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ONGC & OIL: Outlook healthy despite subsidy overhang

Firm crude oil prices during the June quarter resulted in an increase in the subsidy sharing burden

for upstream companies Oil and Natural Gas Corporation and Oil India. Thus, despite gross realisations coming close to $120 a barrel as compared to about $80 in the year-ago quarter, net realisations were impacted and came at $48.8 a barrel and $59.6 a barrel for ONGC and Oil India, respectively. The similarities end there, as their performance for the June quarter reflects divergent trends.

Oil India’s performance got a boost from highest ever volumes, better gas price realisations and the low base of the June 2010 quarter, leading to a spurt in profits. ONGC, though, saw its operating profit take a hit. A Rs 370-crore spurt in other income saved the day.

Going ahead, the recent round of rises in prices of subsidised fuels is likely to reduce the burden for Oil India and ONGC. Analysts hope the subsidy issue will be favourably addressed by the government and estimate net realisations to improve. For ONGC, the resolving of the royalty issue with Cairn will also help. Thus, analysts remain positive on both stocks.

Oil India saw its highest ever oil and gas production during the June quarter, at 0.965 million tonnes and 0.64 billion cubic metres (bcm), respectively. Further boost to profitability was provided by higher administered gas prices, that had been raised to $4.2 per million British thermal units in May-end 2010. The June 2010 quarter had also seen a low base on the back of longer than expected shutdown at the Numaligarh refinery last year. All these helped post a surge in net profits, despite a growing subsidy burden. Going ahead, the company expects oil production of 3.88 mt in 2011-12, compared to 3.6 mt in 2010-11. It also aims to double gas production in the next three to four years.

ONGC’s crude oil production at 6.76 mt was up 2.3 per cent year-on-year. Gas production at 6.162 bcm, however, declined 3.92 per cent year-on-year. While the company says the decline is due to temporary problems with the offshore platform at Mumbai high, it believes production levels will pick up. ONGC’s profits in the quarter, though up 12 per cent year-on-year, were slightly lower than consensus estimates, mainly due to higher dry well write-offs at the Andaman deep water blocks. It would have been lower, but for the 66 per cent spurt in other income to Rs 930 crore.

The recent price rises on fuels are likely to reduce the subsidy burden of the two companies in the coming quarters. Some analysts also expect another round of price rises if the crude oil price remains at $110 a barrel or more. However, while clarity on the subsidy sharing mechanism is awaited, analysts are assuming a sharing for upstream companies at 38.5 per cent in their estimates, in line with recent trends.

Analysts at Prabhudas Lilladher indicate that various options for subsidy sharing being considered by government may bring net realisations of the upstream companies in the range of $60-65 a barrel in 2011-12. Over 2007-11, net realisations of Oil India have been in the range of $55-58 a barrel; for ONGC, it has ranged at $48-65 a barrel during 2009-11. ICICI Securities’ analysts echo similar views. They say if it materialises, it will lead to re-rating of ONGC’s valuations.

The current share price of Oil India indicates the market is assuming a net realisation of just $39 a barrel. Analysts at Bank of America–Merrill Lynch expect Oil India’s earnings per share to rise 24 per cent year-on-year, unless there are any negative surprises. They expect net crude oil realisation of $76 and $60.5 a barrel for 2011-12 and 2012-13 in the worst case and remain positive on the stock.

For ONGC, due to potential accretion from its large exploration and production base, most analysts remain positive on its stock. ONGC is also expected to benefit if Cairn India agrees (most likely) to royalty costs being a recoverable part from revenues. Analysts at Systematix estimate ONGC to receive a reimbursement of Rs 1,920 crore for 2010-11 and Rs 550 crore for the June quarter (the share of Cairn India in royalty paid by ONGC). ONGC, on a consolidated basis, also has a distinct advantage, as rising crude prices benefit its global subsidiary, ONGC Videsh, which does not have the burden of sharing subsidies.

Bloomberg data shows all analysts remain positive on the Oil India stock, while 81 per cent are bullish on ONGC, which at Rs 1,299.90 and Rs 273.30, trade at 8.8 and 8.3 times 2011-12 estimated consensus earnings. Based on these estimates, the stocks may see around 19 per cent and 24 per cent upside in one year.


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