How ONGC Is Trying To Overcome Its Biggest Challenge

The Problems

The oil and gas explorer relies heavily on offshore fields, with the Mumbai High and Bassein, off the west coast, contributing a bulk of its production. Such fields are witnessing a natural decline, ICRA Ltd. said in a September report. They face risk of lower-than-estimated reserves, difficulty in production due to less friendly environments, like in the middle of an ocean.

To add to that, lower demand owing to Covid-19-led disruption, closure of wells amid slowing offtake by customers and supply-chain challenges like delayed arrivals of critical subsea components hit the output in FY21.

The pandemic delayed the drilling schedule of ONGC’s fully owned overseas arm ONGC Videsh Ltd., hurting production. The company also deferred capex after oil prices tumbled. Cuts agreed to by OPEC+ also contributed to the fall.

What It’s Doing

The company's strategy involves boosting output from existing fields as it already has infrastructure there, and also bidding for fresh finds.

Improving Output From Existing Fields

The company has injected "vast resources" into its brownfield re-development projects, the annual report said. These are aimed as improving output from ageing fields. The upfront capital costs are lower since such fields have existing infrastructure.

As many as 27 of its 32 ongoing projects are completed and the rest are under execution. These enhanced oil recovery or EOR projects are targeted at extracting immobile or residual oil.

These are estimated to realise over 200 million metric tonnes over their lifecycle, according to the annual report. The company estimates incremental supplies, accruing from these efforts, to account for over 30% of its standalone domestic oil output.

To arrest the decline in output from mature fields, ONGC is trying to improve recovery. This includes engineering methods to target oil and gas that cannot be extracted using conventional methods.

It submitted 23 EOR proposals, of which 16 have been approved by Directorate General of Hydrocarbons. That's expected to add incremental supply of 1.85 MMT and a recovery of 22.5% by 2040.

Bidding For New Finds

To increase its exploratory footprint, ONGC has bid aggressively in the government’s open acreage licensing policy rounds, which allows oil and gas explorers to select blocks of their choice. In the recently concluded round, the company acquired seven of the 11 blocks on offer. The new territories have the potential to increased supply.

• ONGC has started production from the second deepwater U1B well in Krishna-Godavari basin in the Bay of Bengal starting Aug. 31.

• Redevelopment of the Nandasan field in Mehsana, Gujarat to be completed by August 2022. The project could add incremental production of 0.735 MMT of oil and 0.195 billion cubic metres of gas by 2036-37.

• As of March, 15 major projects worth Rs 60,501.5 crore were under implementation, with a projected gain of 113 million metric tonnes of oil equivalent.

In all, ONGC has spent Rs 1.5 lakh crore in the last five years to boost output. And the company expects that to pay off.

The state-owned giant expects domestic oil & gas output to jump from 45.35 mmtoe in FY21 to more than 60 mmtoe by 2024. According to its annual report, that will be driven by strong output from the Krishna Godavari deep-water field and Heera in the shallow waters off western coast.

Fitch Ratings expects ONGC’s production to stabilise over the medium term. A natural production fall at its mature oil fields will be offset by the ramp-up of volumes in the Krishna-Godavari basin, it said in a November report.

Depleted Cash Reserves

ONGC’s large capital expenditure and its acquisition of Hindustan Petroleum Corp. have depleted its cash reserves. ONGC had acquired 51.1% stake in HPCL in 2018 for Rs 36,915 crore.

The company’s cash and bank balance, according to its annual report, declined from Rs 9,511 crore in 2016-17 to Rs 302.6 crore as on March 2021.

Liquidity remains comfortable. In FY21, working capital needs were met by short-term loans and the company has an overall limit for raising Rs 10,000 crore via commercial paper, according to its annual report.

A strong business profile with strength in oil and gas prices will improve its leverage in the near to medium term, Fitch said in its report.

Yet, according to ICRA, replacing reserves and growing production while maintaining a favorable cost structure would remain a key challenge for ONGC. The company, however, has been able to maintain competitive finding and development costs at $12.55 a barrel of oil equivalent, the research firm said.

The Upshot

ONGC generated more than 87% of its gross revenue from the sale of crude oil and natural gas in FY21. So higher the global and India's administered prices, the better its realisation.

And despite a challenge from solar energy, global oil demand is estimated to surpass pre-pandemic levels of 2019 by March 2022, according to JPMorgan.

Prices, too, are forecast to stay elevated.

U.S.’ Energy Information Administration forecasts spot Brent to average at $70.6 a barrel in 2021 and $70.05 in 2022.

India has already raised administered gas prices by 62% to $2.9 per metric million British thermal unit for the second half of FY22. With the winter demand for gas rising in the U.S. and Western Europe, it's only expected to rise. That has prompted analysts to raise estimates for ONGC.

Analysts’ Outlook

Shares of ONGC have risen 57.9% so far this year despite a pullback since early October.

Of the 30 analysts that track the stock, 23 recommend ‘buy’, three suggest ‘hold’ while four rate it ‘sell’, according to Bloomberg data. The average of analyst price targets suggest a one-year return potential of 27.4%.

• In the past six months, analysts have raised its adjusted earnings per share estimate for FY22 by 51.9%, according to Bloomberg data.

• Analysts increased the adjusted EPS estimate for FY23 by 48.5% during the period.