The Indian energy sources industry can be broadly classified into - oil and gas which can be further classified into - upstream (exploration and production), midstream (storage and transportation) and downstream (refining, processing and marketing) segments.
State-owned Oil and Natural Gas Corporation (ONGC) dominates the upstream segment. It is the largest upstream company in the Exploration and Production (E&P) segment, accounting for approximately 58.3% of the country's total oil output.
Indian Oil Corporation (IOCL) dominates the midstream and downstream segment and operates a 13,391 km network of crude, gas and product pipelines. This is around 30% of the nation's total pipeline network. It also controls 10 out of 22 Indian refineries. Top three companies IOCL, HPCL and BPCL contribute more than 80% of the total length of product pipeline network in the country and Gas Authority of India (GAIL) as the largest share of the country's natural gas pipeline network.
Within the downstream segment, India has 23 refineries - 18 are in the public sector, two in the joint sector and three in the private sector. Within the private sector, Reliance Industries (RIL) has the largest market share (30%) since it launched India's first privately owned refinery in 1999. Top three companies IOC, RIL and BPCL, contribute almost 70% of India's total refining capacity.
India is the second largest refiner in Asia and the third largest consumer of oil in the world. It is also one of the largest exporters of refinery products due to the presence of various refineries. High Speed Diesel (HSD) is the major export item among petroleum products, followed by motor spirit (MS), Automatic Transmission Fluid (ATF) and Naptha.
India increasingly relies on imported Liquified Natural Gas (LNG) and is the fourth largest LNG importer in the world after Japan, South Korea and China, and accounts for 5.8% of the total global trade. LNG imports account for about one-fourth of total gas demand, which is estimated to double over the next five years. To meet this rising demand the country plans to increase its LNG import capacity to 50 MT in the coming years. Gas Authority of India (GAIL) and Petronet LNG are some of the leading natural gas companies in India.
The government of India has allowed 100% Foreign Direct Investment (FDI) in upstream and private sector refining projects. The FDI limit for public sector refining projects has been raised to 49% without any disinvestment or dilution of domestic equity in existing PSUs. According to data released by the Department for Promotion of Industry and Internal Trade (DPIIT), FDI inflows in the Indian non-conventional energy sector between April 2000 and March 2019 stood at US$ 7.8 billion.
How to Research the Energy Sources Sector (Key Points)
In the upstream segment, supply from the domestic market caters to 20% of the total demand for crude oil. In the downstream segment, refining has seen significant capacity addition in the recent past. In the gas segment, with the domestic gas supplies on a decline, the share of imports in gas sector is rising.
In the past, we have seen a fair degree of correlation between the growth in petroleum products and the growth in the overall economic activities. Thus, we expect the long-term demand to be in line with economic growth.
Barriers to entry
High, due to the capital intensive nature of the industry and economies of scale. Government permission is also required to commence operation in the upstream segment.
Bargaining power of suppliers
In the case of crude oil, prices are globally determined and are highly susceptible to geopolitical events, economic growth and demand factors, economic policies, and speculative bets. OPEC has a significant influence on demand supply dynamics in crude oil.
For petroleum products, given the surplus capacity in the country the bargaining power is low.
Bargaining power of customers
Customers have low/non-existent bargaining power as they are price-takers not price makers.
Low, as just a few players operate in the Upstream, Midstream and Downstream segment. However, with new reforms announced in energy sector, more private players are likely to enter the sector thus increasing the competition.
Threat of Substitutes
Low, as other sources of energy like solar, wind, coal and hydro-electric power are less developed. Pressure from alternative sources might rise in future
During FY20, energy demand slowed down to 1.3% YoY. China was by far the biggest driver of this demand, accounting for more than three quarters of net global growth. India and Indonesia were the next largest contributors, while the US and Germany posted the largest declines. Carbon emissions also declined in step with energy consumption, growing at 0.5%, significantly less than the over 2% growth in 2018.
On the growth side, the United States was, by far, the largest producer with a cumulative output of 12.2 million barrels per day (BPD). But this growth was negated by the production cuts engineered by the Organization of Petroleum Exporting Countries (OPEC+) group, led by Saudi Arabia, as well as the Iranian barrels that did not enter the market due to US sanctions.
In the first six months of FY20, prices dropped quite calamitously, in reaction to the ongoing global Covid-19 pandemic. The slide was severe with global benchmark Brent dropping to under US$ 20/ barrel (bbl) and US benchmark WTI going negative (-US$ 37/bbl) at their worst.
The drop in crude prices had a positive impact on the country's import bill. Crude import bill for FY20 was at Rs 7.1 trillion (US$ 101.4 billion) against Rs 7.8 trillion (US$ 111.9 billion) during FY19. Growth in crude oil imports also stalled in FY20 and hit a historic low at 226.9 million metric tonnes (MMT) versus 226.5 MMT in FY19.
Crude oil price of the Indian basket averaged US$ 60.5 per barrel during FY20 compared to US$ 69.8 per barrel in FY19. The intra-year drop in crude prices, from US$ 71/barrel in April 2019 to US$ 33.36/barrel in March 2020, on the back of the pandemic is steeper than that in FY'15 in percentage terms.
India's crude demand for FY20 was a mere 100,000 barrels per day (BPD), a reflection of a broad based economic slowdown, which affected the auto and industrial sectors particularly badly. Supplies declined by 300,000 BPD.
As per Petroleum Planning and Analysis Cell (PPAC) data, domestic crude oil production in FY20 stood at 32.2 MMT versus 34.2 MMT during FY19. ONGC's standalone production was 20.7 MMT vs 21.1 MMT in FY19. Production from Oil India and PSC/JVs was at 3.1 MMT and 8.4 MMT respectively.
On the other hand, domestic petroleum product consumption in FY20 totaled 213.7 MMT, growing by just a measly 0.2% from FY19, recording its worst ever growth. The downtrend in consumption was largely attributable to the countrywide lockdown measurers implemented in late-March to contain the spread of Coronavirus resulting in significant demand cutbacks in large segments of the economy, especially in transportation and industry.
Natural Gas output in FY20 was 31.8 billion cubic metres (BCM), versus 32.9 BCM in FY19.ONGC's standalone domestic output stood at 23.8 BCM. Oil India produced 2.7 BCM and other private operators 4.7 BCM.
Demand for oil post the pandemic is expected to rebound with gradual resumption of economic activity. As per CRISIL Research, domestic petroleum product demand is expected to grow at 3-3.5% CAGR in the next five years against the robust growth of 5.6% in the past five years.
With an economy that has grown consistently, underpinned by robust domestic demand, world's largest youth population and increasing urbanization, India remains vitally important to global energy markets.
Over the past few years, the Government has executed a raft of measures geared to advance the prospects of the upstream hydrocarbon sector. It has formulated and approved a new exploration and licensing policy named Hydrocarbon Exploration and Licensing Policy "HELP" vide resolution in 2016 whereby it provides a uniform license to enable E&P operators to explore and extract all hydrocarbons resources including conventional and non-conventional oil and gas resources.
Some of the key aspects of this new licensing regime are Open Acreage Licensing, uniform license for all types of hydrocarbons, revenue sharing model, marketing and pricing freedom, low royalty for offshore fields, and continuous exploration under contract period etc.
The government has also approved a new policy framework in 2018 to promote and incentivize Enhanced Recovery (ER)/Improved Recovery (IR)/Unconventional Hydrocarbon (UHC) production methods/techniques. Incentives will be available for a period of 10 years from the date of commencement of the projects. Fiscal incentives include waiver of 50% of cess on oil production and 75% of applicable royalty on gas production on the eligible quantum of production volume.
The Government is bullish on long-term prospects of gas and has set a clear mandate of achieving a 15% share for gas in energy mix by 2030. With the aim of spurring indigenous gas production and increasing transparency, it brought in a new pricing framework in 2014, replacing the erstwhile regulated pricing regime with a pricing formula linked to international prices.
It has also implemented a special pricing regime to incentivize gas development in more difficult terrain (Deepwater/Ultra-Deepwater/HP-HT).
In a positive development, the Government launched India's Gas Exchange, the first nationwide online delivery-based gas trading platform, in June 2020. It paves the way for a more transparent, fair and locally discovered pricing mechanism, essentially eliminating formula-driven pricing control and motivating greater participation from companies, sellers and buyers alike.
The Government is also planning to invest US$ 2.9 billion in the upstream oil and gas production to double the natural gas production to 60 BCM and drill more than 120 exploration wells by 2022. Gas consumption is projected to reach 143.1 BCM by 2040.
India targets US$ 100 billion worth investments in gas infrastructure by 2022, including an addition of another 228 cities to city gas distribution (CGD) network. This would include setting up of RLNG terminals, pipeline projects, completion of the gas grid and setting up of CGD network in more cities. Some of the major players operating in the CGD market are Indraprastha Gas Limited and Mahanagar Gas.
In the Budget 2021-22, the Government announced extension of Ujjwala scheme (under which it provides a free LPG gas connection to women below the poverty line), which has already benefitted 80 million households, to cover 10 million more beneficiaries. The government will also add 100 more districts to the CGD network in the next three years.
In a major boost for the Union Territory of Jammu and Kashmir and the sector, the government has also announced that a gas pipeline project will be taken up. Another key announcement by the government includes an Independent Gas Transport System Operator, which will be set up for facilitation and coordination of booking of common carrier capacity in all-natural gas pipelines on a non-discriminatory open access basis.
The Government has also talked of monetizing oil pipelines of Oil Marketing Companies (OMCs) and gas pipelines of GAIL via Infrastructure Investment Trusts (InvITs) though the time frame/roadmap thereof has not been revealed.
How has the energy sector performed in the past decade and when is a good time to invest in the sector?
The energy indices (NIFTY and BSE) have provided investors returns of over 90% in the past decade. The revenues of energy companies are dependent on prices of commodities such as oil and gas. Therefore, the best time to buy stocks in this sector is during a downcycle, when the prices are low.
Which energy stocks were the top performers over the last 5 years?
Indraprastha Gas and HPCL were the top performers over the last 5 years in terms of sales and profit growth.
Indraprastha Gas growth can be attributed to it being the pioneer in city gas distribution (CGD) and enjoying an exclusive position in the business, besides the strong parentage of GAIL and Bharat Petroleum Corporation (BPCL).
HPCL has also done well in the domestic energy sector on account of its strong parentage (Oil and Natural Gas Corporation (ONGC)), its established brand name and its leading position in the domestic oil marketing business.
What kind of dividend yields do energy stocks offer?
As majority of the energy (oil and gas) companies in India are PSUs and current norms prescribe PSUs to pay a minimum annual dividend of 30% of profit after tax (PAT) or 5% of net worth, whichever is higher, PSU energy stocks pay handsome dividends.
Which are the energy stocks with the highest return on capital employed (RoCE)?
Return on capital employed (ROCE) is a financial ratio that can be used in assessing a company's profitability and capital efficiency by determining how well the management is able to allocate capital for future growth. An RoCE of above 15% is considered decent for companies that are in an expansionary phase.
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