In the past six months, Cairn India has made two major oil and gas discoveries in the subcontinent. In November, it announced a gas find in the offshore Mannar Basin of Sri Lanka. Last week, its second oil discovery in the Krishna-Godavari basin (on-shore block) was announced. The management has conveyed these discoveries have estimated reserves of 550 million barrels (57 million barrels in the first and 500 million barrels in the latest one). The recovery rates are likely to be 10 per cent, given the impermeable nature of the reservoir. The company will, therefore, need to undertake fracking and stimulation to recover the oil. Fracking or hydraulic fracturing is used in impermeable and tight reservoirs.
Though fracking is a somewhat controversial technique globally, oil experts believe since the oil is light and low in viscosity, it would flow to the surface easily. Edelweiss Securities believes while Cairn will operate the block during exploration, ONGC will do so during production. Assuming $10 a barrel of value for reserves, Cairn’s net value accretion will be Rs 1,350 crore, implying value addition of Rs 7 per share. The brokerage has increased valuation of its sum of the parts (SOTP) to Rs 326 per share from Rs 319 earlier. This valuation is lower than the current market price of the stock (Rs 348) because unlike other brokerages, Edelweiss has assumed a long–term crude price at $95 a barrel while calculating SOTP. The market is estimating the long-term average of crude at $105 a barrel.
Apart from these discoveries, higher crude oil prices have also helped in the stock’s recent rise. According to Kim Eng Securities, with Brent priced at $120 a barrel, Cairn’s oil spread would be $54.9 a barrel for Q4. Given that production cost has remained static at $22 a barrel, an increase of every $1 in prices results in 1.1 per cent increase in earnings per share. While this has been priced in, analysts claim the management has conveyed its expectation to scale up production as well.
The company has guided for a peak production of 240,000 barrels per day from the Mangala, Bhagyam and Aishwarya (MBA) fields, along with satellite fields. Cairn announced on Tuesday gross oil production from operating units was 167,663 barrels of oil per day (bopd) and 160,635 bopd during Q4 and the full year, respectively, as compared with 148,288 bopd and 135,811 bopd in the corresponding prior periods. Analysts believe MBA fields alone can produce 240,000 bpd. Additional output from satellite fields would be an added bonus.
Finally, the company is expected to generate free cash flow of Rs 5,300 crore, according to Jigar Shah of Kim Eng Securities. Vedanta Group, the new owner, hinted at a special first dividend up to Rs 2,700 crore this financial year and increased dividend payouts in future. A combination of these factors is driving Cairn’s stock price, in an otherwise subdued market.
