The oil & gas exploration and production (E&P) company, Oil & Natural Gas Corporation Ltd. (ONGC), has registered a flat performance for FY02, as compared to an 18% topline growth in the previous fiscal. The decline in sales is due to lower production during the year.
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ONGC has been experiencing declining production over the past five years with output falling from an estimated 30 m metric tonnes per annum (MMTPA) to 26 MMTPA. After marginal growth in FY01, production once again declined by an estimated 1.9% during fiscal '02. Although gas production growth rates are modest, they fair better compared to oil. It is likely that the company experienced a decline in realisation values of other carbon compounds, which are by-products from E&P operations, as commodity prices declined in FY02.
With a marginal decline in operating margins, the drop in operating profits is largely due to lower sales. Oil prices of public sector companies was controlled by the Government till FY02. With oil prices remaining above the stipulated ceiling price, ONGC was compensated at $16/ barrel for crude oil. Average international oil prices (Brent blend) are likely to have declined by 16% to $22.4/ barrel. Gas prices continue to be controlled by the Government due to sensitive nature of downstream consumers; namely power and fertilisers. Gas prices have been fixed in a band of Rs 2,150/ thousand standard cubic meters (tscm) and 2,850/ tscm. Gas markets are aligned with oil markets and with oil prices staying firm domestic gas prices are estimated to have been locked at the upper band. Oil & gas account for an estimated 81% for ONGC's revenues. Therefore, margins have remained steady for the year.
The key costs of ONGC are statutory levies and other expenditures, which account for an estimated 90% of operating costs. Statutory levies pertain to cess, royalty, sales tax and excise duty. Cess and royalty are the primary constituents of this expense head. Post FY02, technically, the Government has deregulated crude oil prices for public sector companies. Consequently, going forward, ONGC is likely to realise international rates for oil production. Having said that, clarity on subject is required, as the Government wants to ensure a smooth transition to a deregulated regime. At the same time, to adjust for windfall gains from deregulation, cess on oil has been increased from Rs 1,000 to Rs 2,000/ tonne.
E&P is a very cash rich business and in absence of significantly large re-investment opportunities results in strong free cash flows, which seems to be the case of ONGC. Over the past three years, interest expense has been on a decline, as the company repays debts from excess cash. As per reports, the company plans to become debt free in the next two-years. Depreciation includes well depletion and write offs. Also, investment of free cash is likely to have generated other income gains.
Recognising the need of reserve accretion, the company participated in both rounds of the New Exploration Licensing Policy (NELP) and has bagged an aggregate of 24 blocks. Further, as per reports, the company has developed a plan to invest Rs 82 bn in Bombay High fields to boost production yields to 40% from 24%. Over the next two years, the company plans to double reserve accretion. However, the exploration stage is risky with wide variations is anticipated reserves. The company, through a subsidiary, ONGC Videsh Ltd., is scouting for opportunities in foreign wells. However, besides Sakhalin - I, the company has not met with much success. The company has extended an interest free loan of Rs 21.1 bn to ONGC Videsh Ltd. for exploring and developing fields.
A positive for the company is that with dismantling of administered prices (APM), it is a matter of time before gas prices are linked to international markets. As per reports, the Government, in two phases, could link international and domestic prices by FY04. Domestic gas prices are estimated to be ruling at half the international rates. At Rs 330 the scrip is trading on a multiple of 7.6x FY02 earnings. Pure E&P players from emerging markets tend to trade in a band of 4x-6x.
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