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Oil & Gas
Prices mix, margins firm
In 3QFY2011, crude oil price stood firm (hitting 27-month high)
at US $80-90/bbl. While natural gas price, which weakened
during the later part of 2QFY2011, continued its weak trend in
the first half of 3QFY2011 before showing some recovery in
the second half of 3QFY2011. However, petchem margins
improved. Refining margins were also higher sequentially due
to improvement in heating oil and naphtha cracks.
Crude hits a 27-month high, passes the US $90/bbl mark
Crude price hit a 27-month high, rising past the US $90/bbl
mark, during the second fortnight of December 2010, boosted
by an unexpected surge in global demand that fueled the biggest
drop in US crude stockpiles in more than a decade. Stockpiles
in the US, the world's biggest oil consumer, fell by 19mnbbls
since November 26, 2010, roughly equivalent to one day of
US fuel consumption, being the biggest three-week drop since
1998. The higher-than-expected fall in inventories was due to
the cold weather in the northern hemisphere. Consequently,
crude oil soared substantially (~39%), since hitting a CY2010
low of US $66/bbl in May, driven by a faster-than-expected
recovery in global fuel demand and continued optimism for US
economic recovery. Further, Chinese government's reports
claiming that China (world's second-largest oil-consuming
country) nearly doubled its net oil-product imports in November
led to higher crude oil price. With positive developments taking
place, crude price stood firm in 3QFY2011 (US $80-90/bbl)
against US $71-82/bbl in 2QFY2011. On an average, crude
price rose by 12% qoq in 3QFY2011. Crude price has now
moved above US $70-80/bbl, the preferred level for OPEC.
However, OPEC, at its December 11, 2010, meeting at Quito
(Ecuador), left production quotas unchanged after reviewing
the oil market's outlook, including overall demand and supply
projections for CY2011. OPEC has not formally changed its
output policy since agreeing on the record cut in December 2008.
The Indian crude oil basket averaged US $85.3/bbl in
3QFY2011 v/s US $74.9/bbl in 2QFY2011. Despite this recent
sharp run up, we expect crude price to average ~US $80/bbl
in FY2011 and ~US $80-85/bbl in FY2012, as expectation of
lower demand growth in FY2012 v/s FY2011 along with
challenging risks to the fragile global economic recovery,
including the adverse effect of possible currency conflicts and
fears of a second banking crisis in Europe, would negatively
affect oil demand.
On the supply side, as per the IEA's December outlook, OECD
stocks rose by modest 0.7mnbbl in October 2010 to
2,745mnbbl. Thus, October OECD forward demand cover rose
marginally to 60.1 days. However, as per November preliminary
data, OECD oil stocks fell by 8.4mnbbls. Global oil supply rose
by 0.4mnbpd mom to 88.1mnbpd (its highest-ever level) in
November, largely due to increased non-OPEC production to
53.4mnbpd, up 0.3mnbpd mom, notably from Canada,
Kazakhstan and Brazil. Global oil output in November increased
by 1.6mnbpd yoy, of which half came from higher non-OPEC
supply, one-third came from OPEC NGLs and one-sixth came
from OPEC crude. Non-OPEC supply is expected to average
52.8mnbpd in CY2010 and 53.4mnbpd in CY2011,
representing growth of 1.1mnbpd and 0.6mnbpd, respectively.
OPEC crude oil supplies also stood higher by 45kbpd in
November to 29.2mnbpd. Effective spare capacity of OPEC,
thus, fell marginally mom to 5.6mnbpd. The demand for OPEC
crude and stock change for CY2011 has been raised by
100kbpd to 29.5mnbpd on higher demand projections.
On the demand side, IEA has increased its global oil demand
estimates by 130kbpd to 87.4mnbpd in CY2010 and by
260kbpd to 88.8mnbpd in CY2011 on stronger data from
OECD North America and non-OECD Asia. In CY2010, yoy
growth of 2.5mnbpd was mainly led by buoyant gasoil demand,
notably in 3QCY2010; however, demand growth in CY2011
should slow to 1.3mnbpd, as temporarily supportive factors fade.
Average gas price takes a hit, dips 11.6% qoq
Natural gas price, which stood weak at US $3.75-4/mmbtu in
the latter part of 2QFY2011 after declining from the peak of
US $4.9/mmbtu in August 2010, continued its weakness and
touched a low of US $3.18/mmbtu in October 2010. Post that,
natural gas price tried to recover and got a fillip only towards
the beginning of December on increasing demand for gas due
to lower-than-expected temperatures, thus leading to natural
gas price hitting 3QFY2011 high of US $4.5/mmbtu towards
mid-December. However, in the subsequent weeks, despite low
temperatures, the price corrected by 10-12% due to sufficient
gas supply. Currently, natural gas price is at US $4-4.2/mmbtu.
With this, average natural gas price in 3QFY2011 stood at
US $3.78/mmbtu, a fall of 11.6% qoq, due to subdued price in
the second half of 3QFY2011. Thus, natural gas price, which
was on a recovery path through 1QFY2011 and in the first half
of 2QFY2011, gave up much of the gains due to subdued
demand and sufficient availability of LNG, with increasing shale
gas production in the US.
Spot LNG price during 3QFY2011 was marginally high qoq,
with delivered price of LNG procured by Indian firms (Petronet,
LNG and GAIL) being in the range of US $9.0-9.5/mmbtu.
Despite higher demand, the market is expected to remain amply
supplied in CY2011 as new production in Russia, Yemen,
Indonesia and Qatar comes on stream. Thus, we expect spot
LNG prices to be subdued going ahead.
Petchem and refining margins improved
Polyethylene and polypropylene prices increased higher than
naphtha, thus increasing polymer cracks sequentially. Asian
polymer plants operated at relatively higher rates in 3QFY2011
on account of higher demand. Polyester prices added
significantly to average global petchem margins due to tighter
cotton market. Demand supply imbalance resulted in a spurt in
cotton prices, benefiting relatively cheaper polyester producers.
The cotton market is expected to remain tight in the coming
quarters, leading to sustainably high polyester demand.
During 3QFY2011, global refining margins on an average
increased due to higher heating oil demand because of the
cold weather coupled with strong Chinese demand for diesel
due to its government's mandate to meet emission reductions
and energy-efficiency targets, lending a considerable support
to regional middle distillate markets. Naphtha cracks in Asia
continued to improve in November due to strong petrochemical
demand in line with stronger economic activity. BP's generic
Refining Global Indicator Margin also witnessed a marginal
improvement in 3QFY2011. We expect margins for complex
refineries to improve due to the increase in heavy-light spreads
during 3QFY2011. Benchmark Singapore margins are likely
to average at US $5.5-6.0/bbl v/s US $4.25/bbl in 2QFY2011.
Key developments
Rising under recoveries put ONGC and IOC FPO in limbo
Rising crude price has again tested the government in many
ways. The biggest casualty is the government staring at the
possibility of missing the disinvestment target of `40,000cr in
FY2011 with FPO of two major oil companies (ONGC and
IOC) in limbo. The problem is government's unwillingness to
share the mounting under recoveries beyond one-third of the
total under recovery and delay in the implementation of Kirit
Parikh committee's recommendation of freeing up diesel,
cooking gas and kerosene prices. This has led to the expectation
of total under recovery touching a whopping ~`70,000cr for
FY2011. Even on petrol, the price of which has been hiked six
times post its deregulation on June 26, 2010, is bearing the
brunt of the under recovery as the recent December 16, 2010,
price hike of ~`2.96/litre was still less than the required. The
EGoM meeting, scheduled on December 30, 2010, to take a
call on hiking diesel price is also postponed and, thus, only
time will tell how much courage the government shows in hiking
fuel prices to stem under recovery for FY2011.
GSPC - OMCs win `18,000cr gas pipeline bids
GSPC, along with its consortium partners (OMCs - IOC, HPCL
and BPCL), in a field so far dominated by GAIL and RIL, is set to
get authorisation for three major gas pipeline projects worth
`18,000cr. In the venture, GSPC and IOC owns 52% and 26%
stake, while HPCL and BPCL holds 11% each. The consortium
is said to be ahead of the other bidders (GAIL-Engineers India
and Adani-Welspun) in all the three projects put up for bidding.
However, the PNGRB has not yet declared the official winner
since an interim order of the Supreme Court has prevented it
from passing final decisions. PNGRB has requested the Supreme
Court to modify its order, since the government has notified
Section 16 of the PNGRB Act. The three trunk pipelines being
won by the consortium are Mallavaram-Bhilwara,
Mehsana-Bhatinda and Bhatinda-Jammu-Srinagar wherein
GSPL , its subsidiary would be the ultimate beneficiary of
contructing these pipelines. We have not factored these bids for
valuing GSPL, waiting for further operational and financial
visibility.
Oil & gas index underperforms the Sensex
On the bourses, the oil & gas index underperformed the Sensex
by 0.7% in 3QFY2011 despite significant outperformance by
index heavyweight RIL (59.9% weightage). After a substantial
fall of 9.3% in 2QFY2011, RIL registered robust gains of 7.3%
during 3QFY2011 due to the improving refining margin
scenario with cracks widening on the back of the cold weather.
However, the substantial increase of 12% in average crude price,
resulting in mounting under recoveries and reducing chances
of any further deregulation reforms, has proved to be a major
spoilsport for OMCs and upstream PSU companies. HPCL, BPCL
and IOC registered whopping loss of 23.1%, 12.3% and 18%,
respectively; whereas, ONGC and Oil India lost 7.7% and 7.2%,
respectively. Cairn also lost 1% despite robust gains in crude
price, as it awaits clearance for the Vedanta-Cairn Energy deal.
However, gains were seen in gas companies, with GAIL and
Petronet LNG posting robust gains of 7.4% and 18%,
respectively, on higher petchem margins and spot LNG imports,
respectively. Non-index gas companies, including IGL and GSPL,
also registered gains of 12.2 and 6.8%, respectively.
3QFY2011 expectations
ONGC is likely to report net realisation of US $65/bbl v/s
US $58/bbl in 3QFY2010 and US $63/bbl in 2QFY2011.
Despite the expected rise in subsidy burden by 45% to `43.2bn,
ONGC is expected to report the highest net realisation in the
last two years due to material increase in crude oil price
(US $85/bbl v/s US $79/bbl in 2QFY2011). However, the
positive effect of the spurt in crude oil price to some extent has
been offset by stronger INR/USD qoq, resulting in mere 2%
growth in the bottom line.
RIL is likely to post higher GRM qoq at US $9.3/bbl v/s
US $7.9/bbl. The spurt in GRMs could be attributed to higher
middle distillates crack and wider heavy-light crude oil spread.
Petchem margins are expected to improve due to better polymer
cracks over naphtha and higher polyester prices on account of
higher cotton prices globally. Higher petchem and refining
margins are expected to offset the dip in natural gas production
(55mmscmd v/s 60mmscmd) qoq from KG-D6.
Cairn, being highly leveraged to crude oil, is likely to benefit
from the spurt in crude oil price, although stronger INR/USD
will offset gains to a certain extent. Production from MBA fields
is likely to remain stagnant qoq due to approvals awaited from
JV partners and management committee for additional production.
GAIL is expected to report flat transmission volumes qoq. Higher
transmission tariff and petchem margins are offset by higher
subsidy burden, leaving bottom-line flatter qoq.
Petronet is likely to post volume growth qoq with the company
importing spot LNG cargoes due to lower production from KGD6.
For 3QFY2011, we expect volumes to stand at 106.6TBTUs.
GSPL’s bottom-line is likely to decline by 19% yoy, as we expect
tariff adjustment, which is happening over the last few quarters,
to adversely impact profitability. We expect volumes to increase
marginally by 2.5% yoy to 36mmscmd during 3QFY2011.
IGL's volumes are likely to grow by 29% yoy due to the recent
commonwealth games and remain flat qoq. Margins are likely to
be flat qoq and fall yoy due to increased sourcing of costlier gas.
Gujarat Gas' volumes will be supported by restart of the PMT
field and LNG imports . We expect the company to report volume
of 3.52mmscmd for the quarter, up 18.2% yoy and 2.8% qoq.
Overall, for 3QFY2011E, our universe of stocks is likely to
witness mixed performance.
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