Reliance Industries Ltd., being India’s largest public company having a market valuation of more than ₹ 12 lakh crore, has few things going their way in the recent past when it comes to the cash cow business – oil and chemicals.
We spoke about the audacious moves Reliance makes on our podcast: The Big Hairy Audacious Reliance
RIL’s chemical prices have a direct positive impact on profitability from higher oil prices. While refinery operating cost rises with higher oil prices, the demand-led rise in oil supports refined product margins. The company has also initiated the process of reorganisation of its O2C (oil-to-chemical) business into a new subsidiary.
Higher Oil Prices
Brent Crude – the Asian benchmark for oil – is now trading around $65 per barrel mark as compared to $50 per barrel at the start of the year. Prices have rallied over recent weeks as vaccine rollouts promised to revive demand and producers kept supply reined in. OPEC and allied producers in OPEC+ settled for production cuts, while in the U.S. crude output was lower because of cold weather – frozen pipes and power supply interruptions slow their recovery.
In 2020, for RIL, the only underperforming segment was oil and chemicals. This was on account of lower demand and prices due to the Covid-19 pandemic. In fact, the company’s plan to sell a stake in its oil and chemicals segment was stalled due to unforeseen circumstances in the energy market amidst the pandemic.
The earnings from the retail segment did decline compared to last year, however, the company was able to close to ₹ 47,265 crore from 8 investors.
However, the tables have now turned around with crude prices now at a 13-month high.
With a continuous rise in crude prices, the global chemical industry and margins are now above 2019 levels. This has significantly improved the outlook for RIL’s chemical portfolio. RIL also has the flexibility to utilize 45% of its feedstock (raw material) as cheaper ethane gas/LPG for its petrochemicals. As prices of chemicals rise with oil and outperform gas, we can expect RIL margins to expand in chemicals.
In the petrochemical business, the product prices of five of its key products as up in the range of 16-66% in the last six months. The rise in prices would result in strong margins of Polypropylene (PP), Polyethylene terephthalate (PET), Purified terephthalic acid (PTA), Paraxylene (PX), and Polyethylene (PE) which in turn is expected to aid the segments revenue and EBITDA.
The Singapore gross refining margin – Asian benchmark – has shown a steady rise YTD after having struggled in the past two years due to demand challenges in 2020 and rising crude prices in 2019. Most of these headwinds are waning off, and as oil product inventories decline, margins should rebound. Moreover, the permanent shut down of few global refining capacities should also support margin gains.
Long Awaited Demerger
RIL’s de-merger plan for the O2C business is a step towards monetisation. After selling stakes in both Jio Platforms and Retail, it is yet again using a leaf from its own book. The move to merge the refining and petrochemical businesses and to keep it a net cash company may attract investments.
In 2020, the demerger of the telecom and retail segment was a precursor to stake sales.
The refining, petrochemicals, fuel retail JV with BP, and trading operations will be in the O2C business which will be a 100% subsidiary of RIL. The subsidiary will house $ 42 billion of assets, i.e, nearly 28% of consolidated assets. This will be funded by a $25 billion loan which will be provided to O2C by RIL at a floating interest rate. Rest will be balanced in equity ($12 billion) and non-current liabilities ($5 billion).
The O2C transfer came into effect on January 1, 2021, and approvals from SEBI and stock exchanges are in place. The management expects the consent process from shareholders and creditors to be completed by Q1FY22, with NCLT approval expected in Q2FY22.
The O2C entity will be able to efficiently upstream cash through dividends, interest, and debt repayment, which may also include any receipts from strategic investment in the O2C business. RIL has indicated that the discussions with Saudi Aramco are underway for a strategic transaction, without providing any further details on investment and timeline.
The goal of the O2C business will be to maximize the conversion of crude to chemicals. RIL wants to turn his refineries’ focus away from petrol and diesel – in the face of waning demand – and towards chemicals that are used to make plastics, paints, lubricants, and synthetic fibres. Focusing more on conversion will lead to a better margin going forward for the company.
Earlier the reported valuation of these O2C assets was close to $75 billion and Aramco was supposed to purchase a 20% stake for $15 billion. The valuations multiple was close to 7.5-8 times. The deal valuations could largely remain the same as crude demand and prices and refining margins are on an uptrend.
With this reorganization, RIL will become a holding company with four growth engines – O2C (100%), retail (85%), Jio Platforms (67%), and new energy and materials.
RIL’s oil and chemical business, which made it possible for RIL to not only become India’s most valued company but also its subsidiaries to become the country’s largest retailer and number one telecom operator, will now see a makeover.
The NEW Business
RIL on a standalone basis will retain the new energy and new materials businesses with a focus to develop a green energy ecosystem and adopt new technologies to reduce carbon footprint. These segments will endeavor to achieve net carbon zero for the group by 2035 while working along with the O2C entity, which will focus on carbon capture and hydrogen production technologies.
The company will envisage building a portfolio of reliable, clean, and affordable energy in renewables and the hydrogen space and develop a portfolio of advanced and specialty materials.
In short, for Reliance, clean energy would be the new oil.
Challenges
Hydrogen, which is produced from fossil fuels could meet one-fourth of the world’s energy needs by 2050, according to research firm Bloomberg New Energy Finance (BNEF). However, the widespread adoption of emission-free hydrogen fuel cells for electric vehicles is still a long time away.
Currently, in India even the adoption of battery-operated electric vehicles is slow and that is because of limited options, lack of charging infrastructure, and high prices. Now RIL is not only betting on the tide turning but is also a late entrant into clean energy businesses in India.
Ahmedabad-based Adani Green Energy, the world’s largest solar power developer, and Goldman Sachs-backed ReNew Power already have a huge head start.
Short Term Opportunity
Despite these few challenges, an immediate opportunity that RIL can tap into is the rise of EVs in India. Through its joint venture with BP, inked last year, RIL could look to set-up EV charging stations. Currently, the JV has 1,400 fuel retail outlets which it intends to expand to 5,500 in five years.
For RIL this could also be achievable as most of RIL’s fuel outlets are present on highways. Charging stations need space, which is available on the highways. RIL will leverage BP’s experience in running over 7,500 charging points in the United Kingdom.
However, these are all just vision statements. In past, RIL has successfully used the money from the oil and chemical business, succeeded in taking an oil giant into retail and telecom. Similarly, even in this venture, the start could look similar – RIL using the capital raised from selling a stake in O2C to fund its new journey towards clean energy.
Though the start is similar, how RIL guides this transition to clean energy will be key for investors looking beyond the near term.
India’s largest company by market cap has been hyperactive with its strategic moves through the last year. And we wrote about it all:
How Reliance Industries plans to get net debt-free
Silverlake’s investment in Reliance Retail
Reliance Jio’s tariff hike hits subscriber resistance
Understanding the Reliance Industries Future Group Deal
This article is for information only and should not be considered as a recommendation to buy or sell any stock. Stocks discussed might be part of our portfolios.
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