Energy For The Growth Engine
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Resource nationalism seems to be a global trend, and Indian companies would do well to catch on. Oil & gas holds potential as a key sector for our rising energy needs and can also lend momentum to the economy. How does this augur for the sector and a few specific stocks within it? DSIJ tells you more
The Indian GDP growth looks like a pale shadow of what it was just a couple of years ago. After recording average growth of 7.35 per cent for the seven years ending FY10, the economy saw just five per cent growth in the last fiscal, the lowest since FY03. While countries like the US, Japan and China are working towards resurrecting their respective economies, it is imperative for India’s policymakers to take some concrete steps to alleviate the economy’s ailments. The global backdrop of declining liquidity and the escalating current account deficit (CAD) are the worrying factors. India should thus focus on correcting its fundamentals rather than foreign inflows.
| Meet The Measures |
|---|
| Bcf/d | Billion Cubic Feet Per Day |
| BCM | Billion Cubic Metres |
| MMBTU | Million Metric British Thermal Unit |
| MMTPA | Million Metric Tonne Per Annum |
| MT | Million Tonnes |
| Tcf | Trillion Cubic Feet |
DSIJ’s attempts to deconstruct this scenario and identify factors that can aid the economy’s revival led us to the oil & gas sector, which has the potential to turn the tables for India. The sector, if handled with astute planning and execution, can work wonders for the economy. Its importance can be gauged through the fact that a country which is struggling with a high CAD, spends a whopping USD 170 billion (Rs 920877.41 crore during FY13) on the import of petroleum products, which is 34 per cent of its total imports. Also, the imports are growing at a disturbing pace of more than nine per cent on a yearly basis.
Finance Minister P Chidambaram has recently remarked, “The only way the country can contain its CAD is by increasing its domestic oil and coal production as we are hugely dependent upon their import. In order to increase production, we must get our policies and priorities right as long-term measures”. This is a good opportunity for companies in the sector to not only create wealth for stakeholders, but also to rewrite the destiny of India along the lines of the revolution created by oil companies in the US with shale gas.
The Current Picture
The present state of the oil & gas sector looks quite subdued, with a consumption of 211.42 MT of crude oil in FY12 against a production of 38.09 MT domestically. An amount of 172 MT of crude was imported, which is more than 70 per cent of our consumption. In spite of every effort, the Indian crude oil production saw a meagre 4.18 per cent CAGR in the period between FY1971 and FY 2012, while growth in consumption went up by six per cent, demanding immediate action in this area.
The Planning Commission has projected that the demand for petroleum products (POL) would increase by 4.7 per cent annually during the 12th five-year plan period and will touch 186.21 MMT by 2016-17 from a level of 148 MMT in FY13. However, the picture on the production side is not very encouraging. This is despite the fact that the country has a proven reserve of 759 MT of oil and 1330 BCM of gas.
| Jargon Busters |
|---|
| CBM | Coal Bed Methane |
| E&P | Exploration & Production |
| EOR | Enhanced Oil Recovery |
| IOR | Improved Oil Recovery |
| POL | Petroleum, Oil & Lubricants |
| R&M | Refining & Marketing |
| USD/bbl | USD per barrel |
The Minister for Petroleum & Natural Gas Veerappa Moily, soon after taking charge, had announced a new vision and set an ambitious target of reducing crude oil imports by 50 per cent by 2020, 75 per cent by 2025 and eventually achieving self- sufficiency by 2030. But this requires a conducive environment that will promote investment.
The biggest challenge today is that oil and gas companies are not finding it lucrative to invest in E&P due to the opaque policies and subpar returns. “We have to understand that the profitability of the business has to be strong. As against 170 MT that the country is importing today, we are producing just 38 MT, which means that even if we double or triple the efforts, it will take us at least another 10 to 20 years”, observes Sudhir Vasudeva, CMD, ONGC.[PAGE BREAK]
Addressing Contentious Issues
The ever-increasing subsidy burden is weighing heavy on the sector. While this is adding pressure on the fiscal health of the country, it is also creating tribulations in the oil & gas PSUs, especially the upstream ones. During FY13, the total subsidy amount stood at around Rs 161029 crore and the upstream and midstream companies like ONGC, OIL and GAIL contributed Rs 60000 crore to the same.
Of late, the government has taken some commendable steps by fully deregulating petrol and initiating the phasing out of diesel subsidy. Also, capping the number of LPG cylinders has helped reduce the burden. The government has estimated bringing down the subsidy burden to Rs 80000 crore in FY14 but the declining rupee is threatening the under-recovery equation.
“By 2030, We Should Be Producing 130 MT Of Oil”
Adequate infrastructure is a must for shale gas, says Sudhir Vasudeva, CMD, ONGC, as he elaborates on India’s energy requirements and the role of ONGC, in a conversation with Vikram Limsay, Consulting Editor, DSIJ and Amit Bhanot, Senior Assistant Editor, DSIJ
As resource nationalisation of the super major structure keeps getting shifted from IOC to the national oil companies, an amount of USD 600 to 700 billion is required in a year. ONGC requires a huge amount of money too. What are your plans regarding this? Is the government supporting ONGC or are we expecting the investments outlay to go up in the next few years?
All our resources are generated through internal accruals and we do not depend on any budgetary support. We spent Rs 1.69 lakh crore in the 11th five-year plan and the target for the 12th five-year plan is Rs 2.65 lakh crore. This amount was spent by ONGC, MRPL and OVL put together. However, it does not include any acquisitions for OVL but only its existing facilities. Also, according to the prospective plan for 2030 (PP2030), we expect to spend around Rs 11 lakh crore during the plan period.
The only issue that we are facing is the subsidy burden, due to which our surplus fund generation is getting stranded. Last year, we billed OMCs at USD 110.7/bbl and gave them a discount of USD 63/bbl. We thus merely got USD 47.8/bbl. Our cost of production is about USD 44/bbl today. The weakening rupee led almost equated the returns of both the fiscals for us. Although we got USD 54.71/bbl in FY12 and USD 47.85/bbl in FY13, its value almost remained unchanged, thanks to the rupee.
Your entry into matured oil fields seems to have positively impacted your productivity. Can you throw some light on this?
We have undertaken specific schemes for enhancing oil recovery and this has helped us in maintaining production. On the surface, production might look stagnant. For the last five years, our production has been consistent at 52-53 million tonnes of oil equivalent from India. If we add the production of OVL to it, it comes to around 58-60 million tonnes. Had it not been for our efforts, the production would have been lower by at least 8 MT. Our IOR and EOR efforts are giving us this 8 MT of additional oil. This might cost us around Rs 41000 crore, out of which Rs 35000 crore have already been spent. Out of the 24 schemes, 16 have already been implemented since 2000-01. Eight schemes are currently ongoing. They have so far given us 80 MT of oil and we cumulatively expect 172 MT to be produced from these schemes by 2030.
Today we are producing from more than 110 fields but nearly 75 per cent of our production comes from the 15 major oil fields - Bombay High, Navagam, Rudrasagar, Ankleshwar, Kandhar, etc. Bombay High is the young- est (37-year old), while Rudrasagar and Ankleshwar were the initial discoveries (52-year old). It is thus not possible to maintain production from this kind of fields at the same level at which they were started.
OVL saw a 44 per cent increase in its bottomline. Is it likely to chart its own course in the future?
OVL’s turnover for FY13 was quite low. Its production was weak at 7.26 MT since production from Syria and Sudan was affected. Although Sudan’s production has recovered, Syria still remains affected. In FY12, we produced 8.753 MT from here. Last fiscal, the turnover stood at around Rs 18000 crore and it was at Rs 22000 crore for FY12. We however made more profit in FY13 because we had to make abnormal provisions in terms of impairment to the tune of USD 400 million in the previous fiscal. After impairment, our profit for FY12 stood at Rs 2200 crore and it stood at Rs 3929 crore for FY13.[PAGE BREAK]
As per the PP2030, OVL is likely to generate 60 MT of oil, and most of the E&P is to come from OVL itself. Where is the money for this going to come from?
The first thing that I did when I came here was drawing the Prospective Plan. This type of exercise has never been done before in ONGC. The basic thought process behind this was: Where do we want ONGC to be in the next 18 years and what will be our starting point?
Going forward, India’s requirement of oil and gas would stand at 500 MT. Even if we contribute to around 30 per cent of this, we should be producing 130 MT. We analysed the production capacities of the Indian basins, which came to around 70 MT. Today, we are producing 46 MT of oil and gas but the quantity will mostly fall considering all the factors related to fields, and we therefore have to add more fields. We have a good reserve replacement ratio of 1.8 times and will discover around 450 MT of new oil and put it on production. We will also put on production 300 MT of oil, which has been discovered and is yet to be put on production. It will take us to a level of 70 MT, and the remaining 60 MT will come from overseas activities.
Is OVL facing problems due to geopolitical risk and will it continue to face them?
Oil and politics go hand in hand. One has to deal with such problems while doing business. We, however, haven’t done too bad. In 2001, we owned only one property in Vietnam but today we have 32 properties in 16 countries. Out of this, 10 are exiting properties, five are under development and the rest are exploratory. We have reached a production figure of 9.5 MT in FY12. There was a time when we had 40 properties in 24 countries. Going forward, we are quite hopeful as Azerbaijan is in the pipeline and we are readying a production of one MT here. The Myanmar production will start this year and Carabobo Venezuela production has just begun. Also, the Sakhalin production will start soon. We have to reach a target of 20 MT by 2018.
ONGC plans to enter R&M. When are things going to begin on that front?
We have licenses for 1600 retail outlets between MRPL and us. Three of them are operating in Mangalore today. But this subsidy mechanism and regulated price for diesel and gas started exactly when we began business, and we therefore put it in on a backburner.
Today, we have a refinery in Mangalore of 15 MT capacity. We plan to upgrade it to an 18 MT production refinery during the 12th five-year plan period and reach 21 MT by the 13th five-year plan. We are also looking at the Rajasthan refinery where HPCL has taken a majority stake. In the Nagarjuna refinery in Kandalur, we are doing the due diligence. So we are consistently increasing our footprints in refining and with this, we want to get into marketing as well. With the licenses in hand, we want to begin operations for all the1600 outlets, as soon as diesel is fully de-regulated.
Is MRPL going to take the lead in R&M?
We, at ONGC, do not have an experience in R&M and MRPL too has limited experience. We will see whether we want to float a separate company for retail and are still studying the idea.
Hotpots are difficult to access for exploration. Is there a strategic initiative to undertake such initiatives?
These fields are a part of the NELP blocks. In the past too, we have drilled 2841 meters (about 9000 ft) which was a world record. Reliance beat that record but we are now drilling around 10365 ft. The problem here is that nobody is producing oil from this kind of fields. So we simply to have to hold these fields till the time the right technology to produce from them is developed.
The R&D that we are undertaking is more of applied technology, which we need to adopt and use in our fields. We are, therefore, willing to partner with anyone who wants to join hands with us to develop such kind of fields.
You have many JVs, ConocoPhillips is one of them. Do you see more such JVs with big companies?
They are only MoUs and not joint ventures yet, but have the potential of getting converted into JVs in the future. They are studying our fields, shale gas basins data and deep water. They have agreed to provide us the technological backup for conducting pilot projects at two shale gas basins. As per the MoU, they can take us on board if they get an opportunity outside, whether in the US or any other country. We are still awaiting such an opportunity.[PAGE BREAK]
We know that the entire energy scenario has undergone a sea change in the US with the shale gas revolution. What is your take on the Indian shale gas scenario?
All these types of disruptive technological breakthroughs in the US have drawn everyone towards shale gas and are expecting a miracle in other parts of the world too. The largest resource of shale gas is in China at 1275 Tcf but the depth of shale is twice than that of the US. Also, they have two basins in one of the driest places in the world. Shale gas requires excess quantity of water - two to three million gallons for one stage of drilling. These shale hold gas only when they are very tight, so you have to fracture the rock to let the gas come out. Considering this process, China’s plans of investing USD 100 billion and producing 65 Bcm of gas by 2015 and 100 Bcm by 2020 seem ambiguous.
Meanwhile, ONGC was asked to assess potential shale gas reserves in India. The study was conducted by the Central Mine Planning and Design Institute (CMPDI - which is under the Ministry of Coal & Mining). The figures paint an optimistic picture. For five basins, the potential of shale gas comes to around 150 Tcf. The productivity of this kind of fields is less and you have to drill a large number of wells. You have to drill horizontally and if the land is not available, you can drill from one place. This is a major problem in a country like India. The government needs to address these issues of land, water and infrastructure. Adequate infrastructure is a must for shale gas.
What are your plans for other sources of energy beyond hydrocarbon?
It is believed that more than 90 per cent of energy comes from fossil fuel in India - around 50 per cent from coal and the rest from oil and gas. But globally, it is estimated at 80 per cent. By 2040, it may go down but oil and gas would still account for the maximum energy requirement along with coal.
Will oil and gas beat coal as an energy source?
No. In India, coal share in the energy basket is supposed to increase from the current 53 per cent to 57 per cent by 2015. The share of oil will come down but that of gas will increase. Oil discoveries are becoming scant while gas discoveries are escalating. Gas consumption, due to its environmental friendliness, is on the rise. The latest theory is that if we are producing 90 MT today, then we will be producing 110 MT by 2030 and all this will be coming from unconventional sources like shale, condensate, etc. As far as other sources of energy are concerned (solar, wind or nuclear etc.), the contribution from these is not likely to exceed 10 per cent.
What are the key bottlenecks that you expect in implementing the integrated energy policy in your PP2030?
We should have unified a ministry of energy. In India, we have a plethora of ministries like power, coal, petroleum and natural gas, Ministry of New & Renewable Energy (MNRE), planning commission, etc. This makes the functioning of companies difficult.
What initiatives are you taking on the corporate social responsibility (CSR) front?
The kind of work we are doing usually goes unsung. With a profit of Rs 20000 crore, we have a budget of Rs 400 crore for CSR every year. We work in the areas of education, healthcare, girl child empowerment, supporting artisans, preserving monuments and heritage sites, sports pro- motion, providing urban facilities to rural areas etc.
“With the depreciating rupee, the subsidy can reach Rs 100000 crore and as per some calculations, for every one rupee decline there would be an additional subsidy burden of Rs 9000 crore on OMCs”, comments T K Ananth Kumar, Director – Finance, OIL. As of June 16, 2013, OMCs are incurring under recoveries worth Rs 286 crore per day and under-recoveries on diesel and kerosene have touched Rs 6.31 and Rs 27.75 per litre respectively.
The upstream companies are there- fore finding it hard to shell out additional funds for their E&P activities in this sector. “We have planned an investment of Rs 11 lakh crore by 2030 but the subsidy burden is an issue due to which our surplus fund generation is getting stranded. Last year, we shared Rs 49421 crore of the subsidy burden”, adds the ONGC CMD. [PAGE BREAK]
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But as the government seems adamant on solving this problem, the sector may witness resurgence in the future. In fact, we have already seen some activity in the downstream segment, with companies like RIL, Essar and ONGC getting into retail ventures after the deregulation of diesel.
Natural gas pricing is another problem in the sector. Both private and public sector companies have been demanding a hike in gas prices from the existing level of USD 4.2/MMBTU. In December last year, the Rangarajan Committee had recommended a formula to calculate gas prices. Applying this formula will double the price from the existing level but some ministries (including Power) are opposing it. The Cabinet Committee on Economic Affairs (CCEA) will now take a decision on this matter.
The Ministry of Petroleum has proposed a price of USD 6.7/MMBTU with a rider of quarterly review. If implemented, this would be a great respite for companies like ONGC and OIL, which are now selling gas at the Administered Price Mechanism (APM) price and are producing more than 26 BCM of natural gas. At the same time, this will also be a windfall for RIL and BPCL as they hold around 4 Tcf of gas reserves in the KG-D6 block are set to invest around USD 5 billion in the coming years for its development. Experts also feel that the increase in price would be particularly beneficial for the sector and the companies as it would bring in more investments.
“The import price of gas is USD 12/unit today. In such a scenario, it is better to buy from an Indian producer to save some money. Price decontrol will encourage other firms to invest in exploration and build infrastructure”, holds Hardeep Yadav, Director of stock advisory company Checkmate Trades.
Role Of Upstream Companies
The oil & gas sector can be majorly divided into two types of companies; those that are involved in exploration and production (upstream companies) and the others that are into the business of refining, marketing and retailing of petroleum products (downstream companies). The upstream companies in India are doing a decent job with the new oil and gas finds they have made in the last 10 years. As per the Energy Information Administration (EIA), India had 43.8 Tcf of natural gas reserves at the end of 2012 and the right implementation of policies can change the oil and gas picture in the country. In fact, overseas giants also believe that with proper planning, the scenario can change drastically.
“BP believes that India has the potential to find significantly more oil and gas, which requires policy and regulatory support to attract investment, right technology and the capability to find and develop resources”, says Sashi Mukundan, Regional President and Head of Country, India BP Group Companies. “Bringing these resources to the market will require a never-before experienced investment inflow, along with technology transfer and infrastructure and capability build-ups”, he adds.
As with gas, oil can also be a game- changer for companies like Cairn India as production has begun at its Rajasthan fields. With this development, the petroleum minister recently announced that the domestic crude oil production is expected to increase by 11.08 per cent from that of the previous year. This is mainly on account of higher crude oil production from the Barmer fields in Rajasthan, where the current oil production is 17000 barrels/day. This will certainly lower the quantum of subsidy, as the government is set to completely deregulate diesel and cap the number of subsidised LPG cylinders. It will also push up the margins of upstream companies like ONGC, Oil India and GAIL. [PAGE BREAK]
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Upstream companies have shared a subsidy burden of Rs 60000 crore due to which their financials have gone haywire last year. FY14, though, could be better. “We have shared a subsidy burden worth Rs 7890 crore last year and I can expect the overall burden to come down this year due to deregulation”, notes Ananth Kumar.
Also, upstream companies are get- ting into unconventional sources of energy like shale gas, CBM and deep- water drilling that can provide them with good growth in the near future. The petroleum ministry is already working on the shale gas policy and this will be finalised soon.
Apart from this, with the deregulation in diesel prices, companies like RIL, Essar, and ONGC are mulling getting into retailing for additional revenue. “We are working on enhancing the production life of the existing fields in the KG-D6 block and are ready to execute the ‘next wave’ of projects to bring more gas resources to the markets. In addition, IGS (India Gas Solutions, 50:50 JV between RIL and BP) would leverage its BP heritage to access global LNG supply and set up infrastructure to receive and market gas in India”, Mukundan tells us.
Companies like ONGC and OIL have been given enough power to acquire oil equity abroad and have been benefited from this. ONGC Videsh (OVL) already has a substantial amount of its topline and bottomline coming from overseas operations and has recently acquired a big stake in Mozambique at USD 2.47 billion. “By 2030, we want to get to a production level of 130 MT, out of which 70 MT will come from domestic production and 60 MT from overseas. OVL has earned a revenue of Rs 22000 crore during FY12”, informs Vasudeva. Considering this, the upstream companies look like good investments from a long-term perspective.
We have done an analysis of the companies in the sector and have recommended only those stocks which have the potential of giving more than 20 per cent returns in the next one year. Since the market has corrected sharply in the last one month, many of the stocks are trading at an attractive valuation but might not give returns of more than 20 per cent in the next one year and hence we have recommended a ‘hold’ on those stocks.
Partial Deregulation Boosts Performance
On a consolidated basis, the aggregate net sales of companies forming a part of the BSE Oil & Gas index have increased by 14.43 per cent on a yearly basis in FY13. The performance of Petronet LNG, HPCL and BPCL led to this strong topline performance of the sector. Profit after tax, on an aggregate basis, demonstrated good growth as compared to sales and was up by 17.59 per cent on a yearly basis. One of the reasons for a good performance by the OMCs was the partial deregulation of the sector and the lower subsidy bur-den shared by these companies. Out of the total burden, these OMCs share a little more than Rs 1000 crore. On the other hand, ONGC has to bear more subsidy burden, which was a little more than Rs 49000 crore for FY13.
FY14, however, promises to be good for the oil & gas sector, especially for the government-owned companies. This is when reforms in the sector, which began with the onset of 2013, will start contributing to the financials of the company in a significant way. For instance, diesel, which is the highest contributor to the gross under-recoveries, accounted for almost 57 per cent. Ever since the government allowed hikes in diesel prices in January 2013, OMCs have increased prices five times and if they continue to do so, under-recovery of around Rs 5/litre in diesel will be achieved by the end of FY14. The only risk here is the forthcoming 2014 General Elections and the depreciating rupee.