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OIL & GAS INDUSTRY OVERVIEW
Key observations
We believe that crude oil price will cross over USD$100/bbls in the near future
mainly on account of steady global economic recovery, severity of winter in Europe
and North America, gush of liquidity due to two rounds of quantitative easing undertaken by the US Federal Reserve, rising demand from Asian economies like China
and India and dollar depreciation. A weaker U.S. dollar is making commodities like
oil more attractive to global players. However, we believe that the crude oil price
rise will be gradual and steady.
Institute for Supply Management (ISM) reported that economic activity in the U.S.
manufacturing expanded for the 17th consecutive month in December 2010. ISM
stated that its Purchasing Managers Index (PMI), a key gauge of the direction of the
U.S. economy, rose to 57 last month - a 0.4-percentage point gain from November
2010.
The key beneficiaries of the rising crude oil price are the upstream exploration companies like Cairn India, Selan exploration and Hindustan oil exploration. The
surge in crude oil price not only improves the realization but also improves the margins. These companies have undertaken huge exploration activity in the last few
years and are now ready to monetize their reserves.
Performance Analysis
We have observed that majority of the crude oil related commodities have been
trading above the average price of last three years.
In December 2010, the average Brent crude oil price surged by 7.6% to USD$92.8/
bbls (MoM) as against an average of USD$86.3/bbls (MoM) in November 2010. The
average Henry Hub Natural gas price surged by 14.3% to an average of USD$4.2/
mmbtu during the same period.
With the rising spread between crude oil and natural gas prices, due to vast supplies
of gas from shale formations in North America, it has become financially appealing
to turn natural gas into liquid fuels. In order to monetize this opportunity, Sasol Limited (South African firm) has recently announced to turn natural gas into diesel and
other liquids. In this regard, it will invest ~ 1 billion US dollars to acquire stake in a
Canadian shale gas field.
In Dec'10, the average Singapore refining margins surged by 208% and 11.8% to
USD$5/bbls as against an average of USD$1.6/bbls in Dec'09 and an average of
USD$4.4/bbls in Nov'10, respectively. We are bullish on refining margins going forward mainly due to rising demand from developing economies and more severe
than expected winter in Europe and North America. The key beneficiaries will be
RIL, MRPL and Essar oil.
Sensex v/s Oil and Gas sector performance analysis
In the last one month, Sensex has given a return of 3.01% whereas Bse Oil and Gas
Index has given 3.73% return i.e. Bse oil and gas Index has outperformed Sensex
marginally. The key performers in the oil and gas index are Aban offshore (10.58%),
Essar Oil (7.76%), Gail (7.25%), Cairn (6.02%) and RIL (5.65%). Oil marketing companies (IOCL, BPCL and HPCL) has dragged the index down by negative performance mainly due to rising under-recoveries on retail fuel oil sales.
Key Concerns
n China's interest-rate and reserve requirement hike added to concern that global
economic growth will slow thereby reducing energy demand.
n Slower economic growth in the developed economies, may impact the demand
of crude oil and fuel products.
n Delay in de-regulation will impact the profitability of all OMCs.
n Strengthening of US Dollar
Crude oil price is trading above the last three years average price.
The key factors supporting this rally are as follows:
n Expected steady global economic recovery
n More severe than expected winter in Europe and North America
n Rising demand from Asian economies like China and India
n Dollar depreciation (makes commodities attractive to investors)
n Gush of liquidity due to two rounds of quantitative easing undertaken by the US
Federal Reserve
n Accelerating manufacturing activity in industrialized economies
n Institute for Supply Management (ISM) report that economic activity in the U.S.
manufacturing expanded for the 17th consecutive month in Dec’10. Moreover,
ISM concluded that the overall economy grew for the 20th straight month during
the period. ISM stated that its Purchasing Managers Index (PMI), a key gauge of
the direction of the U.S. economy, rose to 57 last month— a 0.4-percentage
point gain from Nov’10.
We believe the commodity price is expected to sustain its rally in the near future,
with crude price likely to cross over USD$100/bbls.
n HHNG is trading below the last three years average price mainly on the concern
of vast supply of natural gas in the US.
The chart reflects that spread between Brent crude oil and Henry Hub Natural gas
price has already crossed the last three years average price and is heading towards
last three years high of USD$75.5/boe. This reflects that the natural gas prices failed
to keep pace with the price of crude oil mainly on account of fear of shale gas supply glut in the US.
Major development-Turning natural gas into liquid fuels:
As mentioned above, the widening of spread between crude oil and natural gas
prices, due to vast supplies of gas from shale formations in North America have
driven prices down and made it financially appealing to turn natural gas into liquid
fuels.
Sasol, a South African firm, recently announced that it will invest ~ 1 billion US
dollars to acquire stake in a Canadian shale gas field, so it can explore turning natural gas into diesel and other liquids. The Company aims to convert gas into a mix of
liquids i.e. 80 percent diesel fuel, 15 percent naphtha and 5 percent liquid propane.
We believe more such developments will ensure future product supply
BDCS is trading slightly above the last three years average price but far higher than
its lows.
Brent crude oil is lighter crude as compared to Dubai crude, so Brent crude oil trades
at a premium to Dubai crude oil. All complex refineries have the capacity to process
heavy crude like Dubai crude. The spread between the heavy crude and light crude
oil gives an indication of the incremental margins that a complex refinery will make
over the simple refinery.
We believe companies having complex refining capacity like RIL, Essar Oil, MRPL
and others will show good improvement in GRMs in Q3FY11.
During the period under-review, the correlation between Dollar Index and Crude oil
is - 0.77 which reflects strong inverse relation.
n All global commodities are mainly traded in US dollar. Hence, price of dollardenominated commodities tend to rise when the US currency weakens i.e. there
exists an inverse relationship between the US dollar and the other asset classes.
n The US dollar Index tracks the US currency's progress against a basket of six
leading currencies - EUR (Euro), JPY (Japanese yen), GBP (Pound sterling), CAD
(Canadian dollar), CHF (Swiss franc) and SEK (The Swedish krona).
n The US Dollar Index (USDX) indicates the general intrinsic value of the USD. The
USDX does this by averaging the exchange rates between the USD and six major
currencies.
n We believe one of the key factors strengthening the crude oil prices is the weakening of the US Dollar
n The surge in refining margin was led by an increase in Naphtha cracks, Gasoline
cracks and Diesel cracks.
n Accelerating manufacturing activity in industrialized economies led to rise in demand for fuel oil
n We are bullish on refining margins due to rising demand mainly on account of
cold winter in Europe and North America, steady economic growth in US and rising demand from Asian economies like China and India, etc.
n Naphtha and Dubai crude oil price spread is trading very close to its last three
years high and far above its average, which reflects the rising demand of naphtha and improving profitability of refineries.
n The fuel's crack, a measure of refining profitability, expanded, month on month.
n Asian gasoline's premium to naphtha widened after prices of the motor fuel
reached a two-year high.
n Currently, GNS is trading below its last three years average spread.
n Naphtha is used primarily as feedstock for producing a high-octane gasoline
component via the catalytic reforming process. The reforming margin (gasoline's
premium to naphtha) measures increased demand for chemicals used plastic
pipes to shopping bags.
n Bigger gap signals naphtha is less valuable to refiners relative to gasoline. A narrower reforming margin could prompt Asia's refiners to switch to naphtha from
gasoline.
n Currently, LPG price is trading close to its peak in the last three years and is
expected to rise further due to rising demand. LPG is the generic name for propane and butane gas. The mixture is predominantly propane in winter and butane in summer.
n India is the largest consumer of LPG in Southeast Asia, and it meets its domestic
demand by importing about 3Mn MTPA of cooking gas. In FY11, the demand of
LPG is expected to rise to14 Mn MTPA by the Petroleum Planning Analysis Cell.
The country's dependence on LPG imports is increasing due to a 5-8% annual
growth in consumption.
n International price of LPG has soared due to winter demand. Consequently, the
subsidy on every cylinder is set to jump to Rs 367 per refill from January 1, which
is more than the retail price of Rs 345.35 in Delhi. The oil ministry is planning to
raise cooking gas prices by Rs 50-100 per cylinder.
n We expect the demand will soar with the implementation of the Rajiv Gandhi
LPG Vitrak Yojana that envisages covering 75% of India's population by 2015.
Indian's Refinery performance
n India's Nov'10 oil refining falls for fourth successive month.
n Indian refiners, including RIL and BPCL, reduced crude-oil processing in Nov'10
for the fourth consecutive month. India's refining capacity has been augmented
to 186 Mn MTPA as against the annual demand of about 138 MMTPA leaving
us with a surplus capacity of 48Mn MTPA for exports.
n Further refining capacity addition is expected from the refinery project at Bina, (6
MMPPA), the Bhatinda refinery project and the Paradeep refinery project.
n The correlation between Sensex and Bse Oil and Gas Index is ~ 72.58%, during
the period under review.
n In the last one month, Sensex has given a return of 5.22% whereas Bse Oil and
Gas Index has given 5.92% return i.e. Bse oil and gas Index has outperformed
Sensex marginally.
n We are bullish on Cairn India, Selan Exploration and HOEC and believe rising
crude oil prices will improve their margins.
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