Refiners Beat Bond Market as Japan Earthquake Cuts Oil Costs: India Credit

By Rakteem Katakey and Anoop Agrawal - Mar 15, 2011

Indian refinery bonds rallied the most in at least five months after an earthquake in Japan cut crude oil prices, easing a squeeze on the industry’s profit margins from making fuels.

The yield on the 4.75 percent dollar note due January 2015 in Indian Oil Corp. has decreased 29 basis points this month to 3.40 percent, according to data compiled by Bloomberg. The decline was double the 14 basis-point drop in the average yield on Indian corporate dollar debt to 5.19 percent, HSBC Holdings Plc indexes show. Global refiners also benefited with the yield on February 2015 debt in Valero Energy Corp. (VLO), the largest U.S. refiner, dropping 2 basis points to 2.73 percent on March 14.

Indian Oil, Bharat Petroleum Corp. and Hindustan Petroleum Corp., the three biggest state refiners, are winning some relief after their earnings were eroded by a 29 percent jump in oil costs in six months and state controls on diesel and kerosene prices. Benchmark government bond yields held near this year’s lowest level yesterday as the decline in crude eased concern that inflation will accelerate in Asia’s third-biggest economy.

“The immediate effect is lower oil gives some relief to Indian Oil, helping reduce costs and cap borrowings,” K. Ravichandran, co-head of corporate ratings at ICRA Ltd., the local affiliate of Moody’s Investors Service, said by telephone from Chennai yesterday. Japan will probably need to import more oil products and that would drive up refining margins, which will also help refiners.”
Japan Capacity

The yield on India’s 7.8 percent government debt maturing in May 2020 fell 2 basis points yesterday to 7.96 percent, near the lowest since Dec. 31, as destruction caused by the magnitude 9 earthquake on March 11 and subsequent tsunami rocked equity markets and threatened to slow global economic growth.

Japan shut about 29 percent of its refining capacity after the disaster, according to Bloomberg data based on Petroleum Association of Japan figures. The closures may boost profits for India’s state-run refiners and Reliance Industries Ltd. (RIL), operator of the world’s biggest refining complex, said Ravichandran.

The yield on Reliance’s 6.21 percent dollar bond due in March 2017 has dropped 18 basis points, or 0.18 percentage point, this month to 4.73 percent, the lowest level since Feb. 11. The rate on Bharat Petroleum’s 7.73 percent rupee debt due in October 2012 lost 5 basis points to 9.60 percent. Yields on Hindustan Petroleum’s 7.7 percent local-currency debt due in April 2012 fell 4 basis points to 9.54 percent.
Refining Margins

Margins for turning Brent crude oil into products at a complex Singapore refinery have risen to a profit of $1.08 a barrel from a loss of $4.15 a barrel on March 1. Diesel’s spread over Dubai crude increased to $24.03 a barrel yesterday, the highest since Sept. 26, 2008, according to data compiled by Bloomberg.

“Refiner bonds can sustain these gains because oil isn’t going to see a surge soon, probably not for the next few months,” Jani Kurppa, a bond investor in Helsinki at EQ Asset Management Ltd., which manages $1.5 billion, said by telephone yesterday. “They have scope to extend the rally and I don’t think the situation is going to reverse for them anytime soon.”

Oil rose to a 29-month high of $106.95 in New York on March 7 as escalating violence in Libya bolstered concern that supply disruptions may spread through the Middle East. Crude dropped to $96.71 yesterday, the lowest intraday level since March 1. India imports more than 75 percent of its crude oil requirement.

“Positive demand and price momentum in this highly competitive and cyclical industry leads to higher cash flows, which are credit positives,” said Rene Hermann, a Zurich-based analyst at Independent Credit View AG. “Refiners’ bond risk premiums are now lower and hence it is more attractive to tap the credit market to refinance existing bank debt.”
Price Controls

India’s government allowed state refiners to set gasoline prices in June, while continuing to control diesel, kerosene and cooking rates to help curb inflation. Indian Oil hasn’t increased gasoline prices since Jan. 16, although crude has gained 7 percent. Lower crude cuts revenue losses for the refiners and subsidy payments for the federal government, which partly compensates them for selling fuels below cost.

“We have to see how oil prices are over a longer period of time,” Serangulam V. Narasimhan, finance director at Indian Oil, said yesterday. “The unfortunate incident in Japan means oil prices haven’t increased like they were doing. It is too early to comment on the impact.”
Rising Debt

Indian Oil had borrowings of 550 billion rupees ($12.2 billion) and debt was rising at 25 billion rupees a month because of higher oil prices and controlled fuel rates in India, Narasimhan said Feb. 10. The New Delhi-based refiner’s borrowings were 507.2 billion rupees as of Dec. 31, Narasimhan said the same day. He didn’t say how much the company’s current borrowings are.

The refiner’s $327 million of debt is due this year, according to data compiled by Bloomberg.

India’s Finance Minister Pranab Mukherjee said March 2 higher oil costs are a concern, underscoring the risk fuel subsidies will undermine efforts to curb the budget deficit. India may “struggle” to meet its goals for the next financial year because of the price-control system, Standard & Poor’s said in a March 1 statement.

The rupee has slid 1.2 percent this year against the dollar, the second-worst performance among Asia’s 10 most-traded currencies excluding the yen, according to data compiled by Bloomberg. The rupee fell 0.3 percent to 45.245 per dollar yesterday.
Bond Sales

The cost of protecting the debt of government-owned State Bank of India, which some investors perceive as a proxy for the nation, has dropped 9 basis points to 179 this month, according to CMA prices. Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements.

Relative yields on Indian Oil’s debt have fallen as debt sales by local companies other than banks dried up, bolstering demand for existing securities, according to Nomura Holdings Inc. The difference between the yield on the 4.75 percent note and similar-maturity U.S. swap rate has narrowed to 176 basis points from a four-month high of 226 reached in December, data compiled by Bloomberg show.

Sales of dollar-denominated bonds issued from India this year were $2.9 billion, all of which were by lenders, according to data compiled by Bloomberg. That’s down from $6.7 billion in the fourth quarter when Hindalco Industries Ltd. (HNDL) and Reliance sold debt.

Almost 50 percent of the $5 billion of debt issued from South Korea this year was from non-bank borrowers. The last time an Indian refiner borrowed dollars was in October, when Reliance Industries raised $1.5 billion, Bloomberg data show.

“Non-bank corporate dollar debt supply from India has been quite thin and that’s mainly why spreads have narrowed,” Pradeep Mohinani, Hong Kong-based managing director at Nomura, said in an interview yesterday.

To contact the reporters on this story: Rakteem Katakey in New Delhi at rkatakey@bloomberg.net; Anoop Agrawal in Mumbai at aagrawal8@bloomberg.net.

To contact the editor responsible for this story: Amit Prakash at aprakash1@bloomberg.net.
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