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Oil & Natural Gas Corp – Clarity before divestment?
We believe the government's plan to divest its stake in ONGC would call for prior clarity on two
crucial issues: reimbursement on royalty relating to Rajasthan block (where we have already
assumed best case) and subsidy sharing (where positive surprise is possible). We maintain Hold
and our Rs1300 TP.
Rajasthan royalty issue still pending
Our estimates assume that the Indian government will fully reimburse ONGC the excess royalty
that it currently pays on the Rajasthan block (ONGC pays 100% share compared to its 30%
stake). Zero reimbursement is unlikely, in our view, but its negative impact on our EPS would be
Rs4-10/share over FY11-13F. There is a risk that the government may opt for some formula that
provides for some, but not full, reimbursement. Any such formula should result in a reasonable
DCF value for ONGC’s investments in Rajasthan and a positive correlation with global oil prices
and any rise in production forecasts.
Leverage to higher oil prices not clear
Historically, subsidy sharing by upstream companies has been in the 30-35% range (average
33%), but this policy is still ad hoc. If we assume upstream subsidy of one-third, ONGC will
benefit from rising global oil prices (especially with every rise in the domestic price of regulated
products). However, the one-third formula makes an implicit assumption that the government will
maintain 50-60% subsidy support, to which the finance ministry has been unwilling to commit,
increasing the risk of a higher upstream subsidy share. Basically, ONGC’s earnings could be
assumed to remain positively leveraged to higher oil prices only if the government implements a
subsidy or tax system at various oil price levels.
We use the one-third upstream sharing mechanism for our EPS estimates (in the absence of any
alternative). This results in net crude realisation from ONGC’s own domestic crude rising from
US$55.5/bbl in FY10 to US$64.2/bbl in FY13F. But, ONGC’s stock price is not positively
correlated with rising global oil prices, which probably reflects market scepticism on subsidies.
Hence, for our reserves DCF valuation, we cap oil realisations from ONGC’s own domestic crude
at US$60/bbl. Without this cap, our valuation would rise to Rs1350 (based on Brent US$88/bbl
and ONGC net realisation of US$64.2/bbl) and all else being equal.
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