Oil India

When it rains it pours, or so has been the case for the public sector upstream oil companies, over the past couple of months. The downpour of good news has been heavy — the more than doubling in price of administered pricing mechanism (APM) gas, market-linked prices for additional gas from nominated blocks and the landmark reforms towards fuel price decontrol.



All this, combined with ambitious expansion plans, strong operating dynamics and robust financials, bode well for Oil India (OIL), with operations mainly in the North East.

However, the rapid run-up in stock prices seems to have factored in most positives, at least for the near-to-medium term. Also, clarity is awaited on the new subsidy-sharing mechanism, and the price reset mechanism for transport fuels. At the current market price of Rs 1,433, the OIL stock has appreciated around 37 per cent since its IPO in September 2009, and trades at 12.6 times its trailing 12-month earnings.

Though it is still at a discount compared with its much-bigger peer ONGC (14.4), this may not be out of place, given the latter's size. We suggest a ‘wait-and-watch' approach at this stage and to look out for triggers, especially on subsidy-sharing.

caution required

The Government's decision to more than double the price for APM gas to an effective rate of $4.2/mBtu neutralised under-recoveries on gas sales, and is expected to add close to Rs 500 crore to OIL's topline. Next, the decision to allow freedom in pricing the additional gas from nominated blocks is also expected to boost financials, by incentivising efforts by OIL to sweat its assets better.

The step towards fuel price deregulation last week, is expected to be significantly value-accretive for OIL, given that the company along with ONGC and GAIL currently subsidises (through product discounts) the under-recoveries on transportation fuels (petrol and diesel).

With petrol price freed and stated intent to free diesel price as well, under-recovery on this front is expected to be extinguished or at least reduced significantly. To put this in perspective, OIL's share of transportation fuel subsidy in FY-2010 (close to Rs 1,550 crore) was almost 20 per cent of its topline for the year.

The above policy measures are significant enough to warrant a sector re-rerating. That said, uncertainties still remain, especially on the subsidy-sharing mechanism. Even under the new dispensation, the total under-recoveries are estimated at Rs 53,000 crore in FY-11, and it remains to be seen whether the upstream companies will be made to share the burden.

expansion plans

OIL has lined up aggressive investment plans aggregating close to Rs 8,500 crore over the next two years. The company, which in the past was perceived to be a not-aggressive player restricted to the North East, has upped the ante in recent times. In addition to its nominated blocks and joint ventures (mainly in the North East), the company has around 30 exploration blocks in several high-potential regions in the country secured through NELP, including nine blocks in the latest NELP VIII auction.

Besides, the company has interests (mostly in collaboration with other Indian majors) in several exploration blocks in Africa and West Asia, some of which appear quite promising. It has lately expanded its global presence to South America (3.5 per cent interest in the Carabobo blocks in Venezuela, where daily production is expected to be 400,000 bbl). Large acreages, both within (127,881 sq km) and outside (41,656 sq km) the country provide the company good growth prospects, if it is able to convert the opportunity.

The company plans to almost double its output of oil and gas (25.7 mmbbl and 2.415 bcm respectively in 2010) over the next two to three years through both organic and inorganic expansion. In addition to intensifying its oil exploration efforts in the North East and other blocks, OIL has also begun trial production of heavy oil in its Baghewala field in Rajasthan. Besides, with the improved demand for gas in the North East, the company plans to exploit its formidable gas reserves in the region. The soon to be completed Duliajan-Numaligarh Gas Pipeline (DNPL) project, and the Brahmaputra Cracker and Polymer Ltd (BCPL) (to be completed within the next two years), in which the company has stakes, is expected to provide a boost for OIL's gas business. The company has also lined up plans to enter the city gas distribution space in the North East.

operating dynamics

Despite most of its current operational fields being in a maturing phase, OIL has managed to register an increase in production over the years, primarily due to new technologies, improved oil recovery techniques and enhanced oil recovery measures. In 2010, the company increased its crude oil production over the previous year by 3 per cent, and gas production by 6.4 per cent. Growth can be reasonably expected to be sustained given the company's high reserve replacement ratio (165 per cent in 2010), which was boosted by the 11 small to medium size discoveries from 2007 to 2010. OIL has an enviable exploration success rate (in excess of 70 per cent) compared with the 30-40 per cent global average, and low production cost which boosts profitability. These advantages however may moderate, as the company expands to new geographies, away from its traditional resource base.

Oil India has been consistently posting healthy financials, growing its topline and bottomline at an annual average of 13.6 per cent and 16.8 per cent respectively over 2007-2010. In 2010, the company's sales grew 9.2 per cent to Rs 7,905 crore, while bottomline grew faster at 20.8 per cent to Rs 2,610 crore. The company has a strong balance-sheet with cash reserves of almost Rs 8,500 crore and negligible debt. This, combined with good cash flows, positions its well to fund expansion plans. Healthy margin profile (operating margin of close to 50 per cent and net margin of 33 per cent), along with strong return matrices (ROE of close to 20 per cent) provide comfort.

Risks/Mitigators

Inherent risks in the exploration and production business may result in write-off of huge costs. As the company expands, these risks may be magnified. Also, the company's operations are currently concentrated in the insurgency-affected North-East region. The geographical diversification moves, however, may mitigate the concentration risk to a considerable extent. Also, while the company is a veteran in onshore exploration and production operations, it does not have much experience in the offshore and deep-water exploration segment. The company has hedged this by taking a non-operator interest in such blocks.

In its overseas expansion drive, the company is likely to face challenges, as seen in its failed initial endeavour to acquire stake in Syrian-focussed oil explorer, Gulfsands Petroleum, in May. However, the company's focus on small and medium size acquisitions may address this problem to some extent.

via BL