Higher domestic gas prices, rising volumes to drive ONGC's earnings further

As oil realisation outlook improves, higher domestic gas prices and rising volumes will drive earnings further

As the Brent crude oil price continues its uptrend and is now trading close to its 2019 highs, the share price of India’s largest crude oil producer, Oil and Natural Gas Corporation (ONGC), too, has gained more than 20 per cent from its February lows.

While rising crude prices will benefit the upstream oil producer, which also owns oil and gas fields in the overseas markets through its subsidiary ONGC Videsh, ONGC will also benefit from an increase in domestic gas prices as well as production, being the largest gas producer in the country.

With the pricing and volume outlook improving, analysts expect its gas segment to aid earnings growth significantly during FY19-21. Not surprising, ONGC remains the pick (within oil and gas space) of many brokerages, including Jefferies and CLSA.

Rebounding Brent to boost realisations

During the March 2019 quarter (Q4), Brent crude oil averaged $63.2 per barrel, marginally lower than the average of $64.7 per barrel recorded in the December 2018 quarter (Q3), when daily prices had fallen from a high of $86.09 to a low of $49.73.

While analysts estimate ONGC’s per barrel realisations to decline from $66.4 in Q3 to $63.0 in Q4, Brent crude has rebounded well and hit $72 a barrel on Wednesday — its highest in 2019. Even as this is likely to boost ONGC’s net realisations, expectations are that crude prices could gain further.

“Brent crude oil price remains in a bullish phase and could spike to $80 a barrel due to ongoing geopolitical concerns,” say analysts at Kotak Institutional Equities.

While rising crude price also means that the overhang of subsidy sharing increases, analysts feel that till crude prices don’t sustain levels of over $85, the risk of ONGC being forced to bear significant subsidy burden also remains limited.

In fact, analysts say that oil subsidies have reduced significantly from 1.3 per cent to 0.2 per cent of gross domestic product in the past five years, and expect further action on liquefied petroleum gas subsidies, with the same becoming negligible in the next two-three years.

Those at CLSA say that action to cut oil subsidies further to a more manageable level could allay subsidy burden fears on ONGC/Oil India (OIL) and act as a big trigger, as they forecast the ONGC stock to deliver a 150 per cent return over three years.

Gas price & production improving too

The recent gas price hikes provide further confidence in ONGC’s future earnings. Domestic gas prices have been raised by almost 10 per cent to $3.69 per metric million British thermal unit (MMBtu) for the April–September 2019 period, compared to $3.36 per MMBtu during October 2018 to March 2019 period.

This bodes well for the company’s earnings and more so as it is seeing rising gas production. Analysts say that rising gas prices will benefit ONGC as well as OIL (another state-owned oil and gas producer), where every $1 per MMBtu increase in prices lifts their earnings by 10-11 per cent.

For ONGC, whose gas production is also at lifetime highs, analysts at Jefferies expect the company’s gas segment to be a key tailwind for earnings in FY19-21 and beyond, as its deep-water projects ramp up where realisations are materially higher ($9.32 is the price ceiling during April-September 2019 period).

Analysts say that while ONGC has been not seen significant rise in oil production, they believe that once the KG-DWN-98/2 hydrocarbon block (located off the shore of Godavari Delta on the east coast of India) comes into production, it would result in significant gas production growth for ONGC.

Analysts at Motilal Oswal Securities (MOSL) thus, expect ONGC’s gas production to grow 5-6 per cent annually for the next three-four years, while they estimate its oil production to increase marginally.

Some of the above-stated gains, however, could get offset at the consolidated level (ONGC owns 51.11 per cent in Hindustan Petroleum), given that refining and petrochemical margins have been under pressure recently.

Overall, MOSL analysts say that ONGC has no subsidy burden so far, it has strong dividend yield, and stock valuations are attractive.