Decline in oil prices reduces domestic GRMs

Though Arab light crude oil prices remained firm in January 2012 versus December 2011, middle distillate prices (with the exception of Naptha) declined in the range of 4-5%, rendering into decline in the middle distillate crack spreads. The said price trend is estimated to reduce domestic gross refinery margins (GRMs) by 7% in January to US$1.6 per barrel as against US$1.7 per barrel last month. With reduce spreads and regulatory risk that heightens after the escalation oil prices we hold Market-weight stance on the Pakistan Refinery sector.Product wise basis, negative spread on Naphtha is expected to reduced to (-ve) US$5.5 per barrel as against US$7 per barrel last month, while spread on HSFO could widened to (-ve) US$11 as against US$8 per barrel last month. In the superior product category, HSD and Kero spreads are estimated to decline to US$10 per barrel perviously from US$16 per barrel while MS spreads are expected to dip into negative as against positive US$1 per barrel last month.ATRL still leading the wayCompany wise GRMs suggest that ATRL on account of higher weight-age of superior products (MS and HSD) in its product mix continue to lead the pack with company’s estimated GRMs standing to the tune of US$2.3 per barrel, down 9% from US$2.6 per barrel last month. Amongst the other listed companies, NRL’s GRMs is likely to declined by 5% to US$0.6 per barrel while PRL and BYCO GRMs are estimated to stand around US$0.9 and US$1.0 per barrel, down 17% and 11% respectively.Firm prices culminating into higher regulatory riskWith firm oil prices and their implications on domestic political and economic scenario, we believe the inherent regulatory risk associated with the reduction in deemed duty on HSD comes into lime light. Under the prevalent scheme 7.5% custom duty is charged on the imports of HSD, which in turn is providing a profitability cushion from domestic refineries.In recent price revision, deemed duty is currently hovering around US$9.5 per barrel in absolute terms while current levels of international HSD prices could push the same above US$10 per barrel in the upcoming February price revision. This in turn could bring to live the deemed duty saga which we witnessed in the early part of the year.Being the jugular vein of refinery sector profitability the reduction in the deemed duty from current levels could adversely affect refinery sectors profitability. As per our estimates 2.5% decline in the deemed duty would reduce ATRL and NRL (companies under our coverage) annualize earning by Rs6 and Rs11 per share, respectively.