Drilling profits

The recent increase in crude oil production target and estimated reserves is positive for Cairn India

Cairn India’s stock has delivered smart returns to investors in the last six months vis-a-vis the BSE Sensex. While last year’s news of crude oil gushing out of Cairn’s Rajasthan block brought some cheer, the recent upgradation of crude oil reserves and a hike of peak output would broaden the smile even further. The proven oil reserves estimate in the Rajasthan fields has been raised from 3.7 billion barrels of oil equivalent (boe) to 4 billion boe.

Addition of contingent resources and increase of 2.5 billion boe from its exploration blocks has seen an upward revision in Cairns’ Rajasthan block resource potential to 6.5 billion boe from 3.7 boe earlier. Overall, with higher production from its core MBA fields, Barmer Hill and newer discoveries, Cairn is expected to deliver a plateau production of 240,000 barrels per day (bpd), from the earlier projected 175,000 bpd.

Improved fortunes
Cairn India’s valuations are strongly leveraged to crude oil pricing outlook compared to its peers. One of the reasons why the stock has been doing well recently is also the surge in the crude oil prices beyond $80 dollar levels. In the first half of 2009-10, with tepid crude prices, Cairn’s fortunes did not look bright. However, the second half had a different tale.

The company’s stock been a major outperformer against both the BSE Sensex and peers like ONGC, as crude oil prices improved on the back of receding fears of global recession. The good news was further confirmed when many experts revised their long-term crude oil price forecast from $75 per barrel to around $85-90 in the medium term. Cairn’s recent announcement (on March 23, 2010) further boosted sentiment. The company now expects to touch peak oil production of 240,000 bpd by around 2012-13, which is 20 per cent higher than what was earlier envisaged.

Mangala drives growth
While the peak crude oil production is some time away (2-3 years) and will be achieved in a gradual manner, Cairn’s production is slated to rise sharply in the next few months. The company is already producing 20,000 bpd from Train 1 (against a capacity of 30,000 bpd). However, the production is expected to reach 125,000 bpd by June 2010 quarter when Train 2 and 3 (production capacity of 50,000 bpd each) would become operational. In time with start-up of the two trains, Cairn’s 600 km heated pipeline up to Saylala (Gujarat coast) is expected to get commissioned.
 

SUM-OF-THE-PARTS
Block	NPV (Rs cr)	NPV (Rs/share)
RJ-ON-90/1 (Rajasthan)	45,912.0	240.6
KG-DWN-98/2	2,403.0	12.6
CB/OS-2	1,190.0	6.2
Ravva	964.0	5.1
Exploration upsides	7,460.0	39.1
FY11 end net cash	3,327.0	17.4
Mar 2011 fair target value	61,256.0	321.0
Source: Edelweiss research

With the production ramp up on at the Mangala field, the trains and pipeline infrastructure (to commence operations in the next 3 or 4 months), Cairn has already contracted 143,000 bpd of crude oil sales with MRPL, Indian Oil, Reliance Industries and Essar Oil, providing it the visibility for crude off-take. While the tie-up amounts to about three-fifths of its peak oil production, additional demand could come from new capacity additions from Reliance Industries and Essar Oil in the next few years.

Going ahead, Cairn is extending its pipeline infrastructure to Bhogat, Gujarat coast, which is scheduled to get completed in CY2011 and will give it access to marine transportation of crude. With this, the company’s production is expected to touch 175,000 bpd in CY2011, which is expected to be ramped up further to 240,000 in CY2013. These production upsides are subject to government approvals and considering the country’s burgeoning oil imports, they are expected to come sooner than later.

Conclusion
As per current developmental plans, the processing capacity post-commissioning of all the trains stands at 205,000 bpd, which will be ramped up to achieve a plateau production of 240,000 bpd. Capacity of both the processing terminal as well as the pipeline could be enhanced by minor de-bottlenecking and upgradation of facilities with incremental capex. This along with the planned capex will see Cairn invest about $1.2-1.4 billion by CY2011; it has already invested about $2.7 billion until now. Overall, analysts have implied a value of about Rs 25-35 per share to their earlier target price in line with the enhanced production and new discoveries.
 

OIL PUSH
in Rs crore	FY09	FY10E	FY11E	FY12E
Net sales	1,433.0	1,707.0	7,246.0	12,443
EBITDA	898.0	1,170.0	6,395.0	11,430
Net profit	804.0	1,111.0	3,870.0	7,385.0
EPS (Rs)	4.2	5.9	20.4	38.9
P/E	72.0	52.1	15.0	7.8
E: Analyst estimates

Going ahead, a focus on the latest technologies like 4D, fraccing would come in handy when the company goes for exploration for about 14 wells in three offshore blocks on the west and east coasts of India by September 2010. Cairn India holds exploration and production stakes in 10 blocks in India and one in Sri Lanka (drilling is expected to start in H1 2010-11). The stock currently trades at 7.8 times its estimated 2011-12 earnings, which appears to be fair. Further triggers could come in the form of any major discoveries in its exploratory assets or a spurt in crude oil prices. Investors with a medium-term perspective can consider the stock.