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Oil and Gas -Sector Outlook
Global economic recovery and deregulation make the sector buoyant: With bullish
economic and industry indicators, we expect the oil and gas sector to perform well in the next
fiscal; with the caveat of subsidies which are expected to increase due to the government not
increasing retail fuel prices in tandem with crude due to inflationary concerns in the first half
(higher base effect may allow for larger hikes later in the fiscal).
Crude prices outstripping expectations, GRMs resurrecting: We expect crude prices
to remain strong against the backdrop of improving economic indicators from developed
economies. There are upside risks to our FY12E average price estimates of US$89/bbl
(WTI crude). In our view, refining margins (especially for complex refiners) will continue to
gain strength, albeit slowly.
Incremental deregulation a positive, but subsidies still a matter of concern: The
government has boldly deregulated gasoline and hiked prices of other fuels as well as
APM gas, and the benefits will be clearly visible in FY12. However, with strong crude
prices increasing under-recoveries (FY12E estimates of US$17bn), incremental price hikes
and possible diesel deregulation are triggers that could release fiscal pressure as well as
provide comfort to valuations for the impending FPOs of ONGC and IOCL.
Gas juggernaut rolls on – value as well as volume drivers bullish: Indigenous gas
production has received a quantum jump from KGD6; and further gas coming in from its
(delayed) ramp-up, and higher LNG imports in the interim will continue to provide cheap,
clean energy to industries like power, fertilizer and City-Gas. Bullish price signals, like the
approval of a US$5.25/mmBtu price for ONGC C-series gas, could support noises from
RIL about needing a higher benchmark price for gas to support capex in deepwater.
Services and allied industries to gain: Transmission companies are expected to gain
from PNGRB regulations providing higher tariffs for newer pipelines and common-carrier
volumes as upsides. The commissioning of GAIL’s first 2 pre-approved pipelines should
provide a boost to volumes. In our view, oilfield services firms shall also post improved
earnings from near-100% asset utilizations as well as a recovery in rig-rates in the
background of strong drilling activity in India (local regulatory and corporate trend) and
higher crude prices supporting more capex (global economic trend).
Sector Top Picks
Top Buy Recommendation
RIL (Outperform; TP: Rs1244; 22% upside)
Our forensics with industry consultants and experts suggest that RIL has the best portfolio
of E&P blocks from the NELP regime; and RIL’s operational excellence is evident from KGD6
which is slated to become the world’s largest deepwater gas production facility on its
scale up to 80mmscmd.
An integrated player, we believe RIL is poised to witness accelerated growth, not just in
upstream. RIL is in the process of committing very large capex by re-investing US$ 7-8bn
pa FCF and leveraging balance sheet from a current net-debt to equity level of 28%.
Key Near-Term Catalyst
Clarity on timeline for ramp-up of KG D6 gas production to 80mmscmd
Top Sell Recommendation
Cairn India (Underperform; TP Rs256; -26% downside)
Cairn India trades at a very expensive 25x EV/bbl of 2P reserves relative to the sector.
Key Near-Term Catalyst
In the proposed acquisition by Vedanta group, parent Cairn Plc shall get a 14% higher
price than Cairn India minority holders under the pretext of non-compete agreement, which
raises corporate governance issues. Also, Cairn India management has done a very good
job in exploration and drilling so far and potential de-stabilisation of existing workers is a
key risk.
Switch from ONGC (Underperform, Rs 1176) to Oil India (Outperform, Rs1796)
Oil India, while much smaller than ONGC, has better quality assets; which are expected to
increase oil production by 2-3% in next 2 years, versus a flat-to-declining trend for ONGC.
At ~US$3.5/bbl, Oil India has the lowest finding and development costs in the world, as
well as a three-year average reserve replacement ratio of 135%.
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