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ONGC: ‘What if’ analysis
Dec 20, 2004

Natural gas is fast catching up as the fuel of the future. India currently faces a shortage of over 80 MMSCMD (million standard cubic meters per day) of gas and the recent steps taken by the government to allow ONGC and GAIL to pick up oil and gas equity abroad do look at reducing this demand supply gap. But the pricing environment continues to be in jeopardy. Although the petroleum sector has witnessed substantial de-regulation measures over the last five years, the natural gas sector remains under the watchful eye of the government. Natural gas prices have remained fixed since October 1999 within a price band of Rs 2,150 to Rs 2,850 per TSCM (thousand standard cubic meters). On the contrary, natural gas prices in the international markets are hovering at over Rs 8,600 per TSCM. The graph below highlights the trend in natural gas prices in India and in OECD countries. Not only have companies like ONGC lost out on the profitability but also have to take a direct ‘hit’ owing to the subsidy sharing agreement.

ONGC currently produces nearly 24 BCM (billion cubic meters) of natural gas and the entire produce is allocated by the government at the regulated prices, which are currently 40% below market prices. Adding further fuel to this is the fact that ONGC has to make good the difference between international prices and regulated prices to its joint venture partners, further burdening the company. Also the fact that Rs 2.5 bn is deposited in a Gas Pool Account (GPA) does not help matters for the company.

We take a look at the earnings of the company within the two scenarios:

Scenario I: Gas prices linked to international markets
Although utopian, if natural gas prices in the country are linked to international prices, the following table gives a glimpse of the effect on earnings.

What if' it was de-regulated!
(Rs m) FY01 FY02 FY03 FY04 FY05E
Volumes - TSCM 20,501 20,446 21,110 21,103 21,500
Realizations          
ONGC 49,756 49,446 49,986 52,183 54,502
OECD 140,203 167,243 139,828 168,795 185,975
Difference 90,447 117,797 89,842 116,612 131,473
New realizations @ 50% lower 45,224 58,899 44,921 58,306 65,736
per share 31.7 41.3 31.5 40.9 46.1
EPS (Current) 37.0 43.0 74.0 61.0 82.0
EPS (new) 68.7 84.3 105.5 101.9 128.1
% accretion 46.2% 49.0% 29.9% 40.1% 36.0%

At international parity prices, it adds 36% to the current EPS after factoring in only 50% to ONGC’s bottomline after meeting all the ‘other expenditures’. To put things in perspective, ONGC had to bear nearly Rs 120 bn in FY04 towards gas subsidies apart from the losses faced on account of lower prices.

Scenario II: Gas prices increased by the government by Rs 350 per TSCM.
The government recently had mooted the proposal to hike natural gas prices by Rs 350 per TSCM. Although the decision has been delayed in the current fiscal, if it is passed in FY06, the earnings growth is likely to be nearly 19% for ONGC.

What if' it is Increased by Rs 350…
(Rs m) FY06E
per MMBTU increase (US$) 0.2
Estimated realizations (US$) 1.6
New price (US$) 1.9
price per TSCM (Rs) 3,006
Volume 22,200
Current expected earnings (Rs m) 59,277
Realizations with Rs 350 hike (Rs m) 64,634
Difference (new - old) 5,357
(%) Increase 18.6%

At Rs 843, the stock is trading at a price to earnings multiple of 10.3 times FY05 estimated earnings (price to cash flow multiple of 6.5 times). ONGC is betting big on its recent Krishna Godavari prospects and is also aggressively vying for oil and gas equity abroad. Given the high crude oil prices in the current scenario and also the fact that the indications given by the government to free ONGC from the kerosene subsidies burden augur well for the oil and gas giant. However, huge capex plans and the highly ambitious deep-water drilling projects are a matter of concern.

We had recommended the stock at Rs 840 on December 4th, 2004 with a target price of Rs 1,235 with a medium term perspective. We remain optimistic of the company’s prospects.

Note: We have not factored in any of the above scenarios in our estimates under the research coverage.

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