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Oil & Gas
We expect robust performance from companies in the oil and
gas sector in 1QFY2012. In April 2011, crude oil price increased
sharply on the back of political unrest in MENA region; however,
it came off in May-June 2011, as concerns over weak European
economies and anticipated slowing growth in the US muted the
sentiment. On the domestic front, the government raised fuel
prices and (surprisingly) cut duties to reduce the gross under
recoveries for oil marketing companies (OMCs).
Crude rises in April but cools in May-June 2011
Crude oil price increased to US$127/bbl in April 2011 on the
back of political unrest in MENA region. Further, temporary
disruptions in crude oil production coupled with depreciation
in dollar index aided the crude oil price rise in April 2011.
However, crude oil price declined in May 2011 primarily on
account of weak macro-economic data. Crude oil continued to
slide in June 2011, as there were worries that European effort
to resolve Greek debt crisis will not succeed. Further, IEA’s
decision to release 60mn barrels of oil from its emergency stocks
to reduce the impact of disruption in Libyan oil supplies led to
the crude price cooling off.
OPEC oil supply started improving in April-May 2011 after a
gradual fall in February-March 2011 as supply concerns in
MENA countries eased.
IEA raises its forecast for oil demand
During June 2011, the International Energy Agency (IEA) raised
its forecast for global oil demand growth to 1.3% annually over
the coming five years on the back of anticipated economic
expansion in China. However, it cautioned that increased crude
oil prices threaten the recovery in developed nations. As per
IEA, consumption is expected to rise to 95.3mnbpd in 2016
compared to 88.0mnbpd in 2010 (China accounting for about
41% of the increase in demand).
IEA expects oil production capacity to increase by 1.1mnbpd to
100.6mnbpd by 2016 (compared to 93.8mnbpd in 2010).
OPEC capacity is expected to expand to 37.9mnbpd in 2016
(compared to 35.7mnbpd in 2010), driven by increased output
from Iraq, Angola and the UAE.
Production in Libya is expected to recover gradually in CY2012;
current production is hovering around 200,000bpd from
pre-conflict levels of about 1.6mnbpd. However, as per IEA,
Libya will not reach its full production capacity until 2015. Iraq
will increase its oil output capacity by 1.5mnbpd to 4.1mnbpd
by 2016. Non-OPEC supply is expected to grow on the back of
sustained investment with increased output anticipated from
Canadian oil sands, Brazil deepwater and Colombia.
OPEC meeting inconclusive
In OPEC's recent meeting to review output targets, only
Saudi Arabia, UAE, Qatar and Kuwait were willing to raise
output. Saudi Arabia is expected to increase the output to cool
down crude oil prices as most economies are reeling under
inflationary pressure. We believe easing of MENA crisis would
lead to a gradual decline in crude oil price.
Gas prices rise due to higher demand from Japan
Natural gas prices increased in 1QFY2012 to average
US$4.37/mmbtu compared to US$4.18/mmbtu in 4QFY2011.
The qoq price increase was mainly due to increased demand
from Japan. US Henry Hub prices increased by 7.1% mom in
April 2011 due to increased demand from North America
Refining margins improve further
For 1QFY2012, gross refining margins are expected to improve
due to increased middle distillate cracks in Asia. After the
earthquake in Japan, diesel and SKO cracks spiked, thus
improving refining margins. The Singapore refining margin for
the quarter is expected to be at ~US$8.7/bbl.
Key developments
Goverment hikes fuel prices, cuts duties to tame
mounting under recoveries
In a meeting held on June 24, 2011, the Empowered Group of
Ministers (EGoM) took bold steps on the country's retail fuel
pricing after a long wait of one year. As expected,
the government not only hiked prices but also re-jigged the
duty structure. Hence, it was an all-round effort to help the
cash-starved bleeding OMCs. On the price hike front, the
government hiked diesel price by `3/litre; whereas the price of
cooking fuels, LPG and kerosene, was increased by `50/cylinder
and `2/litre, respectively. The resultant price hikes will help
reduce under recoveries of OMCs by around `21,000cr. Further,
to reduce the burden of under recoveries on OMCs,
the government lowered the customs duty on crude oil to nil
from 5%; whereas on the petrol and diesel front, the revised
customs duty will stand at 2.5% from 7.5% earlier. This will
result in a loss of `26,000cr to the exchequer. Excise duty on
diesel has also been reduced by `2.6/litre to `2/litre, resulting
in a loss of `23,000cr to the exchequer. Thus, the duty cuts will
cost the exchequer a whopping `49,000cr. We believe the steps
taken by the government are per se in the right direction as
they provide more clarity on the way ballooning under recoveries
will be financed.
RIL hits a 52-week low on CAG report
RIL stock price declined in June 2011 due to a broad decline in
the overall stock market and an adverse report from the
Comptroller and Auditor General (CAG) of India. The CAG
accused the Oil Ministry for favouring RIL by allowing it to double
the development cost of its KG-D6 gas field. A draft report of
the CAG has reportedly questioned the decision of the oil ministry
and its technical arm, the Director General of Hydrocarbons
(DGH), to allow RIL to raise the development cost of its KG-D6
field. Meanwhile, the Home Ministry has reportedly given an
unconditional nod for UK's British Petroleum to buy a 30% stake
in RIL's oil and gas blocks for US$7.2bn.
Cairn India gets a conditional clearance for sale of stake
to Vedanta
The Cabinet Committee on Economic Affairs has endorsed the
group of ministers' recommendation and granted conditional
nod to the sale of stake in Cairn India to Vedanta Resources.
The two main conditions are that Cairn will have to allow cost
recovery of royalty on Barmer crude from the revenue it earns
from the field, and it will have to withdraw the arbitration case
against the government. The total royalty burden over the project
life is estimated to be `18,000cr. In addition, the cess of
`2,650/tonne on crude oil will have to be borne by Cairn.
However, this deal is subject to acceptance by the board of
Cairn. In case Cairn accepts the conditions, it will have a negative
impact on Cairn's valuations, as it will lead to higher outflow of
royalty. Nevertheless, this development will be positive for
ONGC as it will save on royalty costs (approximately `13,600cr).
Oil stocks decline, while gas stocks inch up
The oil and gas index, similar to the previous quarter,
underperformed the Sensex by 7% during 1QFY2012 due to
huge underperformance by index heavyweight RIL (falling by
14.3% vs. the Sensex fall of 3.1%). RIL stock declined in June
2011 due to a broad decline in the overall stock market and an
adverse report from CAG claiming that RIL had benefitted at
the cost of the government by hiking the cost of development of
its prolific KG-D6 field. In fact, losses in RIL stock would have
been higher had some smart recovery not taken place towards
the end of the quarter, after the stock hit a
52-week low of `829 towards mid-June. OMCs were the major
beneficiaries of the government's decision to hike fuel price and
reduction in customs duty and excise duty, with HPCL, BPCL
and IOC registering gains of 11.4%, 6.2% and 1%, respectively.
However, ONGC lost 5.6% as it fell during the middle of the
quarter following the government's decision for the upstream
sector to share higher subsidy burden of 38.7% in FY2011.
Nevertheless, gas stocks performed well during the quarter, with
IGL and Petronet LNG gaining whopping 27.7% and 11.8%,
respectively.
1QFY2012 expectations
ONGC is expected to report higher net realisations for the
quarter on account of increased crude price and the
government's decision to cap the upstream companies' subsidy
burden for 1QFY2012 at 33% of under recoveries compared
to 38.7% in FY2011. Consequently, we expect a sequential
increase of 40% in ONGC's bottom line during the quarter.
On a yoy basis as well, we expect an increase of 6.6% in ONGC's
bottom line.
RIL is expected to report higher GRM qoq at around
US$11/bbl (US$9.2/bbl in 4QFY2011). Higher demand for
diesel and SKO consequent to the earthquake in Japan resulted
in a spurt in petro cracks in Asian benchmark indices. It could
also be attributed to a wider heavy-light crude oil spread.
Consequent to the same, we expect RIL's profitability for the
quarter to increase by 4.4% sequentially, despite lower gas
production. On a yoy basis as well, we expect RIL's profit to
increase by 15.7%.
Cairn, being highly leveraged to crude oil, is expected to benefit
the most from the ~13% spurt in crude price sequentially.
Production from MBA fields is expected to be higher qoq as
there was production shutdown in the previous quarter.
GAIL is expected to report flat transmission volumes qoq. Higher
transmission tariff and lower subsidy burden on a sequential
basis is expected to result in GAIL registering a robust 20% qoq
increase in profit during the quarter. On a yoy basis, GAIL is
expected to report modest growth of 6% yoy.
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