Oil India: Optimism on gas prices, subsidies

These larger benefits, added to other favourable factors, outweigh near-term concerns, causing analysts to be bullish on the stock

Oil India Ltd (OIL), the upstream major in the sector, has seen its stock under pressure for quite a while, with concerns on production volumes, uncertainty over subsidy burden and, recently, the government’s plan of selling its stake in Indian Oil Corporation to the company. While the concerns might continue to exert pressure in the near term, there are bigger gains likely to accrue to OIL that are not reflecting in market sentiment, say analysts.

These include gas price rise, continued diesel price increases (reducing the subsidy burden) and reserve upgradation at its Mozambique assets. Given the analysts’ target price of Rs 575-600, there is a potential upside of 19-24 per cent from the current Rs 482.

Volume, subsidy concerns
The disruption in oil and gas production in Assam due to a strike call by the All Assam Students Union since March 1 had raised concerns. By March 6, OIL’s average daily oil production had dropped to 5,000 tonnes from 9,000 tonnes, while gas production halved to 3.5 million standard cubic metres a day, leading to an estimated loss of Rs 20 crore a day, according to ICICI Securities. Though the issue has been sorted and clarity is awaited on the actual loss, disruptions aggravate risks to volume expectations. Analysts at Kotak Institutional Equities believe intermittent disruption might also put at risk their assumptions of modest growth in volumes over the medium term.

OIL already has seen a decline in oil production from 3.86 million tonnes in FY12 to 3.68 mt in FY13, due to disruptions and declines from mature fields. Analysts at Antique Broking observe that if the current depressed production level persists, FY14 oil and gas production would fall to 3.56 mt and 2.6 bcm (billion cubic metres) from their current estimate of 3.63 mt and 2.65 bcm, respectively, with an earnings impact of Rs 1.4 per share or 2.5 per cent. Without disruptions, however, OIL could achieve oil production of four mt annually.

The government’s tight fiscal position has also increased fears of a higher upstream share in overall subsidies in FY14 (45-50 per cent or Rs 65,000-70,000 crore of total under-recoveries, by Ambit Capital estimates). In FY13, their share stood at 37.3 per cent or Rs 60,000 crore (the total was Rs 161,000 crore). While Oil and Natural Gas Corporation bears a little more than 80 per cent of the upstream subsidy, for OIL it means an increase in absolute terms. Lack of clarity with regard to the gas price for the power and fertiliser sectors also aggravates uncertainty on upstream companies’ contributions, as the APM gas price stands to double from April 1. Analysts believe clarity on this will emerge in three or four months.

Price hikes bring respite
Nevertheless, the diesel price increases being undertaken monthly are providing respite. Ambit Capital estimates under-recoveries (assuming regular price rises continue) would decline from Rs 132,900 crore in FY14 to Rs 106,800 crore and Rs 84,300 crore in FY15 and FY16, respectively. Thus, in spite of the upstream share estimated to increase from 48 per cent in FY14 to 57 per cent each in FY15 and FY16, OIL’s subsidy burden is seen declining from Rs 63,800 crore in FY14 to Rs 60,900 crore in FY15 and to Rs 48,000 crore in FY17 (assuming an oil price of $108-110/barrel).

Ambit’s analysts feel OIL’s share price is factoring in a perpetual net crude oil realisation of $20/barrel (lower than average) and a gas price of only $4.2-4.5/mBtu. With gas prices set to double to $8.4/mBtu next month, analysts remain bullish.

Analysts at Antique Broking say for every $1/mBtu rise in gas price, OIL’s earnings should rise by Rs 4.8 a share. Chirag Dhaifule at LKP Securities estimates a $1/mBtu increase in gas prices would lead to an eight per cent and 7.8 per cent increase in earnings in FY15 and FY16, respectively. Analysts at Ambit, even after adjusting for a gas subsidy burden of $3/mBtu, still see OIL’s net realisations increasing from $4.2/mBtu in FY14 to $5/mBtu each in FY15 and FY16. Dhaifule, however, sees gas realisations at $6/mBtu.

In this backdrop, while analysts at Ambit have increased their price target to Rs 596 (from Rs 585) for Oil India, analysts at Antique have a target price of Rs 600.

The company is also likely to benefit from the recent upgrade in reserves at its Mozambique hydrocarbon assets (acquired jointly with ONGC from Videocon) from 35-65 trillion cubic feet to 45-70 trillion cubic feet. Dhaifule adds OIL’s debt-free balance sheet, estimated cash balance of Rs 7,300 crore in FY14 and estimated free cash flow of Rs 1,480 crore over FY14-16 enables it to opt for both organic and inorganic growth.