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Reliance Industries (RIL)
Energy
DGH versus RIL. In a recent meeting of the management committee (MC) of the KG
D-6 block, the DGH has highlighted several shortfalls versus the field development plan
(FDP). These include (1) lower-than-agreed wells under production in D1 and D3 fields,
(2) delays in identifying drilling locations in laminated sand and channel area and
(3) RIL’s target of starting new development wells in mid-2014. RIL has reportedly
indicated production of 52-53 mcm/d in FY2012E and 46-47 mcm/d in FY2013E.
We retain REDUCE on RIL with a 12-month SOTP-based target price of `1,000.
DGH highlights several shortcomings in complying with FDP of KG D-6 block
As per a report in Infraline dated April 14, 2011, the DGH has highlighted several shortfalls in RIL’s
execution of the FDP of KG D-6 block. (1) RIL has currently 18 wells under production in D1 and
D3 fields as against a target of 22 wells by April 1, 2011 and 31 by April 1, 2012. (2) There is
limited progress in identifying drilling locations in laminated sand and channel areas, which hold
about 3.5 tcf of proved reserves and 8 tcf of probable reserves.
Production targets well short of our/the Street’s estimates; overall production may fall short
RIL has apparently indicated production of 44 mcm/d in FY2012E and 38 mcm/d in FY2013E from
18 wells in D1 and D3 fields. The FY2012E figure is in line with our estimate (total production of
52 mcm/d including 8 mcm/d from MA-1 field) but FY2013E indication is far below our estimate
of 57 mcm/d (65 mcm/d including MA-1 field). The FDP envisages production of 62 mcm/d by
end-FY2011 from 22 fields and 80 mcm/d by end-FY2012 from 31 fields. RIL has indicated that it
will drill another three wells in addition to two completed wells but will start production from
these five new wells by mid-2014. We model total production of 17.1 tcf from RIL’s KG D-6 block
against 16.6 tcf of proved plus probable reserves.
Grave risks to gas supply in India; likely severe under-utilization of downstream assets
We believe it would be best to take cognizance of likely lower gas supply in India and its severe
implications for downstream companies (GAIL, GSPL) that are building downstream infrastructure
at a frenetic pace. The DGH’s observations (see Exhibits 1 and 2) should put to rest the market’s
feeble hope that RIL may be suppressing production to extract higher prices from the government.
We dismiss this notion as unduly optimistic and specious. In our April 8, 2011 report titled Gone
with the gas, we discuss the likely severe under-utilization of downstream units (pipelines and LNG
import terminals) and related impact on companies’ earnings and valuations.
Implications of lower gas production from KG D-6 block
We have discussed this issue in great detail in our April 8 report Gone with the gas. We
highlight the key points for the sake of completeness but focus on developments post the
report.
Negative implications for RIL’s earnings and valuation. We estimate RIL’s FY2012E
EPS and FY2013E EPS at `66 and `72 based on KG D-6 block gas production of 52
mcm/d and 65 mcm/d. RIL’s FY2013E EPS may decline by 4% if we model gas production
at 46 mcm/d in line with latest ‘guidance’ from RIL and KG D-6 oil production at 15,000
b/d compared to our assumption of 30,000 b/d.
Furthermore, failure to meet peak production rates of 80 mcm/d for the D1 and D3 fields
will likely lead to (1) reassessment of recoverable reserves in KG D-6 block and (2) lower
valuation of other blocks such as KG D-3, KG D-9, MN D-4 and NEC-25. We ascribe
`257/share (`766 bn) to RIL’s E&P segment in our SOTP valuation (see Exhibit 3). Out of this,
we value KG D-6, KG D-3, KG D-9, MN D-4 and NEC-25 blocks at `190/share (`526 bn).
Negative implication for GAIL’s gas transmission volumes, earnings and valuation.
We see downside risks to GAIL’s transmission volumes from lower-than-expected gas
supply. We model GAIL’s FY2012E, FY2013E and FY2014E gas transmission volumes at
127 mcm/d, 144 mcm/d and 162 mcm/d against 118 mcm/d in FY2011E. GAIL is in the
process of setting up several long-distance pipelines, whose capacity utilization may be
quite low in the initial years of operation unless RIL can ramp up production from its KG
D-6 block and India is able to source sufficient spot LNG at reasonable prices.
Exhibit 4 shows our estimates of gas transmission volumes of GAIL’s new pipelines and
compares the same with their stated capacity. We note that the regulator will likely
compute the tariffs based on its standard capacity utilization assumptions of 50%,
60%, 70%, 80% and 90% in the first five years of operation of the pipeline and 100%
thereafter.
Negative implication for GSPL’s gas transmission volumes, earnings and valuation.
We see downside risks to GSPL’s transmission volumes from lower-than-expected gas
supply. We model GSPL’s FY2012E, FY2013E and FY2014E gas transmission volumes at
40 mcm/d, 46 mcm/d and 50 mcm/d compared to 36 mcm/d in FY2011E (35.3 mcm/d in
3QFY11).
Reallocation of KG D-6 gas triggered by dip in production. The oil ministry recently
modified the original allocation of KG D-6 gas to meet the demands of the priority
sectors in light of the sharp decline in production from the block. The ministry had
previously provided for a pro rata cut to be imposed on all firm consumers in the case of
insufficient gas availability. However, the oil ministry has modified its earlier order and has
asked RIL to meet the entire allocation for the priority sectors—(1) fertilizer, (2) LPG,
(3) power and (4) city gas distribution. If gas availability is insufficient to meet the firm
demand of these four sectors, the least important sector in the order of priority will face
cuts first.
Exhibit 6 gives the original allocation of gas from RIL’s KG D-6 block. We note that EGoM
had allocated 63 mcm/d on a firm basis of which the power sector was allocated 33
mcm/d, fertilizer sector 16 mcm/d and LPG 3 mcm/d. Thus, the allocation to these three
sectors is modestly higher than RIL’s current production of 49 mcm/d from the KG D-6
block. This would result in no gas being available to petrochemical plants, refineries, steel
plants from the KG D-6 block and they will have to depend on liquid fuels or high-priced
imported LNG. We expect the profitability of these industrial units to be impacted by
(1) current high levels of crude oil and FO/diesel prices and (2) high spot LNG prices given
adverse developments in Japan. Exhibit 7 lists of petrochemical plants, steel plants and
refineries, which had been allocated gas from KG D-6 block on a firm basis.
No arbitrage opportunity for GAIL. We highlight that a recent decision of the oil
ministry has closed the arbitrage that GAIL was availing by (1) charging a consumer of KG
D-6 gas on a ‘ship or pay’ basis and (2) charging transmission tariff for the imported LNG
that was consumed by these units to make up for the shortfall from the KG D-6 block.
The oil ministry has stated that “once the customer has booked certain capacity on GAIL's
pipeline, and in the situation that booked capacity is not entirely utilized for the flow of
D-6 gas, the customer should be allowed to utilize the booked capacity without payment
of additional tariff for transportation of spot RLNG so as to meet the shortfall in supply of
D-6 gas.”
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Reliance Industries (RIL)
Energy
DGH versus RIL. In a recent meeting of the management committee (MC) of the KG
D-6 block, the DGH has highlighted several shortfalls versus the field development plan
(FDP). These include (1) lower-than-agreed wells under production in D1 and D3 fields,
(2) delays in identifying drilling locations in laminated sand and channel area and
(3) RIL’s target of starting new development wells in mid-2014. RIL has reportedly
indicated production of 52-53 mcm/d in FY2012E and 46-47 mcm/d in FY2013E.
We retain REDUCE on RIL with a 12-month SOTP-based target price of `1,000.
DGH highlights several shortcomings in complying with FDP of KG D-6 block
As per a report in Infraline dated April 14, 2011, the DGH has highlighted several shortfalls in RIL’s
execution of the FDP of KG D-6 block. (1) RIL has currently 18 wells under production in D1 and
D3 fields as against a target of 22 wells by April 1, 2011 and 31 by April 1, 2012. (2) There is
limited progress in identifying drilling locations in laminated sand and channel areas, which hold
about 3.5 tcf of proved reserves and 8 tcf of probable reserves.
Production targets well short of our/the Street’s estimates; overall production may fall short
RIL has apparently indicated production of 44 mcm/d in FY2012E and 38 mcm/d in FY2013E from
18 wells in D1 and D3 fields. The FY2012E figure is in line with our estimate (total production of
52 mcm/d including 8 mcm/d from MA-1 field) but FY2013E indication is far below our estimate
of 57 mcm/d (65 mcm/d including MA-1 field). The FDP envisages production of 62 mcm/d by
end-FY2011 from 22 fields and 80 mcm/d by end-FY2012 from 31 fields. RIL has indicated that it
will drill another three wells in addition to two completed wells but will start production from
these five new wells by mid-2014. We model total production of 17.1 tcf from RIL’s KG D-6 block
against 16.6 tcf of proved plus probable reserves.
Grave risks to gas supply in India; likely severe under-utilization of downstream assets
We believe it would be best to take cognizance of likely lower gas supply in India and its severe
implications for downstream companies (GAIL, GSPL) that are building downstream infrastructure
at a frenetic pace. The DGH’s observations (see Exhibits 1 and 2) should put to rest the market’s
feeble hope that RIL may be suppressing production to extract higher prices from the government.
We dismiss this notion as unduly optimistic and specious. In our April 8, 2011 report titled Gone
with the gas, we discuss the likely severe under-utilization of downstream units (pipelines and LNG
import terminals) and related impact on companies’ earnings and valuations.
Implications of lower gas production from KG D-6 block
We have discussed this issue in great detail in our April 8 report Gone with the gas. We
highlight the key points for the sake of completeness but focus on developments post the
report.
Negative implications for RIL’s earnings and valuation. We estimate RIL’s FY2012E
EPS and FY2013E EPS at `66 and `72 based on KG D-6 block gas production of 52
mcm/d and 65 mcm/d. RIL’s FY2013E EPS may decline by 4% if we model gas production
at 46 mcm/d in line with latest ‘guidance’ from RIL and KG D-6 oil production at 15,000
b/d compared to our assumption of 30,000 b/d.
Furthermore, failure to meet peak production rates of 80 mcm/d for the D1 and D3 fields
will likely lead to (1) reassessment of recoverable reserves in KG D-6 block and (2) lower
valuation of other blocks such as KG D-3, KG D-9, MN D-4 and NEC-25. We ascribe
`257/share (`766 bn) to RIL’s E&P segment in our SOTP valuation (see Exhibit 3). Out of this,
we value KG D-6, KG D-3, KG D-9, MN D-4 and NEC-25 blocks at `190/share (`526 bn).
Negative implication for GAIL’s gas transmission volumes, earnings and valuation.
We see downside risks to GAIL’s transmission volumes from lower-than-expected gas
supply. We model GAIL’s FY2012E, FY2013E and FY2014E gas transmission volumes at
127 mcm/d, 144 mcm/d and 162 mcm/d against 118 mcm/d in FY2011E. GAIL is in the
process of setting up several long-distance pipelines, whose capacity utilization may be
quite low in the initial years of operation unless RIL can ramp up production from its KG
D-6 block and India is able to source sufficient spot LNG at reasonable prices.
Exhibit 4 shows our estimates of gas transmission volumes of GAIL’s new pipelines and
compares the same with their stated capacity. We note that the regulator will likely
compute the tariffs based on its standard capacity utilization assumptions of 50%,
60%, 70%, 80% and 90% in the first five years of operation of the pipeline and 100%
thereafter.
Negative implication for GSPL’s gas transmission volumes, earnings and valuation.
We see downside risks to GSPL’s transmission volumes from lower-than-expected gas
supply. We model GSPL’s FY2012E, FY2013E and FY2014E gas transmission volumes at
40 mcm/d, 46 mcm/d and 50 mcm/d compared to 36 mcm/d in FY2011E (35.3 mcm/d in
3QFY11).
Reallocation of KG D-6 gas triggered by dip in production. The oil ministry recently
modified the original allocation of KG D-6 gas to meet the demands of the priority
sectors in light of the sharp decline in production from the block. The ministry had
previously provided for a pro rata cut to be imposed on all firm consumers in the case of
insufficient gas availability. However, the oil ministry has modified its earlier order and has
asked RIL to meet the entire allocation for the priority sectors—(1) fertilizer, (2) LPG,
(3) power and (4) city gas distribution. If gas availability is insufficient to meet the firm
demand of these four sectors, the least important sector in the order of priority will face
cuts first.
Exhibit 6 gives the original allocation of gas from RIL’s KG D-6 block. We note that EGoM
had allocated 63 mcm/d on a firm basis of which the power sector was allocated 33
mcm/d, fertilizer sector 16 mcm/d and LPG 3 mcm/d. Thus, the allocation to these three
sectors is modestly higher than RIL’s current production of 49 mcm/d from the KG D-6
block. This would result in no gas being available to petrochemical plants, refineries, steel
plants from the KG D-6 block and they will have to depend on liquid fuels or high-priced
imported LNG. We expect the profitability of these industrial units to be impacted by
(1) current high levels of crude oil and FO/diesel prices and (2) high spot LNG prices given
adverse developments in Japan. Exhibit 7 lists of petrochemical plants, steel plants and
refineries, which had been allocated gas from KG D-6 block on a firm basis.
No arbitrage opportunity for GAIL. We highlight that a recent decision of the oil
ministry has closed the arbitrage that GAIL was availing by (1) charging a consumer of KG
D-6 gas on a ‘ship or pay’ basis and (2) charging transmission tariff for the imported LNG
that was consumed by these units to make up for the shortfall from the KG D-6 block.
The oil ministry has stated that “once the customer has booked certain capacity on GAIL's
pipeline, and in the situation that booked capacity is not entirely utilized for the flow of
D-6 gas, the customer should be allowed to utilize the booked capacity without payment
of additional tariff for transportation of spot RLNG so as to meet the shortfall in supply of
D-6 gas.”
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