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Energy sector: Lacking in direction

Oct 7, 2004

Over the last decade, India has witnessed steep growth in imports of crude oil (to the extent of 70% of the domestic requirements). Given this backdrop, let us now analyze the various steps being taken by the government (through the PSUs) to secure crude oil supply for the country.

  • ONGC: A back of the envelop calculation suggests that as per FY04 production of nearly 26.1 MMT (million metric tonnes) of crude oil (Independent), ONGCís reserves will last for another 16.25 years. In order to elongate this period, ONGC has planned a capex of Rs 100 bn every year during the 10th five-year plan for domestic exploration activities. This is directed towards improving the recovery factor (the amount of oil that can be recovered from the proved reserves) from the current 28% to global standards of 40% by 2020. Some of these initiatives are already paying off (production has increased by 50,000 barrel per day from Mumbai fields).

  • ONGC Videsh (OVL): ONGCís wholly owned subsidiary, OVL, is planning to invest US$ 1 bn per annum upto 2010 so as to achieve the target of securing 20 MMT of crude oil and gas abroad for the country. The company is already present in nine countries across continents having significant stakes. OVL currently has a production share of nearly 3 MT of oil and gas abroad. We believe this is likely to increase going forward with the addition of Sakhalin fields in Russia to producing properties in FY06.

  • Oil-marketing companies: Recently, oil-marketing companies have begun focus on oil exploration and production (E&P) so as to secure a part of their refining requirements. To put things in perspective, IOC is planning to acquire 40% stake in an Indonesian E&P firm for an investment consideration of nearly US$ 600 m. This is a strategic move by IOC, which imports nearly 70% of Indiaís crude imports as the company aims to secure nearly 25% of its refining requirement.

We believe it would be a better option for these companies to come together and bid for equity oil abroad rather than compete against each other. Given ONGCís expertise and OVLís better knowledge abroad, the oil marketing companies would be better off riding on ONGCís back. On the other hand, ONGC could stick to its expertise rather than entering into downstream marketing business.

At the current price of Rs 804, ONGC is currently trading at a P/E multiple of 12.4x 1QFY05 annualized earnings. The subsidy burden that the government imposes on ONGC is likely to result in sub-optimal profits, as the company is forced to sell its products at a discount to oil marketing companies. To put things in perspective, ONGC offered discounts to the tune of Rs 4.8 bn during 1QFY05. However, given the current spike in crude prices, we believe the current fiscal is likely to be better than expected.

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