Higher oil and gas prices, as well as pro­duc­tion, should drive earn­ings, but sub­sidy shar­ing risk rises if crude oil sustains above $70, which could drive down stock


The Oil and Nat­u­ral Gas Cor­po­ra­tion (ONGC) stock has sig­nif­i­cantly lagged the bench­mark S&P BSE Sen­sex over the past year, even as prices of crude oil, its main­stay, have ral­lied (see chart). There has been some catch­ing up in the past week, led by im­prov­ing prospects in the busi­ness. If the trend sustains, which seems likely, ONGC’s in­vestors could see good re­turns.

The un­known, how­ever, is whether the gov­ern­ment will ask the com­pany to bear the sub­sidy bur­den if oil prices rise sharply, as was the case a few years ago. This is one rea­son the mar­ket is cau­tious on gov­ern­ment-owned pro­duc­ers like ONGC, as well as its three oil mar­ket­ing com­pa­nies, Hin­dus­tan Petroleum (HPCL), Bharat Petroleum (BPCL) and In­dian Oil (IOC). For now, an­a­lysts pre­sume this might not hap­pen and, hence, ex­pect ONGC to gain from ris­ing prices and out­put.

With gas prices for lo­cally pro­duced fields be­ing re­vised to $3.06 per mBtu (mil­lion Bri­tish ther­mal units) for the first half of FY19 from $2.89 per mBtu in the sec­ond half of FY18, an in­crease of 5.9 per cent se­quen­tially and 10.1 per cent year-on-year, gas pro­duc­ers re­main in a sweet spot. The ceil­ing price to be pro­duced from dif­fi­cult fields has been raised by 7.6 per cent to $6.78 per mBtu. This should ben­e­fit up­stream oil and gas ex­plo­ration com­pa­nies such as ONGC, Oil In­dia and Reliance In­dus­tries fur­ther, re­sult­ing in higher earn­ings.

Rat­ing agency ICRA has said an in­crease in gas prices will en­cour­age these com­pa­nies to take up more ex­plo­ration.

Among ex­plo­ration and pro­duc­tion com­pa­nies, ONGC would ben­e­fit the most, say an­a­lysts at ICICI Se­cu­ri­ties, as it ac­counted for 75 per cent of the gas pro­duced in the coun­try in FY18. Fur­ther, as gas prices are ex­pected to rise 19 per cent year-on-year to $3.6 per mBtu in FY19, they ex­pect the com­pany’s FY19 earn­ings per share to rise by ~1.3 per or five per cent. Ab­hi­jeet Bora at Sharekhan has a sim­i­lar view and ex­pects in­cre­men­tal earn­ings of ~5.49 bil­lion for ONGC in FY19 on an an­nu­alised ba­sis from the cur­rent gas price hikes.

No­tably, ONGC is also see­ing a rise in gas pro­duc­tion and is ben­e­fit­ing from higher crude oil prices. Pro­duc­tion, flat ear­lier, is seen grow­ing 10-15 per cent an­nu­ally over the next three to four years, say an­a­lysts. They ex­pect earn­ings to grow by 17 per cent an­nu­ally over FY17-20.

The March quar­ter, too, is likely to be bet­ter for ONGC. Ko­tak In­sti­tu­tional Eq­ui­ties es­ti­mates the com­pany’s net in­come to rise by a sharp 27 per cent se­quen­tially (to ~63.4 bil­lion). Driven by an in­crease in crude re­al­i­sa­tion to $66.2 a bar­rel (up $5.6 a bar­rel se­quen­tially), say an­a­lysts.

As higher oil prices re­sult in higher re­al­i­sa­tions, the Street feels the threat of sub­sidy shar­ing also in­creases. An­a­lysts say these risks will be only if oil prices sus­tain above $70 a bar­rel; these are now around $71. At cur­rent lev­els, Bora says under the cur­rent sub­sidy shar­ing mech­a­nism (the gov­ern­ment bears a sub­sidy of up to ~12 per litre on kerosene and up to ~15 per kg on cook­ing gas), it would en­sure strong net oil re­al­i­sa­tion of $60-63 a bar­rel for ONGC.

The com­pany has been show­ing growth in its oil and gas pro­duc­tion, un­like Oil

The March quar­ter is likely to be bet­ter for ONGC. Ko­tak In­sti­tu­tional Eq­ui­ties es­ti­mates the com­pany’s net in­come will rise by 27% se­quen­tially to ~63.4 bil­lion

In­dia, say an­a­lysts at Motilal Oswal. The bro­ker­age prefers ONGC, as it be­lieve the com­pany’s cost ef­fi­ciency would re­sult in a de­cline in op­er­at­ing ex­pen­di­ture, as gas pro­duc­tion is likely to grow 10-15 per cent an­nu­ally for the next three to four years. They also ex­pect ONGC’s oil pro­duc­tion to in­crease.

The key will be crude oil prices and sus­te­nance above $70 needs to be watched, as it could mean an over­hang of sub­sidy shar­ing, keep­ing the stock price under check. If the gov­ern­ment does push its oil com­pa­nies to share the sub­sidy, it could see these stocks un­der­per­form fur­ther.

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