Have ONGC's investments in ageing fields paid off?

Both its production and market share have dropped over the past decade

State-run Oil and Natural Gas Corporation may be pressing the government for premium gas pricing to make its Rs 40,000-crore investment plan in the Krishna Godavari basin viable. Its recent history, however, is overburdened with massive capital expenditures to upgrade ageing fields to overcome the natural decline in production.

India's largest oil exploration firm, according to a Business Standard analysis, has pumped in more than Rs 1.94 lakh crore on such projects over the past eight years - with expenditure increasing 37 per cent from Rs 21,820 crore in 2008-09 to Rs 29,997 crore in 2014-15.

Despite the mammoth spending, however, ONGC's annual crude production fell 12 per cent to 22.2 million tonnes (mt) over the period. Natural gas output also dipped 2 per cent to 22,022 million standard cubic meters (mmscm).

There are only a few signs of these huge outlays having much of an impact on production so far: ONGC managed to arrest the decline in output last financial year, reporting a flat output at 25.9 mt on the back of a 4.3 per cent jump in production from the western offshore fields, and plans to report a marginal rise in output this financial year.

With private explorers like Cairn India, a Vedanta Resources subsidiary, and Reliance Industries, clawing their way into ONGC's market share, the company's contribution to India's total crude oil output has fallen from 76 per cent to 59 per cent over the same period (2008-2015). ONGC's hold over natural gas market has also dipped from 68 per cent to 65 per cent.

The past eight years have also seen ONGC slipping on its investment commitments. In 2008-09, its actual expenditure stood at Rs 21,820 crore - Rs 2,483 crore more than the Rs 19,337 crore budgeted for the year. This extra spending was slashed to Rs 1,752 crore in 2010-11, and fell short of the budgeted target by Rs 3,558 crore in 2012-13 and Rs 6,062 crore last financial year. The gap between committed and achieved investment, therefore, has been widening.

Justifying investments
What then justifies the investment of Rs 30,000 crore annually over the past eight years by ONGC? Chairman D K Sarraf explains this by drawing an analogy between upstream business and running on a treadmill. "You may continue to run at 8-10 Km per hour on the treadmill only to find you are at the same place after an hour. So, to maintain the production itself, you have to run. Otherwise, production will fall 6-8 per cent per annum," he told Business Standard.

ONGC has managed to limit the fall in production to 2.5 per cent per annum over the past decade, and this year it is expecting a marginal increase. In addition, the drop in onshore production so far this year has been less than expected and offshore production has shown an increase.

"Globally, too, the production from old fields is declining at 8-10 per cent per annum and India is no exception. Most of ONGC's fields are quite old," says Sarraf. He says ONGC's future output will mostly come from the western offshore fields.

Analysts give a thumbs up to ONGC' future outlook. Their optimism is based on four counts - the company's massive reserve base, improved reserve replacement ratio, a conservative balance sheet and the recent fall in crude prices that has significantly reduced its subsidy sharing burden, leading to improved net realisations. However, the lack of clarity over the government's subsidy sharing formula could derail ONGC's plans.

ONGC had proven reserves of 6.8 billion barrel of oil equivalent at the end of March 2015. "At current production levels and based on its reserves, ONGC has a long reserve life of 16 years. In addition, its exploratory success and reserve replacement rates have gradually improved. The reserve replacement ratio for ONGC-operated domestic oil fields has remained above 100 per cent for the past nine years, achieving 138 per cent for FY2015," ratings agency Moody's said in a report earlier this month.

The reserve replacement ratio is a measure of the amount of proven reserves added to a company's existing reserves during a year relative to the amount of oil and gas produced. Under stable demand conditions, this ratio must be at least 100 per cent to ensure sustained long term operations for an oil exploration company.

According to ratings agency ICRA, the expected marginal rise in India's hydrocarbon production over the medium term will be driven by ONGC commercialising its marginal fields in addition to its initiatives to improve oil recovery from its existing fields.

To lead the way in oil exploration and discovery, ONGC has drawn up a strong capex plan which includes six major projects in the western offshore fields at an investment of around Rs 28,000 crore. These projects when completed will produce 20.5 mt of oil and 57.5 bcm of gas annually. In the current financial year, projects worth Rs 10,000 crore were approved till September and nine projects valued at Rs 21,500 crore were completed.