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UBS Investment Research
Asia On The Ground: India Oil and Gas
K ey takeaways from industry meetings
We met with officials at the ministry, and govt owned oil sector companies
We met with policy makers at the oil ministry and managements of upstream
companies and industry consultants/suppliers over the past week.
We were looking to get industry perspective on deregulation and on E&P
From the meetings we hoped to get insights on the current thinking on govt
response to the increasing subsidies and on the issues with private E&P operators.
Diesel deregulation unlikely; View on upstream
We got a sense that 1) diesel deregulation is unlikely and 2) there might be some
progress on capping the number of subsidised LPG cylinders a household could
buy. Further, we believe the government allows the downstream companies to
make a fixed regulated return on their assets. Post the meetings, we believe that the
current gas pricing formula for KG-D6 gas will remain unchanged till 2014. The
pricing of satellite fields, though, can be different from that of the current
producing fields. For the ramp up on Cairn production – it became clear that while
the ramp up to 240 kbopd may be possible, it may so happen only if the DGH is
convinced that this will maximise production from the field over the reservoir life.
We assume peak production of 210 kbopd.
UBS top picks: RIL(Buy) and Cairn(Buy)
We believe that production ramp up at Cairn should improve once the focus shifts
back from the deal to operations and expect that government/JV approvals will
start coming in faster. The ballot will be declared on 14 Sept 2011. Reliance looks
attractive at current levels and is trading near our bear case valuation of Rs 755/sh.
Meetings with sector participants
Policy has been playing a strong role in the country’s upstream and downstream
oil sector. Increasing subsidies, M&A activity and volatility in oil prices have all
lead to increased investor interest in understanding policy response both from a
sector and country perspective. We met with policy makers and stakeholders
over the past few weeks to discuss possible govt response to the current scenario.
To get in depth perspective of all stakeholders we met with :
- Two senior officials in the ministry of Petroleum and natural gas
- Officials at ONGC, OIL, management at industry suppliers/experts
Govt not contemplating total deregulation
Our key takeaways from the meetings corroborated our earlier views that we
have expressed in our related notes:
Diesel deregulation is unlikely and there is no proposal for the same under
review
LPG seems the only priority on the agenda- ie move to cut subsidies rather
than eliminate them- provision of 5 -6 cylinders at subsidized rates and the
rest at market rates. We estimate that LPG constitutes 20-25% of the under
recoveries depending on the prevalent oil prices (see table 2).
We came away with the impression that the government is allowing the
downstream companies to make a regulated return of 13% on fixed assets.
We may see some refinery additions – some of which may be imminent
given that many of our refineries are PSU getting obsolete.
Despite media highlighting various formulae for subsidy sharing, we got a
sense that the industry believes that the formulae are always reversible and
hence no formula can be assumed to be set in stone even if adopted for a
quarter or two. The current share is 33% and there is no new thinking on the
issue as of now.
Expect no change to KG-D6 gas pricing formula
till 2014
It was very clear that the industry belief on RIL’s gas pricing is that it was a
market determined process which was accepted for five years. The terms are
very unlikely to change for now.
In 2014 the pricing will again be market discovered. The government is
flexible on the gas pricing but will not be ad hoc about it and not change
pricing either ways in the middle of the accepted contract period
The pricing of satellite fields can be different from that of the current
producing fields.
It seems that BP has been brought in because of its deep water technical
expertise
Currently there is no precedent of recourse if the oil and gas operator of a
field is not performing satisfactorily, but one of the participants we
interviewed says that the Govt has the right to take away the fields.
Production ramp up at Cairn should maximise
production over the life of the reservoir
For the ramp up on Cairn production: It has become clear that while the ramp up
to 240 kbopd may be possible, it may so happen only if the DGH is convinced
that this is the best course of action to maximise production from the field over
the reservoir life and does not affect the integrity of the reservoir. We currently
assume a peak production of 210 kbopd in our estimates.
UBS view
The government pays the OMCs for not only whatever losses they make on
selling diesel, LPG and kerosene at controlled prices but also includes a notional
profit on the sale of these products. Hence, in effect, the companies do not bear
incremental losses if under recoveries are higher. The main financial impact of
under recoveries is the increased working capital of the company as the
government subsidy comes with a lag.
ONGC’s realisations are range bound as the upside from increase in
international crude prices is limited by the subsidy payout to OMCs. The
company was given most of its producing blocks on a nomination basis and
hence the company needs to contribute to the subsidy payout and that is
something neither we nor the company expects to change.
We believe petroleum product pricing reforms will materialize over a longer
duration of time. We believe suggestions like dual pricing of diesel have
execution challenges and do not expect full deregulation in the medium term.
Though, we do expect price hikes if global crude prices rise.
Further, we believe that capping LPG per household will not help much, given
execution challenges and relatively low number of cylinders that would actually
not be subsidized.
On the upstream side we are assuming a hike in price of KG-D6 gas only post
2014. Also, we have incorporated a peak production of 210 kbopd from the
MBA fields in our estimates for Cairn.
Statement of Risk
The petroleum product pricing regime is policy and regulation driven and
traditionally decisions on the pricing and on the subsidy sharing formula have
been ad hoc. At times, price and duty cuts and decisions on subsidy sharing have
been rolled back. Exploration in itself is a risky business; besides that, execution
on government decisions on pricing and production peaks could be counted as
other risks.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
UBS Investment Research
Asia On The Ground: India Oil and Gas
K ey takeaways from industry meetings
We met with officials at the ministry, and govt owned oil sector companies
We met with policy makers at the oil ministry and managements of upstream
companies and industry consultants/suppliers over the past week.
We were looking to get industry perspective on deregulation and on E&P
From the meetings we hoped to get insights on the current thinking on govt
response to the increasing subsidies and on the issues with private E&P operators.
Diesel deregulation unlikely; View on upstream
We got a sense that 1) diesel deregulation is unlikely and 2) there might be some
progress on capping the number of subsidised LPG cylinders a household could
buy. Further, we believe the government allows the downstream companies to
make a fixed regulated return on their assets. Post the meetings, we believe that the
current gas pricing formula for KG-D6 gas will remain unchanged till 2014. The
pricing of satellite fields, though, can be different from that of the current
producing fields. For the ramp up on Cairn production – it became clear that while
the ramp up to 240 kbopd may be possible, it may so happen only if the DGH is
convinced that this will maximise production from the field over the reservoir life.
We assume peak production of 210 kbopd.
UBS top picks: RIL(Buy) and Cairn(Buy)
We believe that production ramp up at Cairn should improve once the focus shifts
back from the deal to operations and expect that government/JV approvals will
start coming in faster. The ballot will be declared on 14 Sept 2011. Reliance looks
attractive at current levels and is trading near our bear case valuation of Rs 755/sh.
Meetings with sector participants
Policy has been playing a strong role in the country’s upstream and downstream
oil sector. Increasing subsidies, M&A activity and volatility in oil prices have all
lead to increased investor interest in understanding policy response both from a
sector and country perspective. We met with policy makers and stakeholders
over the past few weeks to discuss possible govt response to the current scenario.
To get in depth perspective of all stakeholders we met with :
- Two senior officials in the ministry of Petroleum and natural gas
- Officials at ONGC, OIL, management at industry suppliers/experts
Govt not contemplating total deregulation
Our key takeaways from the meetings corroborated our earlier views that we
have expressed in our related notes:
Diesel deregulation is unlikely and there is no proposal for the same under
review
LPG seems the only priority on the agenda- ie move to cut subsidies rather
than eliminate them- provision of 5 -6 cylinders at subsidized rates and the
rest at market rates. We estimate that LPG constitutes 20-25% of the under
recoveries depending on the prevalent oil prices (see table 2).
We came away with the impression that the government is allowing the
downstream companies to make a regulated return of 13% on fixed assets.
We may see some refinery additions – some of which may be imminent
given that many of our refineries are PSU getting obsolete.
Despite media highlighting various formulae for subsidy sharing, we got a
sense that the industry believes that the formulae are always reversible and
hence no formula can be assumed to be set in stone even if adopted for a
quarter or two. The current share is 33% and there is no new thinking on the
issue as of now.
Expect no change to KG-D6 gas pricing formula
till 2014
It was very clear that the industry belief on RIL’s gas pricing is that it was a
market determined process which was accepted for five years. The terms are
very unlikely to change for now.
In 2014 the pricing will again be market discovered. The government is
flexible on the gas pricing but will not be ad hoc about it and not change
pricing either ways in the middle of the accepted contract period
The pricing of satellite fields can be different from that of the current
producing fields.
It seems that BP has been brought in because of its deep water technical
expertise
Currently there is no precedent of recourse if the oil and gas operator of a
field is not performing satisfactorily, but one of the participants we
interviewed says that the Govt has the right to take away the fields.
Production ramp up at Cairn should maximise
production over the life of the reservoir
For the ramp up on Cairn production: It has become clear that while the ramp up
to 240 kbopd may be possible, it may so happen only if the DGH is convinced
that this is the best course of action to maximise production from the field over
the reservoir life and does not affect the integrity of the reservoir. We currently
assume a peak production of 210 kbopd in our estimates.
UBS view
The government pays the OMCs for not only whatever losses they make on
selling diesel, LPG and kerosene at controlled prices but also includes a notional
profit on the sale of these products. Hence, in effect, the companies do not bear
incremental losses if under recoveries are higher. The main financial impact of
under recoveries is the increased working capital of the company as the
government subsidy comes with a lag.
ONGC’s realisations are range bound as the upside from increase in
international crude prices is limited by the subsidy payout to OMCs. The
company was given most of its producing blocks on a nomination basis and
hence the company needs to contribute to the subsidy payout and that is
something neither we nor the company expects to change.
We believe petroleum product pricing reforms will materialize over a longer
duration of time. We believe suggestions like dual pricing of diesel have
execution challenges and do not expect full deregulation in the medium term.
Though, we do expect price hikes if global crude prices rise.
Further, we believe that capping LPG per household will not help much, given
execution challenges and relatively low number of cylinders that would actually
not be subsidized.
On the upstream side we are assuming a hike in price of KG-D6 gas only post
2014. Also, we have incorporated a peak production of 210 kbopd from the
MBA fields in our estimates for Cairn.
Statement of Risk
The petroleum product pricing regime is policy and regulation driven and
traditionally decisions on the pricing and on the subsidy sharing formula have
been ad hoc. At times, price and duty cuts and decisions on subsidy sharing have
been rolled back. Exploration in itself is a risky business; besides that, execution
on government decisions on pricing and production peaks could be counted as
other risks.
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