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Oil PSUs – to gain in case of
global economic weakness
„Oil PSUs to do well in case of global economic weakness
There are concerns of recession in the US in 2012 (see Economic Commentary,
04 August 2011) and global economic weakness. Global economic weakness will
mean a decline in oil prices, which would mean a decline in the oil subsidy in
India. Stocks of Indian state-owned (PSUs) oil companies are therefore likely to
do well in case of global economic weakness. Another reason why oil PSU stocks
should do well is the significant progress in oil sector reforms since June 2010.
Subsidy cut of US$7bn for every US$10/bbl fall in oil price
Global economic weakness is likely to cause a fall in oil demand and therefore in
oil prices. Already, the IEA is forecasting 2Q-4Q 2011 oil demand growth at 0.7-
1.2m b/d, which is 45%-68% lower than 1Q 2011 growth of 2.2m b/d. A decline in
Brent price by US$10/bbl will cut FY12 oil subsidy by Rs300bn (US$6.7bn).
Reforms since Jun’10 cut FY12 subsidy by US$23bn (49%)
Fuel prices have been raised by 15-54% since June 2010. Excise and import duty
on petrol and diesel was also cut in June 2011. These fuel price hikes and tax
cuts have cut FY12 subsidy by Rs1.0trillion (US$23bn). Thus reforms have cut
FY12 subsidy by 49% from Rs2.1trillion (US$47bn) to Rs1.1trillion (US$24bn).
Gains from reforms ignored due to high oil prices
Fuel prices were hiked by 5-32% in June 2010. Oil PSU stocks were up 14-35%
over the next three months. However, since the price hike and tax cuts on June
24, 2011 these stocks are up just 3-11%. Investors thus appear to have ignored
gains to oil PSUs from reforms. This is due to high oil prices.
At US$90/bbl FY13 subsidy US$10bn (lowest since FY06)
Gains to oil PSUs from reforms will get noticed especially when Brent price falls
below US$95/bbl (no diesel subsidy below US$95/bbl). At our FY13 Brent price
forecast of US$114/bbl subsidy will be Rs1.2trillion (US$27bn) despite reforms.
However, at Brent of US$90/bbl FY13 subsidy will be just Rs455bn (US$10bn),
which is the lowest since FY06.
Upstream better play on reforms; Buy OIL & HPCL
As discussed, reforms done have already cut subsidy substantially. More reforms
could follow like limiting the number of LPG cylinders at subsidized price, which
could cut LPG subsidy by 20-30%. Upstream companies are better placed than
R&M companies to gain if FY13 subsidy were to be just US$10bn. However,
stocks of R&M companies have usually reacted more positively to reforms than
upstream. Retain Buy on OIL and HPCL.
Price objective basis & risk
BPCL (XBPCF, Rs702.30, C-2-7)
Our PO of Rs739/share is based on P/E of 9.5x on BPCL's FY12E consolidated
EPS (excluding dividend income from IGL and PLNG) of Rs53.0/share. PO
includes value of BPCL's share in oil reserves in Wahoo block (Brazil) and gas
resources in Mozambique at Rs104/share. It also includes the market value of
investments in Indraprastha Gas (IGL), Petronet LNG (PLNG), Oil India (OIL) and
cost of investment in Bina oil refinery of Rs131/share.
Upside risks: (1) Government compensation/grants are higher than our
expectations, (2) Government eliminates subsidies on all products, (3) Refining
margins are higher than forecast by us, (4) Rise in market prices of IGL and
PLNG. (5) Significant reserve accretion in BPCL's E&P exploration assets in India
and abroad. Downside risks: (1) Government does not issue enough oil bonds,
(2) government reverts to a cost-plus-based regulated pricing mechanism, (3)
steep decline in regional and hence BPCL's refining margins, and (4) steep
decline in the market price of IGL and PLNG.
Hindustan Petro. (XHTPF, Rs404.45, C-1-7)
Our PO of Rs500 is based on a PE of 9.0x on FY12E EPS (excluding dividend
income from MRPL) of Rs43.6. It also includes the market value of investments in
MRPL (ONGC's subsidiary), Oil India (OIL) and cost of investment in JV refinery
HPCL Mittal Energy Ltd. of Rs108. Upside risks: (1) Significant reserve accretion
in HPCL's E&P exploration assets in India and abroad (2) Subsidy R&M
companies have to bear is lower than assumed by us or oil sector is fully
deregulated , (3) Refining margins are higher than forecast by us, (4) Rise in
market prices of MRPL. Downside risks: (1) Indian oil sector continues to be
regulated and HPCL is not adequately compensated for subsidies it has to bear,
(2) steep decline in regional and hence HPCL's refining margins, and (3) steep
decline in the market price of MRPL.
Oil India Ltd (XLCRF, Rs1,305.80, C-1-7)
Our sum-of-the-parts PO of Rs1,764 includes the DCF value of its 2P reserves
(Rs1,271), best-case resources (Rs18) and exploration upside (Rs73). It also
includes net cash (Rs354), value of the product pipeline on an EV/EBITDA basis
(Rs28) and investments at cost (Rs20). We have used a WACC of 13.6pct to
calculate DCF value. The DCF value is based on a long-term Brent price forecast
of US$95/bbl. However, given our subsidy assumptions, the PO is effectively
based on oil price realization net of subsidy of US$76.0/bbl. We think that DCF is
the most appropriate measure to value E&P assets. Downside risks are (1)
Standard oil and gas industry operating risks, which include exploration,
development and production risks, oil price fluctuations, currency risk and reserve
estimation, (2) sovereign risks, which include changes in the government and/or
policies (e.g., withdrawal of the tax holiday), which may have a direct impact on
the business, cash flow and profit, (3) OIL's subsidy hit being higher than
assumed by us, (4) terrorist attacks in North East India, causing significant
damage to OIL's installations and facilities. Upside risks are: (1) Reforms that
permanently reduce or eliminate OIL's subsidy hit, (2) Large oil or gas discovery
leading to significant reserve and value accretion.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Oil PSUs – to gain in case of
global economic weakness
„Oil PSUs to do well in case of global economic weakness
There are concerns of recession in the US in 2012 (see Economic Commentary,
04 August 2011) and global economic weakness. Global economic weakness will
mean a decline in oil prices, which would mean a decline in the oil subsidy in
India. Stocks of Indian state-owned (PSUs) oil companies are therefore likely to
do well in case of global economic weakness. Another reason why oil PSU stocks
should do well is the significant progress in oil sector reforms since June 2010.
Subsidy cut of US$7bn for every US$10/bbl fall in oil price
Global economic weakness is likely to cause a fall in oil demand and therefore in
oil prices. Already, the IEA is forecasting 2Q-4Q 2011 oil demand growth at 0.7-
1.2m b/d, which is 45%-68% lower than 1Q 2011 growth of 2.2m b/d. A decline in
Brent price by US$10/bbl will cut FY12 oil subsidy by Rs300bn (US$6.7bn).
Reforms since Jun’10 cut FY12 subsidy by US$23bn (49%)
Fuel prices have been raised by 15-54% since June 2010. Excise and import duty
on petrol and diesel was also cut in June 2011. These fuel price hikes and tax
cuts have cut FY12 subsidy by Rs1.0trillion (US$23bn). Thus reforms have cut
FY12 subsidy by 49% from Rs2.1trillion (US$47bn) to Rs1.1trillion (US$24bn).
Gains from reforms ignored due to high oil prices
Fuel prices were hiked by 5-32% in June 2010. Oil PSU stocks were up 14-35%
over the next three months. However, since the price hike and tax cuts on June
24, 2011 these stocks are up just 3-11%. Investors thus appear to have ignored
gains to oil PSUs from reforms. This is due to high oil prices.
At US$90/bbl FY13 subsidy US$10bn (lowest since FY06)
Gains to oil PSUs from reforms will get noticed especially when Brent price falls
below US$95/bbl (no diesel subsidy below US$95/bbl). At our FY13 Brent price
forecast of US$114/bbl subsidy will be Rs1.2trillion (US$27bn) despite reforms.
However, at Brent of US$90/bbl FY13 subsidy will be just Rs455bn (US$10bn),
which is the lowest since FY06.
Upstream better play on reforms; Buy OIL & HPCL
As discussed, reforms done have already cut subsidy substantially. More reforms
could follow like limiting the number of LPG cylinders at subsidized price, which
could cut LPG subsidy by 20-30%. Upstream companies are better placed than
R&M companies to gain if FY13 subsidy were to be just US$10bn. However,
stocks of R&M companies have usually reacted more positively to reforms than
upstream. Retain Buy on OIL and HPCL.
Price objective basis & risk
BPCL (XBPCF, Rs702.30, C-2-7)
Our PO of Rs739/share is based on P/E of 9.5x on BPCL's FY12E consolidated
EPS (excluding dividend income from IGL and PLNG) of Rs53.0/share. PO
includes value of BPCL's share in oil reserves in Wahoo block (Brazil) and gas
resources in Mozambique at Rs104/share. It also includes the market value of
investments in Indraprastha Gas (IGL), Petronet LNG (PLNG), Oil India (OIL) and
cost of investment in Bina oil refinery of Rs131/share.
Upside risks: (1) Government compensation/grants are higher than our
expectations, (2) Government eliminates subsidies on all products, (3) Refining
margins are higher than forecast by us, (4) Rise in market prices of IGL and
PLNG. (5) Significant reserve accretion in BPCL's E&P exploration assets in India
and abroad. Downside risks: (1) Government does not issue enough oil bonds,
(2) government reverts to a cost-plus-based regulated pricing mechanism, (3)
steep decline in regional and hence BPCL's refining margins, and (4) steep
decline in the market price of IGL and PLNG.
Hindustan Petro. (XHTPF, Rs404.45, C-1-7)
Our PO of Rs500 is based on a PE of 9.0x on FY12E EPS (excluding dividend
income from MRPL) of Rs43.6. It also includes the market value of investments in
MRPL (ONGC's subsidiary), Oil India (OIL) and cost of investment in JV refinery
HPCL Mittal Energy Ltd. of Rs108. Upside risks: (1) Significant reserve accretion
in HPCL's E&P exploration assets in India and abroad (2) Subsidy R&M
companies have to bear is lower than assumed by us or oil sector is fully
deregulated , (3) Refining margins are higher than forecast by us, (4) Rise in
market prices of MRPL. Downside risks: (1) Indian oil sector continues to be
regulated and HPCL is not adequately compensated for subsidies it has to bear,
(2) steep decline in regional and hence HPCL's refining margins, and (3) steep
decline in the market price of MRPL.
Oil India Ltd (XLCRF, Rs1,305.80, C-1-7)
Our sum-of-the-parts PO of Rs1,764 includes the DCF value of its 2P reserves
(Rs1,271), best-case resources (Rs18) and exploration upside (Rs73). It also
includes net cash (Rs354), value of the product pipeline on an EV/EBITDA basis
(Rs28) and investments at cost (Rs20). We have used a WACC of 13.6pct to
calculate DCF value. The DCF value is based on a long-term Brent price forecast
of US$95/bbl. However, given our subsidy assumptions, the PO is effectively
based on oil price realization net of subsidy of US$76.0/bbl. We think that DCF is
the most appropriate measure to value E&P assets. Downside risks are (1)
Standard oil and gas industry operating risks, which include exploration,
development and production risks, oil price fluctuations, currency risk and reserve
estimation, (2) sovereign risks, which include changes in the government and/or
policies (e.g., withdrawal of the tax holiday), which may have a direct impact on
the business, cash flow and profit, (3) OIL's subsidy hit being higher than
assumed by us, (4) terrorist attacks in North East India, causing significant
damage to OIL's installations and facilities. Upside risks are: (1) Reforms that
permanently reduce or eliminate OIL's subsidy hit, (2) Large oil or gas discovery
leading to significant reserve and value accretion.
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