Oil & Gas (Awaiting further regulatory reforms, but high oil prices a dampener): ICICI Securities

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Oil & Gas (Awaiting further regulatory reforms, but high oil
prices a dampener) Neutral
PSU upstream and gas utility companies are our preferred bets in the oil &
gas space for CY11. On the valuation front, the BSE oil & gas index, has
most of the times traded in the P/E range of 12-18x and is hovering at a P/E
of ~14x over the last couple of quarters. Based on FY10 numbers, OMCs
are currently trading at P/BV multiples of 1.2 to 1.9x. Upstream PSU
companies are currently trading at a P/E of 10-10.2x FY12E EPS.

⇒ We believe the government would implement regulatory reforms
ahead of the upcoming FPOs of ONGC and IOC. We expect the
clarity on the subsidy sharing mechanism to augur well for PSU
companies. We prefer to play reforms in the oil & gas sector through
upstream companies (Oil India and ONGC) on account of better risk
reward trade-off, reasonable valuations and possible exploratory
upside
⇒ We expect crude oil prices to remain at ~US$ 80-85 per barrel in
CY11 on the back of increased demand from emerging countries,
stable global outlook and higher liquidity in the system
⇒ Hence, we expect private upstream and refining companies (Cairn
and Reliance Industries) to report improved profitability compared to
last year. We believe the Singapore gross refining margins (GRMs) to
remain stable at current levels of US$4-5 per barrel in the next year
on increased heavy-light crude oil spreads
⇒ We remain cautious on oil marketing companies (OMCs – HPCL,
BPCL and IOC) if crude oil prices sustain above $90 per barrel. At
higher oil prices, the implementation of reforms could become
politically sensitive and would lead to an increase in oil under
recoveries. We expect under recoveries at ~| 70,500 crore at oil
prices of US$85 per barrel in FY12E. The under recoveries would
reduce by ~| 18,000 crore to ~| 52,500 crore if the government
decides to increase diesel and LPG prices by | 2 per litre and | 50
per cylinder, respectively (HPCL would be major beneficiary). We
assume subsidy sharing for upstream companies at 33.3%,
government at 50% & OMCs at 16.7%
⇒ We prefer gas utility companies (GAIL, GSPL & Petronet LNG) as
defensive bets in the oil & gas sector on the back of a stable increase
in gas supply volumes. Expansion of the national gas grid and city
gas distribution (CGD) network (capex of | 69,000 crore over the next
four or five years) would help to report good profit growth.