Cairn's 60% cut in capex to hit reserve ratio

Given the company's strong balance sheet, analysts say capex reduction too severe

Lower oil prices are beginning to take a toll on capital spending of oil majors. Cairn India shares fell on Thursday, after the company slashed its capital expenditure plans for FY16 by 60 per cent to $500 million and deferred its FY17 capex plans. Given the low finding and production costs, the Street believes the cuts are very severe. The company is also said to be reducing workforce.

Along with capex, the company has also cut its production guidance. In FY14, the company had guided for a production increase of 7-10 per cent compounded annual growth rate over FY14-17. Now the management has said volumes will grow by three to five per cent. Both announcements have impacted the stock and resulted in earnings downgrade and, consequently, lower stock price targets. Jefferies says given Cairn's strong balance sheet and low finding and production costs, the extent of capex reduction seems too severe.

The company has decided to defer investments in four key projects. The first is the development of satellite fields. The second project to be deferred is the Mangala Processing Terminal upgrade. The third is the Bhagyam/Aishwarya polymer injection plant. And finally, the Rajasthan exploratory drilling to increase oil output.

This is bad news as the company was targeting three billion barrels of oil equivalent to incremental prospective sources under the new exploration programme. According to Religare Institutional Equities, so far 2.1 billion barrels of oil equivalent has been drilled — of which 1.5 billion barrels of oil equivalent has been established and the rest is under evaluation. Lower exploration spends could severely hit the aspired reserve replacement ratio.

In a bid to cut costs, the company has also been renegotiating contracts with service providers. Edelweiss Securities says the company expects substantial cost savings to flow from service providers, as service charges do not show in oil prices. These savings could potentially reignite capex if oil prices firm up.

While the market is expecting oil prices to remain well below $100 a barrel in FY16 and FY17, Carin’s capex plans might pick up if oil prices recover.