Why BP's KG D6 write-off does not matter

One stock that has been conspicuous by its absence in the market rally has been Reliance Industries. Most of the frontline stocks in the market have touched new highs but Reliance has been languishing at below Rs 1,000 levels. The company is nowhere close to its adjusted all-time-high price of Rs 1,626.

One of the main reasons for the non-performance was that fortunes of the company were linked to gas output and gas price. There has been disappointment on both the front for the company.

Gas output has been steadily declining with all efforts by the company to arrest its decline not producing results.  Against a peak expectation of 80 mmscmd of gas production by April 2012, KG D6 well is now producing only 11.9 mmscmd (Q3FY15).

International oil giant BP Plc. was roped in by Reliance to use their deepwater drilling expertise to help resolve the declining gas production issue. BP Plc. put in $7.2 billion in mid of 2011 and picked up a 30 per cent stake in the gas venture. When BP had made the investment gas production in KG D6 was at 50 mmscmd which had sharply fallen from 60 mmscmd a few months earlier.

With the continuous fall in production BP Plc. has written off part of their investment. While announcing their 2014 numbers the company has written down the value of its investment in KG-D6 block by $830 million. But the entire amount written off is not account of lower production and lower estimates of future production. According to BP’s statement part of the write-off, $415 million write off has been due to impairment of charges and the remaining was on account of loss due to lower price of gas.

Analysts too are now attributing lower value for the gas business. According to BNP Paribas the KG D6 gas business is worth Rs 66 per share, a fraction of what BP Plc. had valued while making the investment.

For Reliance KG D6 is soon losing its relevance. KG D6’s gas production is even lower than that of Reliance’s shale gas business in the USA. For the December 2014 quarter the entire exploration and production of domestic oil and gas yielded earnings before interest and tax (EBIT) of Rs 267 crore. While the shale gas business of the company with a production of 16 mmscmd posted an EBIT of Rs 567 crore. BNP gives a valuation of Rs 46 for the shale gas business of Reliance. Lower valuation in the shale gas business is because its prices are linked to global oil prices while Reliance enjoys a fixed price for its domestic gas business.

If production does not pick up Reliance’s KG D6 business share in the sum of the part calculation of analysts will become inconsequential. Already the retail business of the company is being valued at Rs 59 per share. This division has seen good amount of investment which is expected to continue going forward. Further, analysts have not accorded any valuation to the telecom business of the company.

Valuation of the telecom business will drive future valuation of the company. Moreover, the petrochemical and refining business which has already seen $10 billion of investment out of the proposed $14 billion will start contributing to its numbers. KG D6 basin will soon fade away ones the numbers from other business start contributing. Contribution of the entire domestic E&P business to the EBIT in any case is less than five per cent currently.