Oil & Gas Q3FY12 - Estimates & analysis

With the Q3 results season drawing to a close, the investor focus seems to be shifting to expectations from individual sectors and the firms therein. The Sept 2011 results for the oil & gas sector was a mixed bag, with upstream majors like ONGC, OIL and GAIL doing well, but the domestic refineries suffering on account of a lack of govt. subsidies, rising crude oil prices and a weak rupee. In the private sector, RIL posted yet another quarter of its highest-ever net profits, but failed to attract investor fancy due to lower-than-expected GRMs and flagging KG-D6 output.

Going forward, the Q3 earnings season for the oil & gas sector is more or less expected to be in line with that seen in the previous 2 quarters, if not worse. With Brent crude appreciating by 10% to USD 106.87/barrel and the rupee weakening further by 8% to Rs 53.025/dollar over the past 3 months, it is almost a given that the OMCs (IOC, BPCL, HPCL) will face further financial pressures in the Dec 2011 quarter results. It must also be noted that the OMCs have not been allowed to hike the petrol prices over the past couple of occasions over political pressures faced in the wake of the 5 state elections coming up in 2012. Added to this is the fact that they are currently incurring a combined daily loss of Rs 388 cr on subsidised sale of diesel, kerosene and LPG and are pegged to report an annual under-recovery of Rs 138000 cr for FY12E.

Upstream majors like ONGC and OIL are poised to witness yet another robust quarter, as they are benefited by rising crude prices and a depreciating rupee, which tends to improve realisations. ONGC would be additionally benefitted from the one-time income of Rs 2000-2500 cr on account of recovery of royalty from the Rajasthan fields. However, owing to the rising subsidy bill and pressure on the central govt. to stay within the fiscal deficit targets, we expect ONGC and OIL to share a larger chunk of the bill to compensate the OMCs for their massive losses. Consequently, this will eat into their year-end earnings and affect the financials.

In the case of the private players, RIL’s Dec 2011 quarter earnings will face pressure on account of poor refining margins. As per media reports, the Dec 2011 Singapore benchmark GRMs dipped to USD 7.9/barrel, which is its lowest point in FY12. This will bear a negative effect on RIL’s GRMs, which is estimated to be around USD 6.3/barrel in Q3 FY12 as compared to USD 10.2/barrel in Q2 FY12. Being already battered by forex losses in Q2, Essar Oil is expected to suffer the same fate in its Q3 earnings on account of adverse forex fluctuations.

In the natural gas space, owing to the flagging output in the KG-D6 block and the lack of any ramp ups in other gas fields in the country, gas volumes are expected to be strained in Q3. Ultimately, it will boil down to the ability of the gas distributors to transfer prices in order to improve realisations. Petronet LNG is expected to do well, but a weakening rupee proves to be a downside risk. The same is the case for other transporters such as GGCL, GSPC and IPG. GAIL’s performance will depend on its ability to counter the margin pressures in the petrochemical business and solve the subsidy issue.

On the global front, fresh concerns from the Middle East, with Iran at the center, have yet again managed to spike up crude prices. As stated earlier in the report, Brent crude oil has shot up sharply between Oct and Dec 2011, as Iran’s flamboyant nuclear power-house ambitions have sparked off some high-intensity geopolitical tensions against the western powers USA and EU, and the world economy is back on the brink of witnessing yet another war-for-oil situation.

Back home, in recent times, it has also come to light that as a result of the cuts in customs duties and excise reductions on crude products over the past year, coupled with lower corporate tax and dividends for OMCs, the govt’s revenue estimates for the oil & gas sector seems to have dropped significantly. On the other hand, due to soaring international crude prices, the weak rupee and financial strain on OMCs, the govt’s subsidy expenditure is about to increase massively this fiscal.

In conclusion, we expect another good quarterly performance for Dec 2011 by the upstream majors (ONGC & OIL) as a result of high crude prices and the weak rupee, but also expect OMCs to face the heat and report losses. Private mid-stream players will face pressure on account of poor GRMs and forex fluctuations. Natural gas players are expected continue their steady performance, as the availability of gas remains tight.