The stock has been buzzing with news flow of late, both good and bad. The buzz surrounding the finance minister asking ONGC to pay a special interim dividend had led the scrip to dip to closing low of Rs 246.3 on November 22.
However, the recovery in broader indices and new discoveries on December 1 led it to gain some lost ground. While new discoveries add to its long-term prospects, there are near-term concerns, too. Higher crude oil prices, coupled with a steep depreciation in the rupee, is leading the underrecoveries (subsidies borne by oil and gas companies) to swell sharply. According to analysts, with the government under pressure on fiscal deficit and the limited ability of oil marketing companies (OMCs) to bear subsidies, upstream companies like ONGC may be forced to share 54 per cent of the burden, compared to 33 per cent in the first half of FY12. Also, after the appointment of the board of directors, the government may want to bring in the follow-on public offer, which would keep a tab on the share prices.
New discoveries
With the announcement of two new oil and gas discoveries this month, the total FY12 discoveries by ONGC have gone up to 11. Put together, these are adding to the reserve replacement ratio (measures new reserves against the amount of oil extracted). ONGC has maintained a ratio of more than one for the last six years, with the same at 1.8 in FY11. This is a huge positive for the oil and gas giant, which accounts for 68 per cent of the country’s oil production. Simultaneously, its subsidiary, ONGC Videsh (OVL), is eyeing expansion of its overseas assets. OVL’s efforts to gain 20 per cent stake in the Sakhalin-3 oil and gas fields in Russia, if successful, will give it access to higher liquefied natural gas reserves (worth 46 trillion cubic feet.
Rising subsidy burden
The steep rupee depreciation and high crude oil prices are adding to the subsidy burden of PSU oil and gas players, which sell fuel at subsidised prices. ONGC, which saw strong benefits in the September quarter due to lower subsidies, will feel the heat in the coming quarters. It had seen net realisations per barrel of oil increase to $83.7 in the September quarter, compared to $48.1 in the June quarter and $62.7 in September 2010 quarter.
| ADDITIONAL BURDEN | |||
| FY12 estimates (Rs ) | Old | New | Change (%) |
| Total gross underrecovery | 107900.00 | 138,200 | 28 |
| Upstream subsidy* | 42100.00 | 74,200 | 76 |
| Government bonds | 54000.00 | 60,000 | 11 |
| Net underrecovery of OMCs | 11900.00 | 4,000 | -66 |
| Sharing (%) | Change (bps) | ||
| Upstream* | 39.00 | 54.0 | 1500.0 |
| Government bonds | 50 | 43 | -700 |
| OMCs | 11 | 3 | -800 |
| * Majority to be shared by ONGC Source: Enam Research | |||
With the changed macros, analysts see huge increase in the overall under-recoveries pool. In a December 1 report, analysts at Enam estimate underrecoveries to rise to Rs 1,40,000 crore in FY12. The increasing fiscal deficit will limit government subsidy, pegged at Rs 60,000 crore (Rs 30,000 crore already reimbursed so far) by analysts. OMCs can share up to Rs 4,000 crore, beyond which they will run into losses. This can lead to government forcing companies like ONGC to share the remaining — translating into 54 per cent of the underrecoveries against 33 per cent in the first half.
However, OVL (contributes 20 per cent to ONGC’s revenues) will gain from higher crude oil prices, as it does not have to bear any subsidy, the rupee’s depreciation also being a positive factor. Additionally, ONGC should gain from its stake in the Rajasthan block of Cairn India, where output is expected to be scaled up. Also, with Cairn agreeing to pay 70 per cent of royalties, ONGC will have to pay a lower amount. Arindam Pal, analyst at Asian Market Securities, adds that dollar-denominated administered gas prices ($4.2 per mmbtu) for ONGC may help it achieve break-even in the gas business.
Outlook
The changed macro scenario has led analysts to cut estimates for FY12. Analysts at Enam have reduced their FY12 EPS estimates by 34.2 per cent to Rs 21.5. However, FY13 estimates haven’t seen much change. Overall, while near-term headwinds exist and may keep the stock under pressure, analysts believe investors with a one-year prospective (consensus target price of Rs 331) can expect some gains from the current levels of Rs 267.