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ONGC: Market's stepchild

Sep 8, 2001

Crude oil production, in India, is synonymous with Oil & Natural Gas Corporation (ONGC). Although the latest avatar has been around for less than a decade, its predecessor has been instrumental in meeting the country's energy requirements over the past 43 years.

The genesis of ONGC was in 1955 with the Government establishing the Oil & Natural Gas Directorate under the erstwhile Ministry of Natural Resources & Scientific Research. It was in 1959 that the Directorate, which by then was changed to a commission, was converted into a statutory body by an act of parliament. Oil & Natural Gas Commission was mandated to undertake development activity in the field of oil & gas exploration & production (E&P) in the country. With the advent of liberalization in 1991 and deregulation plans for the sector the commission was incorporated as a company in 1994.

Historically, the sector has always been under Government control due to the strategic importance it holds for the country from the industry and security angle. Both the up and downstream petroleum sector have been under the monopoly of public sector units (PSUs) in the past. The underlying reasoning for such thinking seemed to be to ensure affordability in fuel prices to different customer categories and for making fuel available across the Indian landscape. Consequently, the Government regulated fuel prices in the marketplace and company returns were controlled under the retention pricing mechanism. Under this mechanism, after providing for the operational expenses the return on net worth (RoNW) was capped at 12% for oil upstream companies.

However, in FY98, the Government deregulated the refining sector and laid down a schedule for dismantling the administered pricing mechanism (APM). Under the proposed schedule the domestic crude oil procurement prices, for upstream PSUs, were to be progressively linked to the import parity prices with a floor of $7.5 / barrel. But with international crude oil prices, over the past two years, galloping to new 20-year highs the Government has reportedly put a price cap on domestic crude oil at $16 / barrel. Consequently, any upside from a favourable cyclical turn is limited for ONGC. On the other hand the Government, to attract private investments in oil upstream, purchases oil & gas from private producers at prevailing international rates.

Having said that, ONGC has always operated in a regulated environment. Any boost to the top and bottomline has been driven by new discoveries. ONGC's biggest find has been the Bombay High fields in the early 70's. Based on new exploration activity the oil reserves of the company steadily grew over the 70's and 80's. However, in the 90's oil production has stagnated. In fact, over the last decade, oil production at ONGC has declined by 13.7% while in the last five years production has dipped by 17.9%.

Crude production Refinery throughput
(MMT) 2000 2001 % change 2000 2001 % change
April 2.6 2.6 -0.3% 8.0 7.9 -1.4%
May 2.7 2.6 -5.7% 8.3 9.0 8.8%
June 2.7 2.5 -7.5% 8.2 9.1 11.8%
Total 8.0 7.6 -4.6% 24.5 26.0 6.4%

Crude Imports* POL Imports** (Rs bn)
(MMT) 2000 2001 % change 2000 2001 % change
April 5.5 5.4 -2.0% 56.2 55.5 -1.3%
May 5.5 6.4 15.9% 59.3 68.3 15.2%
June 5.5 6.6 21.2%
Total 16.5 18.4 11.7% 115.5 123.8 7.2%
* Extrapolated as difference between crude throughput and production. ** Estimates

The declining trend has continued into the current fiscal with production declining by 5.8% YoY in 1QFY02. The Assam and Bombay High fields are now proving to be a drag on production growth. The two fields have registered de-growth in all three months of the quarter ended June '01. Nevertheless, post tax profits of the company have grown at a compounded rate (CAGR) of 13.2% in the last ten years. A factor contributing to this bottomline growth has been the rise in natural gas production, which has increased by 7.3% CAGR over the same period.

In order to identify new growth opportunities and cognizant of the strategic importance of black gold to the country, ONGC has undertaken initiatives to augment oil & gas reserves and production. As a step in this direction, the company participated in both rounds of the New Exploration Licensing Policy (NELP) and has bagged an aggregate of 24 blocks. Further, the company has developed a plan to invest Rs 75 bn in the Bombay High fields to boost the production yield from 26% to 40%. ONGC has also established a 100% international subsidiary, ONGC Videsh Ltd. (OVL) to explore opportunities abroad.

OVL recently acquired 20% equity stake in the Russian oilfield Sakhalin - I from Rosneft for a consideration of $1.7 bn to be paid in tranches on reaching certain milestones. Reportedly, ONGC has already made a payment of $339 m in June '01. Other equity partners in the project include ExxonMobil, U.S and Sodeco, Japan, which hold 30% each. As per reports, the project is expected to be as large as Bombay High and Bassein fields put together and holds a lot of promise with in place reserves increasing by 12%-14% since signing of the agreement. The project is expected to commence production by 2005 and generate profits of Rs 25 bn by 2010. The company, reportedly, is also evaluating opportunities in Iraq.

That said, pricing for upstream PSUs continues to be regulated by the Government. The Finance minister reiterated the intentions of the Government to adhere to the original APM dismantling schedule in his budget speech. However, the focus seems to be more towards deregulating marketing of transportation fuels and no indication has been given for linking domestic oil prices to international prices. In fact, the Ministry of Petroleum & Natural Gas (MoPNG) has classified ONGC as a strategic asset. This could lead to prices charged by ONGC remaining under a cap. Also, this rules out the disinvestment trigger, which put other PSU companies on the trading screen. With price caps on crude the juice in the stock has been squeezed out leading to poor investor mind share. Further, poor liquidity on the counter could also be keeping institutional buyers at bay. Therefore, although the stock may offer value the counter suffers from the lack of triggers.

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