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Reliance Industries (RIL)
Energy
E&P disappointment continues, others may follow. We see the recent
disappointments in RIL’s E&P segment as reflected in (1) the abandonment of the
second exploratory well in KG D-9 block and (2) further decline in gas production from
KG D-6 block to 50 mcm/d as providing downside risks to our fair valuation of RIL’s
emerging E&P segment. We do not see any positive triggers for the stock and do not
agree with the Street’s optimism about refining and chemical cycles. We retain our
REDUCE rating with a revised SOTP-based target price of `1,055 (`1,065 previously).
As per Hardy Oil’s press release, RIL-Hardy Oil consortium has plugged and abandoned the second
exploratory well in KG D-9 block. RIL has a 90% participating interest in the block. We highlight
that the consortium had revised gross risked prospective resources (best estimates basis) of KG D-9
block to 5.2 tcf in April 2010 from 10.6 tcf in May 2009, after abandonment of the first
exploratory well in October 2009. We await further clarity from the company before revising our
recoverable reserve estimate of 5.2 tcf of gas from RIL’s KG D-9 block. We currently ascribe fair
value of `18/share to KG D-9 block in our FY2012E SOTP of RIL.
Gas production from KG D-6 block declines further
As per recent media reports, KG D-6 gas production has declined further to 50-52 mcm/d for the
week ending December 26, 2010. We are concerned by the fact that RIL has informed DGH
recently that there are no plans to increase the production from current levels till 2013-14. We see
significant downside risk to our earnings estimates from potentially lower-than-expected gas
production given our generous assumptions. Our FY2012E and FY2013E EPS for RIL will decline to
`67 (-7.6%) and `70 (-13.1%), if gas production remains at 52 mcm/d versus our estimate of 70
mcm/d in FY2012E and 88 mcm/d in FY2013E.
E&;P disappointments add risks to RIL’s fair valuation
We highlight that the recent news flows on RIL’s E&P business have not been encouraging. The
disappointments from RIL’s E&P business include–(1) a sharp decline in gas production from KG D-
6 block, (2) recent decline in oil production from MA-1 field, (3) abandonment of two wells in KG
D-9 block and (4) downward revision in reserves of NEC-25 block. We see downside risk to
valuation of RIL’s E&P business from (1) downward revision in reserves/resources on account of
abandonment of wells, (2) lower value being ascribed to RIL’s other discovered blocks and (3)
lower option value being ascribed to RIL’s potential new E&P discoveries. We currently ascribe
`141/share to RIL’s emerging E&P business (NEC-25, KG D-3, KG D-9, MN D-4 and CBM). We
highlight that we assume significantly higher recoverable reserves for RIL's E&P blocks versus the
company's guidance
E&P segment needs to be the driver given the state of chemical and refining
cycles
We expect the refining and chemical cycles to remain subdued over the next 9-12 months given continued
global supply-demand imbalance.
Chemicals. We expect the global capacity utilization rate for ethylene and downstream
units to increase in CY2011-12E but note that operating rates will still be meaningfully
lower than the rates seen in 1996-2007 period (see Exhibit 4). Thus, we rule out any
meaningful recovery in chemical margins. In any case, chemical margins have held up
reasonably well over the past 12 months and we see limited scope for positive surprises.
Also, RIL’s selling prices seem to be at a huge premium to global prices (see Exhibit 5),
which increases risks to earnings from any narrowing of differential between domestic
and global prices.
Refining. In the case of refining, we expect (1) incremental global capacity addition of
3.2 mn b/d in CY2011-12E (including restart of previously closed units in the US) and
(2) OPEC NGL supply of 1 mn b/d to more than offset incremental increase in global
demand of 2.6 mn b/d over the same period. Exhibit 6 shows new capacity addition
broken down by regions and Exhibit 7 shows global oil demand and supply from OPEC,
non-OPEC and OPEC NGLs.
We note that the Street has positive expectations of a sharp recovery in chemical and
refining cycles over the next 12-18 months. We note that we already factor in improved
refining margins and elevated chemical margins in FY2012-13E (see Exhibits 8 and 9 for our
major assumptions on the refining and chemical segments).
Thus, we believe any disappointment in RIL’s chemical and refining segments may put the
burden of any potential outperformance on RIL’s E&P segment. This looks unlikely given the
recent developments concerning RIL’s E&P segment. On the contrary, the spate of negative
developments in E&P segment may be a drag on stock performance even if the other
segments perform in line with our expectations. We also note downside risks to the earnings
of the E&P segment from higher-than-expected taxation. We assume that RIL will get
income tax exemption for gas production from KG D-6 block. However, if the tax exemption
is not available, we note that our FY2012E and FY2013E EPS will decline by 8.8% and 9.8%
to `66 and `73.
Earnings revision
We have revised our FY2011-13E EPS to `58 (-2.9%), `72 (-0.8%) and `81 (-5.6%) to
reflect (1) lower gas production from KG D-6 block, (2) higher crude price assumption,
(3) change in exchange rate assumption and (4) other minor changes. We discuss the same
in detail below:
Gas production from KG D-6 block. We have revised our estimate of gas production
form RIL’s KG D-6 block for FY2011E to 56 mcm/d versus 57.5 mcm/d previously. We
note that RIL has achieved a production rate of 58.5 mcm/d in 1HFY2011 and the current
production rate stands at ~50-52 mcm/d. We maintain our gas production estimate of
70 mcm/d for FY2012E and 88 mcm/d for FY2013E.
Crude oil prices. We have revised our crude price assumption to US$82/bbl for FY2011E
and US$85/bbl for FY2012E versus US$79/bbl and US$81/bbl previously. We maintain our
long-term crude price assumption of US$85/bbl.
Exchange rate assumption. We have revised our exchange rate assumption for FY2011-
13E to `45.6/US$, `45.5/US$ and `44/US$ from `45.5/US$, `44.5/US$ and `44.5/US$.
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