PL Stock Report: Oil & Gas - Sector Update – Weak petrochemical cycle expected in 2024

Oil & Gas - Swarnendu Bhushan - Co-Head of Research, Prabhudas Lilladher Pvt Ltd.

Sector Update – Weak petrochemical cycle expected in 2024

Quick Pointers:

§ China added 2.75 mmtpa of new PE capacities in 2022, while the country announced 4.15 mmtpa of new PP capacities in 2023.

§ China’s net PP imports fell sharply from 6.1 mmt in 2020 to 3.2 mmt in 2022; similarly PE imports fell from 18.9 mmt to 13.4 mmt in the same period.

Chinese refiners have been increasing their petrochemical capacities to (1) diversify from transportation fuels like petrol & diesel (whose demand is expected to decline with anticipated pick up in EV) and (2) reduce dependency on imports. Increase in capacities would lead to supply glut, amidst lack of commensurate global demand. We expect Reliance Industries (RIL), GAIL India (GAIL) and Indian Oil Corporation’s (IOCL) petrochemical margins to remain suppressed in the near to medium term. Accordingly, we downgrade our rating on RIL to ‘Accumulate’ from Buy with SOTP based TP of Rs2,618 (unchanged, valuing the standalone business at 7.5x FY26 EV/EBITDA, Jio at 15x FY26 EV/EBITDA and Retail at 37x FY26 EV/EBITDA). We maintain ‘Buy’ rating on GAIL, driven by strong transmission and trading segments with TP of Rs151 (earlier Rs139) based on 10x FY26 EPS of 12.7 and value of listed and unlisted investments at Rs24. For IOCL, we maintain ‘Hold’ rating with TP of Rs94 (unchanged) based on 0.7x FY26 P/BV.

Global petrochemicals demand: Global PP demand for FY23 is projected at ~90 mmt, out of which China accounts for 40%. Similarly, global demand for PE is projected at ~118 mmt, out of which China accounts for 34%. Current PE/PP spreads are at lower end of last decade and are expected to remain weak going ahead too.

Surplus supply from China: China, the world’s largest producer and consumer of petrochemicals has been adding new petchem capacities and improving its self-sufficiency. About 1.4 mmt of new PE capacities (most of which are for HDPE) are expected to come online in 2023, up 8.5% YoY. China’s net imports of PP have fallen from 26.7% in 2013 to a mere 10.7% in 2023. HDPE imports have halved from 52% to 25.4% during the same period. LDPE and LLDPE imports have declined from 56.7%/44.6% in 2019 to 48.3%/35.4%in 2023, respectively. Thus, China has reduced its reliance on imports. Along with this, demand concerns too persist in Europe on the back of high inflation and interest rates. This has led to suppressed product margins.

Indian petchem companies’ margins to remain weak: The above macro developments are likely to impact the Indian petrochemical sector. Reliance has announced expansion plans across its petrochemical value chain by CY26. IOCL is planning to enhance its petrochemical capacity from 4.1 mmtpa to 15 mmtpa by FY30 (link). GAIL is setting up a 500 KTA PP plant based on PDH technology at Usar, Maharashtra to be commissioned by 2025 and another 60 KTA PP plant is also being set up at PATA petchem complex, to be commissioned by 2024. Petchem margins have been suppressed since the beginning of 2023 and we expect RIL, GAIL and IOCL’s petchem margins to remain weak going into 2024 too, on the back of production capacities exceeding demand.

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