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Essar Oil Ltd.
▲ Overweight
Previous: Neutral
ESRO.BO, ESOIL IN
Good time to own complex refining; Upgrade to OW
• Time to own complex refiners: ESOIL's refinery expansion is expected
to be complete by 2QFY12, significantly raising its ability to process
tougher crudes and optimize its product slate. With global diesel demand
remaining robust, complex refiners with a diesel tilt would benefit from
higher diesel spreads and widening light-heavy differentials. We expect
an EPS CAGR of 58% over FY11-14, and upgrade to Overweight, with
a Mar-12 PT of Rs160, implying 26% upside from current levels.
• Rising complexity simplifies investment case: Post the expansion to
18MMT (and then to 20MMT in FY13/14), ESOIL's refinery Nelson
Complexity Index will rise to 11.8 (from 6.1) with addition of significant
secondary processing capacity - enabling ESOIL to capitalize on
structurally strong diesel spreads. Higher complexity will also allow the
company to take advantage of wider light-heavy crude differentials. We
expect GRMs to stabilize at a level of $8.5/bbl (vs. $7.2/bbl currently).
• Product placement unlikely to be an issue, valuations are attractive:
Expansion will add only 4-6mMT of product to market – this should be
easily absorbed in the Indian market and acquisition of Stanlow provides
further flexibility on placement. Essar trades at c.6.8x EV/Ebitda and
implied EV/bbl of US$16,430 and an EV/complexity bbl of US$1,400.
• Raniganj closer to commercialization: ESOIL expects to commence
commercial sales of CBM gas from the Raniganj field by April-11. At a
plateau production of 3.5mmscmd for 12 years, we estimate an NPV of
$270mn for this asset.
• Upgrade to Overweight: We upgrade ESOIL to Overweight, with a
Mar-12 price target of Rs160. Our PT is EV/EBITDA (8.0x) based for
the main refining business, with an NPV valuation for Raniganj asset and
sales tax/income tax benefits. We are not attributing any value to E&P
potential, retail upsides. Key risks to our call are delays in the refinery
expansion project and an economic slowdown affecting refining.
Complexity wins in the refining world
The refining industry has been plagued with overcapacity, significantly impacting
GRMs in 2009. Better discipline among refiners, coupled with mothballing of suboptimal
capacities has seen GRMs rise from the lows of '09, but remain range-bound,
and on an industry wide basis, are unlikely to match the highs seen from '04-'07.
A key trend that has emerged is the change in the demand mix for refined products.
Diesel accounted for ~44% of total incremental crude demand in 2010, and is
expected to account for ~53% of incremental demand in 2011. Were the global
refining system to stand-still (a highly unlikely scenario), refiners would need to
process ~800kbopd of crude in addition to the ~1.7mbopd of incremental crude in
2011. To incentivize refiners to adjust product slates, diesel spreads are likely to
remain robust, with a drop at both the light and heavy ends of the barrel, with spreads
on products such as gasoline, naphtha and LPG declining.
In the short term too, diesel spreads are likely to continue their robust run per J. P.
Morgan's Global Commodity team quoted below.
The end of the first quarter signifies conclusion of peak heating oil demand across
the northern hemisphere. Middle distillate cracks typically weaken, as demand
tapers off and refineries to move towards higher gasoline yields. This year, however,
several factors seem to be supporting middle distillate cracks above seasonal norms.
First, a very cold winter in Europe has drawn down heating oil inventories.
Germany, Europe’s largest heating oil market saw consumer heating oil stocks fall
to the lower-end of the five-year range at the start of March, according to MWV, the
German oil industry association. Furthermore, the residual impacts of a very strong
La Niña weather effect has left parts of Latin America facing drought conditions and
implies lower hydroelectric output. Regional utilities and governments are turning to
gasoil-fired power plants to bolster electricity generation. Venezuela announced
yesterday that it will increase gasoil supplies to power stations in order to avert
further blackouts that had affected the capital recently. Lastly, additional demand
from Asia is expected, most notably from Japan, following the earthquake, as use of
backup power generators increases, given the current electricity grid problems.
These reports suggest that demand for gasoil in the short-term are likely to be
stronger than would normally be the case and this adds to the structural bias we see
for demand growth to be concentrated in the middle distillate part of the barrel, as
world trade expands, driven by the global economic recovery. Taking all of the
above into consideration, it would seem likely that gasoil futures should outperform
gasoline over the short term. But by the middle of 2Q11, the higher feedstock costs
linked to marginal production of US gasoline as was highlighted in yesterday’s Daily
Oil Note, may yet reverse the situation, particularly as some of the temporary factors
supporting gasoil should start to fade as we approach the middle of the year
In such an environment, complex refiners, which have a greater ability to process a
wide variety of crudes and hence attain optimized product slates are likely to be key
beneficiaries.
ESOIL is expected to complete the first phase of its refinery expansion project in
2QFY12, with capacity rising from ~14MMT currently to 18MMT. More
importantly, the complexity of the refinery will rise from 6.1 to 11.8, significantly
boosting ESOIL's ability to process tougher crudes, and achieve a more desirable
product slate. Widening light-heavy crude differentials would benefit ESOIL going
forward, aiding it to earn a greater premium over benchmark regional GRMs.
We expect ESOIL GRMs to average $8.5/bbl over FY12-13, as the company benefits
from added high value product sales and takes advantage of light-heavy crude
differentials.
Investment positives
Higher complexity
An increase in Nelson complexity allows a refinery to process a wider variety of
crudes, and allows the refiner the opportunity to optimize its product slate, increasing
production of higher value light and middle distillates.
With an increase in complexity from 6.1 to 11.8, ESOIL will optimize production of
diesel and gasoline - leading to an increase in GRMs from the average of $5-6/bbl in
the past to ~$8.5/bbl post the expansion.
Increasing use of Mangala crude
ESOIL currently processes ~30kbopd of crude from Cairn’s Mangala field. Post the
refinery expansion, the refinery would be able to process ~60kbopd of Mangala
crude. This would allow the company to save on transportation costs and taxesadding
~$0.5-1/bbl to GRMs.
Use of gaseous fuels
ESOIL plans to use gaseous fuels in the refinery (replacing liquid fuels such as fuel
oil). Spur pipelines have already been put in place to transport gas to the refinery.
While the allocated gas from RIL’s D6 field is unlikely to be supplied in the nearterm
given that production has not yet ramped up, the presence of infrastructure gives
ESOIL the option of using LNG until supplies of domestic gas commence.
At current prices, the delivered cost of LNG is ~$11-12/mmbtu, lower than the ~14-
15/mmbtu cost of fuel oil. This switch would aid GRMs, by reducing operating costs.
E&P
In addition to the Raniganj CBM gas field, ESOIL has significant CBM acreages
across India, making it the largest holder in this niche. The Rajmahal and Mehsana
fields are particularly attractive, and could provide an ongoing boost to E&P earnings
in the next few years, which we do not yet factor in. The Ratna/R-series fields, off
the west coast are proven fields - however, production has not commenced, as
ESOIL is yet to finalize the PSC (production sharing contract) with the government
for the same.
Fuel retailing
ESOIL is expected to expand its retail network to ~1700 outlets shortly. While petrol
de-regulation had worked very well from June '10 through to January this year, petrol
prices have remained static, while Brent has rallied ~18%, leading to losses of
~Rs5/lt on petrol, and Rs15.5/lt on diesel. However, we do expect a window for
further reform to open post the state elections in May this year. Continued
uncertainty in the Middle East/North Africa could adversely impact near-term crude
prices, making reform difficult (Our global commodities team highlights that Brent
could reach $130/bbl in the near term, on supply led worries before settling down at
lower levels).
ESOIL averages sales of ~45KL per day from each retail outlet, which is 1/3rd the
throughput from state owned outlets. In the event of meaningful reform of diesel
pricing (~75-80% of auto fuel market), ESOIL could see a significant uptick in
revenues (adding ~10% in market cap terms). As total diesel de-regulation is likely to
be a long-term event, we do not factor upsides from retailing into our estimates.
Valuations and risks
We introduce a new March-12 price target of Rs160, and upgrade the stock to
Overweight. Our PT is based on an EV/EBITDA multiple for the refining business
(8x – at par with regional peers), and NPV valuations for the Raniganj CBM field,
and the sales tax and income tax benefits. We do not ascribe any value to the other
E&P blocks, which remain a while away from commercialization, or to the potential
refinery expansion to 38mmtpa and fuel retailing ramp-up.
Key risks to our call include a delay in the refinery expansion project, and a renewed
global economic slowdown affecting the cyclical refining business.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Essar Oil Ltd.
▲ Overweight
Previous: Neutral
ESRO.BO, ESOIL IN
Good time to own complex refining; Upgrade to OW
• Time to own complex refiners: ESOIL's refinery expansion is expected
to be complete by 2QFY12, significantly raising its ability to process
tougher crudes and optimize its product slate. With global diesel demand
remaining robust, complex refiners with a diesel tilt would benefit from
higher diesel spreads and widening light-heavy differentials. We expect
an EPS CAGR of 58% over FY11-14, and upgrade to Overweight, with
a Mar-12 PT of Rs160, implying 26% upside from current levels.
• Rising complexity simplifies investment case: Post the expansion to
18MMT (and then to 20MMT in FY13/14), ESOIL's refinery Nelson
Complexity Index will rise to 11.8 (from 6.1) with addition of significant
secondary processing capacity - enabling ESOIL to capitalize on
structurally strong diesel spreads. Higher complexity will also allow the
company to take advantage of wider light-heavy crude differentials. We
expect GRMs to stabilize at a level of $8.5/bbl (vs. $7.2/bbl currently).
• Product placement unlikely to be an issue, valuations are attractive:
Expansion will add only 4-6mMT of product to market – this should be
easily absorbed in the Indian market and acquisition of Stanlow provides
further flexibility on placement. Essar trades at c.6.8x EV/Ebitda and
implied EV/bbl of US$16,430 and an EV/complexity bbl of US$1,400.
• Raniganj closer to commercialization: ESOIL expects to commence
commercial sales of CBM gas from the Raniganj field by April-11. At a
plateau production of 3.5mmscmd for 12 years, we estimate an NPV of
$270mn for this asset.
• Upgrade to Overweight: We upgrade ESOIL to Overweight, with a
Mar-12 price target of Rs160. Our PT is EV/EBITDA (8.0x) based for
the main refining business, with an NPV valuation for Raniganj asset and
sales tax/income tax benefits. We are not attributing any value to E&P
potential, retail upsides. Key risks to our call are delays in the refinery
expansion project and an economic slowdown affecting refining.
Complexity wins in the refining world
The refining industry has been plagued with overcapacity, significantly impacting
GRMs in 2009. Better discipline among refiners, coupled with mothballing of suboptimal
capacities has seen GRMs rise from the lows of '09, but remain range-bound,
and on an industry wide basis, are unlikely to match the highs seen from '04-'07.
A key trend that has emerged is the change in the demand mix for refined products.
Diesel accounted for ~44% of total incremental crude demand in 2010, and is
expected to account for ~53% of incremental demand in 2011. Were the global
refining system to stand-still (a highly unlikely scenario), refiners would need to
process ~800kbopd of crude in addition to the ~1.7mbopd of incremental crude in
2011. To incentivize refiners to adjust product slates, diesel spreads are likely to
remain robust, with a drop at both the light and heavy ends of the barrel, with spreads
on products such as gasoline, naphtha and LPG declining.
In the short term too, diesel spreads are likely to continue their robust run per J. P.
Morgan's Global Commodity team quoted below.
The end of the first quarter signifies conclusion of peak heating oil demand across
the northern hemisphere. Middle distillate cracks typically weaken, as demand
tapers off and refineries to move towards higher gasoline yields. This year, however,
several factors seem to be supporting middle distillate cracks above seasonal norms.
First, a very cold winter in Europe has drawn down heating oil inventories.
Germany, Europe’s largest heating oil market saw consumer heating oil stocks fall
to the lower-end of the five-year range at the start of March, according to MWV, the
German oil industry association. Furthermore, the residual impacts of a very strong
La Niña weather effect has left parts of Latin America facing drought conditions and
implies lower hydroelectric output. Regional utilities and governments are turning to
gasoil-fired power plants to bolster electricity generation. Venezuela announced
yesterday that it will increase gasoil supplies to power stations in order to avert
further blackouts that had affected the capital recently. Lastly, additional demand
from Asia is expected, most notably from Japan, following the earthquake, as use of
backup power generators increases, given the current electricity grid problems.
These reports suggest that demand for gasoil in the short-term are likely to be
stronger than would normally be the case and this adds to the structural bias we see
for demand growth to be concentrated in the middle distillate part of the barrel, as
world trade expands, driven by the global economic recovery. Taking all of the
above into consideration, it would seem likely that gasoil futures should outperform
gasoline over the short term. But by the middle of 2Q11, the higher feedstock costs
linked to marginal production of US gasoline as was highlighted in yesterday’s Daily
Oil Note, may yet reverse the situation, particularly as some of the temporary factors
supporting gasoil should start to fade as we approach the middle of the year
In such an environment, complex refiners, which have a greater ability to process a
wide variety of crudes and hence attain optimized product slates are likely to be key
beneficiaries.
ESOIL is expected to complete the first phase of its refinery expansion project in
2QFY12, with capacity rising from ~14MMT currently to 18MMT. More
importantly, the complexity of the refinery will rise from 6.1 to 11.8, significantly
boosting ESOIL's ability to process tougher crudes, and achieve a more desirable
product slate. Widening light-heavy crude differentials would benefit ESOIL going
forward, aiding it to earn a greater premium over benchmark regional GRMs.
We expect ESOIL GRMs to average $8.5/bbl over FY12-13, as the company benefits
from added high value product sales and takes advantage of light-heavy crude
differentials.
Investment positives
Higher complexity
An increase in Nelson complexity allows a refinery to process a wider variety of
crudes, and allows the refiner the opportunity to optimize its product slate, increasing
production of higher value light and middle distillates.
With an increase in complexity from 6.1 to 11.8, ESOIL will optimize production of
diesel and gasoline - leading to an increase in GRMs from the average of $5-6/bbl in
the past to ~$8.5/bbl post the expansion.
Increasing use of Mangala crude
ESOIL currently processes ~30kbopd of crude from Cairn’s Mangala field. Post the
refinery expansion, the refinery would be able to process ~60kbopd of Mangala
crude. This would allow the company to save on transportation costs and taxesadding
~$0.5-1/bbl to GRMs.
Use of gaseous fuels
ESOIL plans to use gaseous fuels in the refinery (replacing liquid fuels such as fuel
oil). Spur pipelines have already been put in place to transport gas to the refinery.
While the allocated gas from RIL’s D6 field is unlikely to be supplied in the nearterm
given that production has not yet ramped up, the presence of infrastructure gives
ESOIL the option of using LNG until supplies of domestic gas commence.
At current prices, the delivered cost of LNG is ~$11-12/mmbtu, lower than the ~14-
15/mmbtu cost of fuel oil. This switch would aid GRMs, by reducing operating costs.
E&P
In addition to the Raniganj CBM gas field, ESOIL has significant CBM acreages
across India, making it the largest holder in this niche. The Rajmahal and Mehsana
fields are particularly attractive, and could provide an ongoing boost to E&P earnings
in the next few years, which we do not yet factor in. The Ratna/R-series fields, off
the west coast are proven fields - however, production has not commenced, as
ESOIL is yet to finalize the PSC (production sharing contract) with the government
for the same.
Fuel retailing
ESOIL is expected to expand its retail network to ~1700 outlets shortly. While petrol
de-regulation had worked very well from June '10 through to January this year, petrol
prices have remained static, while Brent has rallied ~18%, leading to losses of
~Rs5/lt on petrol, and Rs15.5/lt on diesel. However, we do expect a window for
further reform to open post the state elections in May this year. Continued
uncertainty in the Middle East/North Africa could adversely impact near-term crude
prices, making reform difficult (Our global commodities team highlights that Brent
could reach $130/bbl in the near term, on supply led worries before settling down at
lower levels).
ESOIL averages sales of ~45KL per day from each retail outlet, which is 1/3rd the
throughput from state owned outlets. In the event of meaningful reform of diesel
pricing (~75-80% of auto fuel market), ESOIL could see a significant uptick in
revenues (adding ~10% in market cap terms). As total diesel de-regulation is likely to
be a long-term event, we do not factor upsides from retailing into our estimates.
Valuations and risks
We introduce a new March-12 price target of Rs160, and upgrade the stock to
Overweight. Our PT is based on an EV/EBITDA multiple for the refining business
(8x – at par with regional peers), and NPV valuations for the Raniganj CBM field,
and the sales tax and income tax benefits. We do not ascribe any value to the other
E&P blocks, which remain a while away from commercialization, or to the potential
refinery expansion to 38mmtpa and fuel retailing ramp-up.
Key risks to our call include a delay in the refinery expansion project, and a renewed
global economic slowdown affecting the cyclical refining business.
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