Higher subsidy share could offset ONGC's gains from rise in output

Analysts expect company's share in subsidy burden to rise to 40% in March 2013 quarter from 36% in first nine months of FY13

Oil and Natural Gas Corporation Ltd’s (ONGC’s) stock was up nearly five per cent to Rs 324 on Monday, led by the recent decline in crude oil prices (which means a decline in absolute subsidy burden for the country and the company). The sustainability of these gains, though, depends on how much subsidy burden the company will have to bear. Uncertainty on this has been the key reason for the stock falling 13 per cent from its 52-week high of Rs 354 (made in January).

Analysts expect the company’s share in subsidy burden to rise to 40 per cent in the March quarter from 36 per cent in the first nine months of FY13. If expectations come true, it could impact ONGC’s net realisations and profits. There is uncertainty over the subsidy share of ONGC for FY14 as well.

Analysts say a sharp increase in the subsidy share could potentially shave-off the gains expected to arise from the fall in oil prices (read absolute subsidy) as well as expected increase in its domestic output and likely rise in gas prices in FY14. ONGC has provided a crude oil production forecast of 28.6 million tonnes (mt) for FY14, compared to a production of 26.12 mt in FY13, an increase of 9.5 per cent year-on-year, which is positive. However, one will need to monitor this, given that the company has faced issues in ramping up production in the past, especially at the end of the first half FY13, wherein it had to revise downward its guidance of 27.5 mt for FY13, cut to 27 mt; the actual output came at 26.1 mt, according to reports.

ONGC currently derives 72 per cent of its production from fields which are 37-52 years old. To maintain production from these, it has introduced improved oil recovery and enhanced oil recovery schemes, which have helped sustain output at these (very old fields see a decline in output with each passing year). However, it hasn’t been able to raise production at smaller fields. Analysts at Religare Securities, around November last year, observed that ONGC’s production guidance has been revised lower due to deferment in commissioning of marginal assets and natural decline. They also observed that various marginal assets will come on-stream from 2013-15.

In addition to marginal fields, the company is also hopeful of increasing production from its fields in small clusters. The APM (administered pricing mechanism) gas price decision by the government according to the recommendations of the Rangarajan commission, can also be a strong trigger. The committee has recommended $8 per mmBtu price for APM gas against $4.2 mmBtu currently.

Analysts at Citi expect the recommendations being accepted as they observe that “there seems to be a greater acceptance of higher gas prices within the government. Also, from a political standpoint, a hike in APM prices could be a pre-requisite to justify higher KG gas prices, given the recurrent controversies surrounding the block”. Even analysts at Motilal Oswal observe that given the first leg of reforms, upstream companies like ONGC and Oil India are best plays with likely earnings CAGR of around 35 per cent in FY13-15.

On the flip side, the company is estimated to see higher subsidy impacting its March quarter performance. During the first nine months of FY13, the subsidy share of upstream companies stood at 36 per cent which analysts believe could go up to 40 per cent in the fourth quarter leading to higher burden on upstream companies like ONGC and Oil India and hence impact their profits.

Analysts at Morgan Stanley expect the government to finalise upstream subsidy share at 40 per cent for the full year. Based on this, they estimate ONGC’s net realisation to decline to $45 a barrel in the quarter, leading to sequential decline in its profits. The Street would hence be keenly watching this as well as seeking clarity on FY14 subsidy share of upstream companies.