillate in technical parlance — after the implementation of new fuel norms for ships by the International Maritime Organization (IMO). New rules effective from 2020 say ships will be propelled by fuel that will have sulphur content less than 0.5 per cent against the current limit of 3.5 per cent .

To use lower sulphur fuel, ships could start using blended diesel, and this could lift crack spread (or the effective realisation per barrel) from middle distillates. According to a note by Macquarie, middle distillate cracks could expand from $15 per barrel to $30 due to substantial demand pull from the shipping industry. As a result, the brokerage has raised its GRM assumption for RIL to $20 per barrel for FY21 from $12 previously.

RIL is likely to be the major beneficiary of higher realisation for middle distillates. Every refinery typically has a configuration that decides how much will the output of petroleum product be for every unit of crude oil throughput. The complex refinery produces more of higher priced products.

The Street believes that middle distillates of RIL constitute nearly 45 per cent of refinery output. Therefore, higher profitability from middle distillates could boost GRM by $4-6 per barrel. The effort to reduce sulphur in fuel is likely to expand the differential between higher sulphur crude and Brent. Given that RIL’s refinery could process several grades of high-sulphur and high-viscous crude, this advantage will further expand the GRM.

In the near term, pet-coke gasification is likely to improve GRM by $1.5-2.5 per barrel. Under the pet-coke gasification project, internally produced low-cost petcoke will be used in power generation, and it will replace imported LNG. The four gasifiers of phase one are likely to touch full utilisation by the second quarter of the current fiscal, while the remaining six gasifiers will be commissioned over the next three to six months.

Macquarie has raised RIL stock price target to Rs 1,240 because of the benefits the new emission norms for ships will provide to India’s biggest private company.