ONGC stock: Natural gas price revision, higher volumes are positives

India’s largest gas producer ONGC will be a key beneficiary of the Centre’s decision to hike natural gas prices by 10 per cent from October 1. The price of natural gas has been fixed at $3.36 per million British thermal unit (mmbtu) and will improve revenues on the back of rising gas volumes. 

Given that ONGC is an oil exploration company, a rise in crude oil prices fetches it higher net realisations, while the rupee depreciation helps its subsidiary OVL (ONGC Videsh) earn higher revenues from overseas crude oil production. 

Though rising crude oil prices could translate to a higher risk of subsidy sharing, analysts believe the risk-reward is favourable, given cheap valuations. 

The Centre reviews the prices of domestic natural gas every six months, based on the formula that gauges international gas prices (ruling in the US, Canada and Russia). Given that spot prices in these markets have risen sharply over the last one year, and considering the lag effect, analysts were already expecting a 10-15 per cent price hike. 

Notably, this is the second price hike for the current fiscal year. The government had revised gas prices for the April-September period by 6 per cent to $3.06/mmbtu. This had helped ONGC see gas realisation rise to $3.1 per mmbtu during the June quarter, up 19 per cent from the year-ago quarter. 

Thus, gas realisations will improve further in the second half of FY19, pushing up its earnings. The firm’s gas production had improved about 3 per cent in the June quarter. Analysts at Edelweiss Securities expect gas production to increase to 7 per cent annually during FY18-22, as ONGC’s Rs 800 billion-worth of projects are completed.

Meanwhile, rising crude oil prices are positive for ONGC. The company has already seen its net realisation for oil, at $74.2 a barrel, rise 46 per cent year-on-year in the June quarter. 

Every $1/barrel (bbl) rise in crude oil brings an incremental Rs 10 billion for ONGC, say analysts at IIFL. Rising crude oil prices, though, increase risks of subsidy sharing. 

However, Nilesh Ghughe at HDFC securities says that up to a price of $80/bbl, oil marketing companies could comfortably pass on the inflation by raising the prices of petrol/diesel. 

However, for cooking fuel, upstream companies may have to share a part of subsidy along with the government. Assuming continuation of spot crude oil prices and the rupee in the second half of FY19, under-recoveries on LPG and kerosene will rise by about 124 per cent year-on-year to Rs 574 billion. 

Analysts at CLSA calculate that even under a scenario of ONGC/OIL India absorbing all subsidies in excess of the budgeted Rs 208 billion and using spot crude/rupee, ONGC’s stock price implies no further downside. CLSA finds the risk-reward favourable for ONGC.