ONGC: Handcuffed to Policy

Firm crude prices are reflexive to a healthy outlook for ONGC. However, inspite of a near universal conviction on rising crude prices, ambiguity on policy issues especially regarding the subsidy sharing mechanism is a drag on the stock. The company, though, stands to gain from a petroleum ministry proposal to raise the administered pricing mechanism (APM) for gas by 33% to Rs 4250 per mBTU from Rs 3200 currently, as the government inches towards fuel pricing reforms.  Natural gas sales comprised about 12% of total revenues in FY09.

Total revenues, this quarter, fell 13.5% compared to Q2FY09 to Rs 15134 crore. This was primarily because ONGC has discontinued trading MRPL (Mangalore Refinery Petrochemicals Limited) products from March 2009 and value added product sales were lower. Discounting the trading income, core revenues were up 2% y-o-y.

Profits up, subsidy down

ONGC saw a 6% y-o-y rise in Net profits to Rs 5090 crore in Q2FY10 as crude realizations improved 20% to USD 56.42 from USD 46.42 per barrel (that gross realizations slipped 40% y-o-y from about USD 120 per barrel in Q2FY09  to USD 70.50 per barrel this quarter illustrates the impact of government policy).

In absolute terms the subsidy burden reduced almost 80% from Rs 12,663 crore in Q2FY09 to Rs 2630 crore this quarter. This in turn helped boost operating margins which expanded 972 bps y-o-y to 58.58%. However margins were down 570 bps over the previous quarter this year as expenses were up 18%       q-o-q while revenues increased marginally by 1.6%.

The company saw a 3.4% y-o-y decline in crude oil production in Q2FY10 to 6.63 million metric tons (mmt), a fall-out of the natural decline in production from the ageing Bombay High reservoir. The dip reflects the challenges of arresting this decline inspite of significant capital commitments, as per a Goldman Sachs research report. However, management in a conference call post-results stated that the current production levels will be sustained till FY11. FY12 will see a boost to levels once crude production from the east coast – Krishna Godavari region kick in, they added.

Natural gas production was marginally higher at 6.65 billion cubic meters (inclusive of joint venture’s production) against 6.43 billion cubic meters last year.

Growth forecast

The company has crude oil production targets of 28.129 MMT for FY10 and 27.471 MMT for FY11. Gas production is expected to touch 24.922 billion cubic metres (BCM) in FY10 and 23.579 BCM in FY11. Crude productionis targetted at 29 MMT in 2012-13, as incremental production kicks in from the East Coast fields and shallow areas (such as the Rajasthan joint venture with Cairn). Gas production from Krishna-Godavari fields (K G -98/2) is targeted from 2015-16. Production from these fields is expected to reach 100 million standard cubic meters per day by that time.

The petroleum ministry proposal to hike gas APM would see ONGC being paid Rs 3870 per thousand cubic metres(TCM)  while Oil India gets Rs 4310 per TCM in line with the current formula. This would translate to gas sales gains for ONGC of about 7% in FY11 (revenue  gains of Rs 541 crore over current expectations based on Enam estimates of gas sales of about 23 BCM in FY11)

ONGC has planned capital investment of Rs 24720 crore and Rs 26523 crore in FY10 and FY11 for enhancement of production from both offshore and onshore assets. The bulk of capex in FY10 (Rs 23,948 crore) is on exploration activities. Investment in FY09 was Rs 21820.6 crore. Oil and gas reserve accretion is targeted at 72.65 MTOE and 76.17 MTOE for FY10 and FY11 respectively, against current reserves of 68.90 MTOE.

The key risks for the company are government policy related in terms of subsidy sharing by upstream companies. Other risks are mainly macro in nature in terms of oil price scenario and geopolitical given that it has overseas assets are in unstable areas like Sudan and Syria.

ONGC was up almost 1% on 16 November, 2009, after rising steadily over the last fortnight. It closed at Rs 1199.60 and trades at a P/E valuation of 10.9x FY10 and 10.15x FY11 consensus analyst estimates of earnings per share.