Boost for ONGC but RIL will have to wait

The much-awaited decision on gas prices has finally come. However, production is unlikely to increase in the near term. The decision to raise the price from the current $4.2/mBtu to $5.61/mBtu will impact three of India's upstream companies differently. It is a positive for Oil and Natural Gas Corporation (ONGC) and Oil India (OIL). It is sentimentally negative for Reliance Industries (RIL), as the revised pricing formula is not going to apply to the company till arbitration proceedings are on. Till this is resolved, the difference between the revised and earlier price of $4.2/mBtu will be credited to a gas pool account maintained by GAIL.

The market believes ONGC and OIL would be the biggest beneficiaries of diesel price deregulation and the gas price revision. With underrecoveries disappearing in the case of diesel, ONGC is expected to gain the most, believe oil & gas analysts. Diesel accounts for 55 per cent of total underrecoveries and about half of it is borne by public sector oil and gas producers. Within that, most of it is borne by ONGC.

If crude oil prices remain around current levels (The Indian basket is averaging at $86/bbl against the earlier assumption of $100/bbl), the deregulation of diesel will bring down total underrecoveries to Rs 85,000 crore in FY15 and Rs 50,000 crore in FY16 against the Rs 140,000 crore in FY14.

The increase in gas prices is expected to boost ONGC's earnings. According to one analyst, for every $1 rise here, ONGC's earnings per share rises by Rs 2.5. With its higher output, it should gain more than OIL.

The latter, analysts say, will also gain. It is working towards raising its output from 2.4 billion cubic metres to four bcm in the next couple of years. Analysts at Deutsche Bank recently wrote that elimination of the diesel subsidy would lead to a 24 per cent rise in net crude oil realisation, to $58/barrel by FY16. They estimate a potential $700 million annual improvement (160 per cent over FY14) in OIL's cash flows over FY14-FY20, driven by higher realisations. These, higher gas prices and gradual ramp-up in production is likely to drive Oil India's earnings and return on equity (RoE). Analysts see a 500 basis points increase in RoE, as oil and gas production is also estimated to grow by 6.8 per cent yearly over FY14-17.

On the other hand, as revised gas prices are not applicable to RIL till arbitration is on and its gas production remains below par, there is no impact on its earnings this year. From a peak of 60 mscmd (million standard cubic metres a day) in early FY11, the production in its KG-D6 block has been declining. Analysts say the company reported only 12-14 mscmd from the block in each of the past five quarters, where higher prices are applicable. Hence, it will gain only Rs 0.6-Rs 0.7 a share from higher prices.

Investment advisor S P Tulsiyan says, "I believe $5.61 is a more pragmatic price. In the Rangarajan formula, the Japanese hub was selected, which is most expensive. Japan itself is an importer, so the $8.4 level was too high. However, the markets were not expecting the revised price to be below $6 and, hence, this move is negative for the RIL stock, which should correct on Monday. ONGC, though, will benefit from this move and the stock could move up."

Analysts claim the lower than expected increase in gas price will jeopardise the development of deepwater satellite fields, negative for the RIL stock.