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Reliance is trading at a 20% discount to its core asset value with further upside from development of its
30TCF resource base and exploration of its 200,000km
2
offshore acreage. Completion of the BP farm-in, a
turnaround in D6 production and follow-on KG basin exploration mark three near term catalysts which we
believe will start to improve sentiment and valuation.
We expect the Indian government to give the green light to the BP farm-in to Reliance acreage over
the coming few weeks. The arrival of BP will bring renewed focus to exploration and development
offshore India. It will also help Reliance restore production at D6 through improved reservoir
management techniques. Moreover, Reliance has 30TCF (5bn boe) of undeveloped resources (in D6 and
NEC-25) and 200,000km
2
of deep water offshore acreage which is essentially unexplored. BP's deep
water expertise will help accelerate monetization of this resource base and exploration opportunities.
D6 production to start to improve in the next quarter. Reliance will tie-back 2 additional wells over
the coming months and we expect the drilling of 3 additional wells in the second half of the year which
will take the total well count to 23 (+25%). This will offset natural decline and we expect this will bring
production to back over 50MMSCM/d by the end of this year.
The recent discovery in deep water block D9 bodes well for continued exploration in the KG basin.
RIL announced the first discovery in the west of the KG-D9 block which proves that the gas play in the
northern part of D6 extends further to the south west and into the D9 block, opening up a much larger
prospective area in the basin. Further exploration will take place this year
Reliance cash position may be more of an asset than a liability in the current environment. While
some fret over Reliance's growing cash pile, we believe in an increasingly credit constrained environment
this is more of an opportunity than a liability. We expect more spending on Indian E&P and the
possibility of international upstream acquisitions. With a 45% interest in the company, Mukesh Ambani
remains well aligned with shareholders on the efficient deployment of capital.
At the current share price, investors are getting upstream growth for free. Our core value for
Reliance is INR 1,003, which is our estimate of the value of Reliance developed upstream and
downstream assets plus net cash. Our value for the 30TCF of discovered but undeveloped resources and
exploration acreage which has yet to be drilled is USD9bn, or INR 122 per share.
To account for the decline in market multiples for refining and petrochemical assets we have
adjusted our target price to INR1125. Given the decline in EV/EBITDA multiples for refining and
petrochemical peers, we have reduced our target price to INR1125 from INR1250.
Investment Conclusion
We remain positive on the outlook for Reliance. While most investors would agree that Reliance is cheap,
the question is has the stock bottomed out yet and what are the catalysts to get Reliance moving again?
Despite the negative news flow in the first half of 2011 (CAG review, license issues), we expect a more
positive second half to the year. There are three catalysts in our view. The first catalyst is the BP deal to
close over the coming month which will lead to a new roadmap for exploration and development activity
offshore India. Secondly, the recently announced discovery in D9 confirms that the prospective area of the
D6 block is much larger than the northern part of the D6 block alone. Follow-on exploration later this year
will confirm this. Finally, we expect D6 production to bottom out in 1QFY12 and start to move higher as
new wells are brought on line. As production increases, so will the RIL stock price.
In our view the gas potential offshore India is enormous. Reliance has the best acreage position and over
time natural gas prices will move higher making developments more viable. While some investors fret over
the growing cash pile that Reliance is amassing, we feel there is no reason to assume that Mukesh Ambani
(who controls 45% of the company) will deploy capital in a way that is value dilutive to shareholders. On a
sum of the parts basis we believe that on the current share price, investors are getting undeveloped
resources and exploration for free. While it may yet take another quarter for some of our catalysts to play
out, we see little down side from here. Ultimately we believe that investors need to get ahead of the curve.
We rate Reliance as outperform with a target price of INR 1,125.
Details
Reliance has had a turbulent first half of 2011. In particular, after the announcement of the BP deal in
February 2011, the news flow surrounding the stock has been entirely negative. First, there were concerns
regarding the under-performing KG-D6 gas field in offshore India. RIL admitted technical difficulties and
hence its inability to hit previously announced gas production targets. We, however, believe that the major
reason for the lower production was the lesser number of wells drilled - more details can be found in our
call published on the 4
th
of May Reliance Industries: E&P Fears Overblown, Outperform.
The next storm of bad news to hit the stock was from the Petroleum ministry and the upstream regulator
(Directorate General of Hydrocarbons – DGH) in India. The press statements by the DGH regarding the
hiatus in drilling led to further pressure on RIL.
Over the last few weeks, the leak of the draft report submitted by the Comptroller and Auditor General
(CAG) of India has put additional pressure on the RIL stock. The media has reported extensively on the
allegations of the CAG that Reliance 'gold-plated' its costs for developing the KG-D6 field, and hence
causing a loss to the government. While we think that industry cost inflation (up 50% since start of D6
development) and general industry cost over-runs accounts for most of the difference, some parties intend
see this as a major issue. (For the sake of the Australian E&P industry we hope that the CAG auditors do
not extend their enquiries overseas!)
In spite of the beating the stock has taken on account of the negative news flow, we believe that the intrinsic
value of the company hasn’t changed and the stock is priced at a significant discount to its intrinsic value.
In this call we discuss the valuation of the company in detail. We believe there are three key catalysts for
the valuation of the company to come back to its intrinsic levels:
1) Approval of the BP deal by the government
2) Turn-around in D6 production. We expect the tie back of 2 wells plus drilling of 3 additional wells
to start turning round production. We believe that Phase 2 development (28 additional wells) will
happen, although this may remain linked to gas price.
3) Further exploration in the KG basin following on from the gas discovery in D9
The re-negotiation of the price of gas from KG-D6 block, for the whole or part of the production, before
FY14 is also another important catalyst though we believe it to be less likely in the short term. We believe
current price levels for the core sectors will remain in force till the end of life of the current price regime, in
March 2014. However, we believe we might see a re-negotiation of the gas price for the non-core sectors,
though we haven’t included this scenario in our valuation analysis.
How much gas is there in KG-D6?
The valuation of RIL has hinged around the valuation of the company's (and India's) largest gas reservoir –
the Dhirubhai or KG-D6 block. In the addendum to the Initial Development Plan (IDP), RIL had discussed
2P reserves of 11.3tcf for the D1 and D3 fields and 2P total in-place discovered resources of 42tcf (see
Exhibit 1). Furthermore, RIL also discussed a hydrocarbon potential of 39tcf of gas and 1.6bn bbl of oil
from 25 other potential prospects. RIL mentioned in the document that the total potential of the block was
estimated at around 50tcf.
It is important to note here that the addendum to the IDP discussed the development plan for only 11.3tcf of
gas from the D1 and D3 gas fields. The document was submitted to the Indian Government for approval in
2006 and much water has flown under the bridge since then. With the production problems being reported
from KG-D6, the market has been unsure of the resource potential of the block, and there have even been
doubts over the potential of the entire eastern Indian seaboard. We believe that the current problems are
temporary and with the technical expertise of BP and the drilling of additional wells, we will see an uptick
in production volumes.
In the latest reserves statement from RIL, total gas reserves were taken down by 2.7% , the
first such negative revision of gas reserves by the company, which was a cause of concern for the
investment community. Niko Resources also took down its India proved reserves by 20% . It
is very important to note that even after the negative revisions by Niko, the total 2P gas reserves of the KGD6 block remains at 11.2tcf, at the levels discussed in the addendum to the initial development plan
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