Cheer for ONGC investors: Higher oil and gas prices should drive earnings

ONGCThe Oil and Natural Gas Corporation (ONGC) stock has significantly lagged the benchmark S&P BSE Sensex over the past year, even as prices of crude oil, its mainstay, have rallied (see chart). There has been some catching up in the past week, led by improving prospects in the business. If the trend sustains, which seems likely, ONGC’s investors could see good returns.The unknown, however, is whether the government will ask the company to bear the subsidy burden if oil prices rise sharply, as was the case a few years ago. This is one reason the market is cautious on government-owned producers like ONGC, as well as its three oil marketing companies, Hindustan Petroleum (HPCL), Bharat Petroleum (BPCL) and Indian Oil (IOC). For now, analysts presume this might not happen and, hence, expect ONGC to gain from rising prices and output.With gas prices for locally produced fields being revised to $3.06 per mBtu (million British thermal units) for the first half of FY19 from $2.89 per mBtu in the second half of FY18, an increase of 5.9 per cent sequentially and 10.1 per cent year-on-year, gas producers remain in a sweet spot. The ceiling price to be produced from difficult fields has been raised by 7.6 per cent to $6.78 per mBtu. This should benefit upstream oil and gas exploration companies such as ONGC, Oil India and Reliance Industries further, resulting in higher earnings.Rating agency ICRA has said an increase in gas prices will encourage these companies to take up more exploration.Among exploration and production companies, ONGC would benefit the most, say analysts at ICICI Securities, as it accounted for 75 per cent of the gas produced in the country in FY18. Further, as gas prices are expected to rise 19 per cent year-on-year to $3.6 per mBtu in FY19, they expect the company’s FY19 earnings per share to rise by ~1.3 per or five per cent. Abhijeet Bora at Sharekhan has a similar view and expects incremental earnings of ~5.49 billion for ONGC in FY19 on an annualised basis from the current gas price hikes.Cheer for ONGC investors: Higher oil and gas prices should drive earningsNotably, ONGC is also seeing a rise in gas production and is benefiting from higher crude oil prices. Production, flat earlier, is seen growing 10-15 per cent annually over the next three to four years, say analysts. They expect earnings to grow by 17 per cent annually over FY17-20.The March quarter, too, is likely to be better for ONGC. Kotak Institutional Equities estimates the company’s net income to rise by a sharp 27 per cent sequentially (to ~63.4 billion). Driven by an increase in crude realisation to $66.2 a barrel (up $5.6 a barrel sequentially), say analysts.As higher oil prices result in higher realisations, the Street feels the threat of subsidy sharing also increases. Analysts say these risks will be only if oil prices sustain above $70 a barrel; these are now around $71. At current levels, Bora says under the current subsidy sharing mechanism (the government bears a subsidy of up to ~12 per litre on kerosene and up to ~15 per kg on cooking gas), it would ensure strong net oil realisation of $60-63 a barrel for ONGC.The company has been showing growth in its oil and gas production, unlike Oil India, say analysts at Motilal Oswal. The brokerage prefers ONGC, as it believe the company’s cost efficiency would result in a decline in operating expenditure, as gas production is likely to grow 10-15 per cent annually for the next three to four years. They also expect ONGC’s oil production to increase.The key will be crude oil prices and sustenance above $70 needs to be watched, as it could mean an overhang of subsidy sharing, keeping the stock price under check. If the government does push its oil companies to share the subsidy, it could see these stocks underperform further.
Source: Business Standard