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Oil & Gas (Vidyadhar Ginde, Akash Gupta)
Key drivers of sector outlook
Weak oil demand and GRM key risk; reforms stalling after major progress
Global oil demand weak since 2Q11; weakness in developed world a risk to
2012 demand growth: Global oil demand growth in 2Q 2011 at 0.5m b/d is the
weakest in seven quarters. IEA has forecast demand growth to be 0.5m b/d even
in 3-4Q11. BofAMLe global oil demand growth estimate for 2012 is 1.0m b/d.
However, recession in Europe and/or US could mean global oil demand growth is
weaker or demand even declines in 2012. BofAML global commodity strategist
believes global oil demand may decline by 0.4m b/d in 2012 in case of mild US
recession (see Global Energy Weekly, 05 August 2011).
Risk to GRM from weak demand and large capacity add; first signs of
weakness visible: We expect net refining capacity addition in 2012 of 2mn b/d
(net of 1mn b/d of closures), which is the largest since 1999. If this large capacity
addition coincides with weak growth or decline in oil demand, GRM would decline
steeply from high levels in FY12 (US$8.8/bbl to date in FY12). Signs of weakness
in GRM are visible. Reuters’ Singapore GRM at US$6.6/bbl in November 2011 is
the lowest monthly GRM in 2011. GRM for week ended Nov 25 at US$5.2/bbl is
the lowest in over 1 year while that for week ending Dec 2 is even lower at
US$4.5/bbl. The risk to our view of weakening GRM is if demand holds up and
there is larger than expected refinery closure..
Gains from reforms visible in FY13 if oil price weakens and/or rupee
strengthens: Reforms done since Jun 2010 have cut FY12-13 subsidy by Rs1-
1.2tn. However, high oil price and weak rupee have meant FY12 subsidy would be
at all time high level of Rs1.2-1.3tn. How FY12 subsidy would be shared between
oil companies and government is uncertain with certainty likely only by end-FY12.
FY12 earnings outlook of R&M and upstream companies is therefore uncertain.
Given the poor fiscal situation and very poor R&M company results in 1H FY12, we
expect upstream to bear at least 40% of FY12 subsidy. No further reforms are
likely before the elections in the crucial state of UP in April-May 2012. No further
progress in reforms even after UP elections cannot be ruled out due to elections
thereafter in states like Gujarat. However, if oil price declines and rupee
appreciates, subsidy would decline sharply and benefits from reform done since
Jun 2010 would become visible. If Brent price declines to US$90/bbl (US$112/bbl
assumed in base case) and rupee is at Rs45, FY13 subsidy would be just
Rs455bn or US$10bn (lowest since FY06).
Rupee weakness to hurt PSUs but help private players: If the rupee weakness
persists throughout most of FY13, it would hurt oil PSUs as it would increase the
subsidy burden. However, it would benefit private oil producers and refining and
petrochemical players like Reliance Industries (RIL).
More constructive on petrochemicals than on refining: Demand growth
visibility beyond 2011 remains far from clear for refining and petrochemicals but
we see better risk/reward for petrochemicals, given much less supply overhang
in the next 12-24 months. Petrochemical margins may even expand sometime in
2012 if “normal” demand growth returns due to pent-up consumption and
restocking (see Refining & Chemicals - Asia-Pacific, 12 October 2011)
Top Buy: OIL
Top stock pick: OIL
FY12 EPS to grow 22% YoY even if upstream subsidy share 40%: As
discussed, we expect upstream to bear at least 40% of FY12 subsidy (i.e., 33% of
subsidy, assuming no tax cut on diesel). OIL’s FY12 EPS would be up 22% YoY,
driven by US$8/bbl YoY rise in net oil price if upstream share in subsidy is 40%.
FY12 EPS to be up 8% YoY, even if upstream share 46%: In the worst case,
upstream may have to bear 33% of subsidy, assuming no price hikes and duty
cuts in FY12. This would imply upstream share in subsidy of 46% effectively.
OIL’s FY12 EPS would still rise by 8% YoY in this scenario.
OIL’s share price does not reflect gains from reforms: Based on reforms
already done, we expect OIL’s long term net oil price to be US$68/bbl at our long
term Brent price of US$95/bbl. However, current share price of Rs1,158
discounts a long term net oil price of just US$36/bbl.
FY13 outlook to improve if subsidy-share lower and/or oil price lower: OIL’s
FY13 EPS is expected to be down 7% YoY assuming high oil price
(US$112/bbl), no further reforms and high upstream subsidy share (43%).
However, if upstream share is limited to 33%, OIL’s EPS would be up 16% YoY.
OIL’s EPS growth would be 22% YoY if upstream share in subsidy is 33% and
average Brent price in FY13 is US$95/bbl.
Neutral on: Reliance Industries (RIL)
Expect flat earning in FY13 due to GRM weakness: Weakness in GRM is
posing risk to RIL’s 2H FY12 and FY13 earnings outlook. We expect RIL’s GRM
to be US$7.8/bbl in 2H FY12 and US$8/bbl in FY13 vis-à-vis US$10.2/bbl in 1H
FY12. We expect RIL’s FY13 EPS to be up just 1% YoY despite assuming a
weaker rupee (Rs50 vis-à-vis US$).
Gain from weak rupee and higher other income: RIL’s FY13 earnings would
be YoY lower but for the weak rupee and higher other income on rising surplus
cash. If FY13 average rupee is Rs45, RIL’s EPS would be down 12% YoY.
Inexpensive at 11.1x FY13: RIL is inexpensive trading at 11.1x FY13 EPS. This
is much lower than last 5-year average forward P/E of 16.8x.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Oil & Gas (Vidyadhar Ginde, Akash Gupta)
Key drivers of sector outlook
Weak oil demand and GRM key risk; reforms stalling after major progress
Global oil demand weak since 2Q11; weakness in developed world a risk to
2012 demand growth: Global oil demand growth in 2Q 2011 at 0.5m b/d is the
weakest in seven quarters. IEA has forecast demand growth to be 0.5m b/d even
in 3-4Q11. BofAMLe global oil demand growth estimate for 2012 is 1.0m b/d.
However, recession in Europe and/or US could mean global oil demand growth is
weaker or demand even declines in 2012. BofAML global commodity strategist
believes global oil demand may decline by 0.4m b/d in 2012 in case of mild US
recession (see Global Energy Weekly, 05 August 2011).
Risk to GRM from weak demand and large capacity add; first signs of
weakness visible: We expect net refining capacity addition in 2012 of 2mn b/d
(net of 1mn b/d of closures), which is the largest since 1999. If this large capacity
addition coincides with weak growth or decline in oil demand, GRM would decline
steeply from high levels in FY12 (US$8.8/bbl to date in FY12). Signs of weakness
in GRM are visible. Reuters’ Singapore GRM at US$6.6/bbl in November 2011 is
the lowest monthly GRM in 2011. GRM for week ended Nov 25 at US$5.2/bbl is
the lowest in over 1 year while that for week ending Dec 2 is even lower at
US$4.5/bbl. The risk to our view of weakening GRM is if demand holds up and
there is larger than expected refinery closure..
Gains from reforms visible in FY13 if oil price weakens and/or rupee
strengthens: Reforms done since Jun 2010 have cut FY12-13 subsidy by Rs1-
1.2tn. However, high oil price and weak rupee have meant FY12 subsidy would be
at all time high level of Rs1.2-1.3tn. How FY12 subsidy would be shared between
oil companies and government is uncertain with certainty likely only by end-FY12.
FY12 earnings outlook of R&M and upstream companies is therefore uncertain.
Given the poor fiscal situation and very poor R&M company results in 1H FY12, we
expect upstream to bear at least 40% of FY12 subsidy. No further reforms are
likely before the elections in the crucial state of UP in April-May 2012. No further
progress in reforms even after UP elections cannot be ruled out due to elections
thereafter in states like Gujarat. However, if oil price declines and rupee
appreciates, subsidy would decline sharply and benefits from reform done since
Jun 2010 would become visible. If Brent price declines to US$90/bbl (US$112/bbl
assumed in base case) and rupee is at Rs45, FY13 subsidy would be just
Rs455bn or US$10bn (lowest since FY06).
Rupee weakness to hurt PSUs but help private players: If the rupee weakness
persists throughout most of FY13, it would hurt oil PSUs as it would increase the
subsidy burden. However, it would benefit private oil producers and refining and
petrochemical players like Reliance Industries (RIL).
More constructive on petrochemicals than on refining: Demand growth
visibility beyond 2011 remains far from clear for refining and petrochemicals but
we see better risk/reward for petrochemicals, given much less supply overhang
in the next 12-24 months. Petrochemical margins may even expand sometime in
2012 if “normal” demand growth returns due to pent-up consumption and
restocking (see Refining & Chemicals - Asia-Pacific, 12 October 2011)
Top Buy: OIL
Top stock pick: OIL
FY12 EPS to grow 22% YoY even if upstream subsidy share 40%: As
discussed, we expect upstream to bear at least 40% of FY12 subsidy (i.e., 33% of
subsidy, assuming no tax cut on diesel). OIL’s FY12 EPS would be up 22% YoY,
driven by US$8/bbl YoY rise in net oil price if upstream share in subsidy is 40%.
FY12 EPS to be up 8% YoY, even if upstream share 46%: In the worst case,
upstream may have to bear 33% of subsidy, assuming no price hikes and duty
cuts in FY12. This would imply upstream share in subsidy of 46% effectively.
OIL’s FY12 EPS would still rise by 8% YoY in this scenario.
OIL’s share price does not reflect gains from reforms: Based on reforms
already done, we expect OIL’s long term net oil price to be US$68/bbl at our long
term Brent price of US$95/bbl. However, current share price of Rs1,158
discounts a long term net oil price of just US$36/bbl.
FY13 outlook to improve if subsidy-share lower and/or oil price lower: OIL’s
FY13 EPS is expected to be down 7% YoY assuming high oil price
(US$112/bbl), no further reforms and high upstream subsidy share (43%).
However, if upstream share is limited to 33%, OIL’s EPS would be up 16% YoY.
OIL’s EPS growth would be 22% YoY if upstream share in subsidy is 33% and
average Brent price in FY13 is US$95/bbl.
Neutral on: Reliance Industries (RIL)
Expect flat earning in FY13 due to GRM weakness: Weakness in GRM is
posing risk to RIL’s 2H FY12 and FY13 earnings outlook. We expect RIL’s GRM
to be US$7.8/bbl in 2H FY12 and US$8/bbl in FY13 vis-à-vis US$10.2/bbl in 1H
FY12. We expect RIL’s FY13 EPS to be up just 1% YoY despite assuming a
weaker rupee (Rs50 vis-à-vis US$).
Gain from weak rupee and higher other income: RIL’s FY13 earnings would
be YoY lower but for the weak rupee and higher other income on rising surplus
cash. If FY13 average rupee is Rs45, RIL’s EPS would be down 12% YoY.
Inexpensive at 11.1x FY13: RIL is inexpensive trading at 11.1x FY13 EPS. This
is much lower than last 5-year average forward P/E of 16.8x.
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