Oil India: Some optimism on improving prospects

These include higher gas prices, output expansion and fuel price reforms, beside inorganic opportunities

Oil India Ltd (OIL) has been in the news following its acquisition of a 49 per cent stake in Assam Petrochemicals ltd (APL), as well as a possible deal to buy Videocon's 10 per cent stake in a Mozambique block, along with Oil and Natural Gas Corporation (ONGC). While the latter remains unconfirmed, its investment in APL will push up the company's gas volumes.

Oil India is also likely to gain from higher domestic gas prices and gradual diesel price deregulation. A ramp-up in production and increased exploratory and inorganic initiatives would result in increased revenue visibility. According to Bloomberg consensus data, most analysts remain bullish on Oil India, with the average target price of Rs 635 implying an upside of 11 per cent from Tuesday's closing price of Rs 573.30. The key risks remain uncertainty on subsidy sharing and high concentration in the northeast.

Inorganic growth, production rise ahead
OIL, which has cash of about Rs 12,000 crore (about Rs 200 a share), is working towards putting this money to good use. As part of its inorganic initiatives, last week, it announced the acquisition of a 49 per cent stake in APL, a gas-based petrochemical producer, for about Rs 230 crore. The remaining stake will be held by the Assam government. The company will also partly fund investments worth Rs 1,030 crore in building a new petrochemical plant at Namrup in Assam.

On the acquisition of Videocon’s 10 per cent stake in the Area-1 offshore block in Mozambique, though Oil India has not confirmed the deal, success on this could improve growth visibility. While Anadarko (operator of the block) specified that LNG production will commence in 2018, analysts estimate the recoverable reserves at 50 trillion cubic feet (tcf) versus the former’s estimate of 35-65 tcf.

Total development capex is estimated at $41 billion over eight to 10 years. Oil India’s estimated initial investment for the four per cent stake (the remaining six per cent by ONGC) is pegged at $1 billion.

Apart from the Mozambique block, OIL is exploring inorganic growth opportunities. It plans to spend about Rs 5,800 crore over the next three years towards exploration. It is looking to bid for 13 blocks in the Cauvery and Mannar Basins in Sri Lanka. In addition to raising production, these international operations will also provide natural hedges for any higher subsidy burden. But given the nature of the business, expect gains to accrue only over the long term.

 

In India, the company has readied Rs 3,800 crore towards capital expenditure this financial year.The plan is to expand production of crude oil to 3.95 million tonnes (mt) (up 6.8 per cent over FY13) and gas to 2.74 billion cubic metres (up 3.8 per cent); the latter is expected to rise to three bcm by FY15.

An improving operational environment in the northeast and commissioning of the Brahmaputra Cracker and Petrochemicals Ltd (BCPL) unit will aid higher production.

"A key event for Oil India would be the commencement of gas supplies to the BCPL cracker unit (expected by August), which, upon achieving stable operations, would require 1.35 mscmd (million standard cubic metres a day),” says Saurabh Handa, analyst at Citigroup. Put together, these should help Oil India post better growth in FY14.

Fuel price reforms
Gradual diesel price deregulation (easing its subsidy burden) and likely upward revision in domestic gas prices will benefit Oil India significantly.

It bears a 10-12 per cent share of the upstream subsidy burden, which totalled Rs 161,000 crore in 2012-13 (Oil India’s share was Rs 7,900 crore). While a falling crude oil price is good news for the company, a weakening rupee could play spoilsport and push up total under-recoveries.

More important is the expected increase in the administered price of gas, as a large part of Oil India's sales are regulated (in terms of pricing).

Dayanand Mittal, oil and gas analyst at Ambit Capital, says, "Oil India is a play on the gas price hike. An increase in domestic gas price to $6/mBtu could provide earnings upsides of 15-20 per cent for the company. However, the Street has partly captured some of these gains."