Why Higher Crude Prices Alone Won’t Determine Fortunes Of ONGC, Oil India

Brent crude prices, having plunged to below $40 per barrel in March 2020 following the Covid-19 pandemic, went past the $50-mark for the first time in December. And they are expected to rise more.

“Oil price can definitely surprise on the upside, with GREED & fear easily anticipating a $100-plus oil price if the health fascists ever allow the world to reopen again,” Chris Wood, global head of equity strategy at Jefferies, wrote in a recent note.

Goldman Sachs and Morgan Stanley raised their forecasts for the commodity to $75 per barrel and $70 per barrel, respectively, for 2021.

Some analysts, however, expect demand to taper if oil prices remain above the $75-mark.

Probal Sen, oil and gas analyst at Centrum Broking, said when brokerages estimate earnings for upstream companies, they aren’t factoring in crude oil price averaging at $75 a barrel. Estimating valuations at that price, he said, will be immaterial because ONGC and Oil India aren’t even trading at valuations corresponding to crude at $45 per barrel.

“If crude is at $70 a barrel, ONGC’s share price should be at the very least 50% higher than what it’s right now,” he said. “But I don’t know how to account for the concern around core oil production or the worries around the gas realisations or the profitability of the gas segment.”

That’s because concerns around ONGC extend beyond price realisation, Sen said, as its oil production growth has been declining for the last five years. The decline in older fields not being offset by an uptick in production from newer fields, he said. As long as the concerns outweigh clear benefits on numbers, Sen said multiples may not expand.

Critical Monitorable

The one critical factor to watch for in the next six to 12 months, according to Sen, must be the updates on the Krishna-Godavari Basin execution.

If gas production starts at the site by May as guided by ONGC in its latest quarterly update, he expects it to be a “fantastic positive” because pricing for that gas is slightly higher than the breakeven price for the rest of its gas portfolio. According to Sen, 45% of ONGC’s output, which is natural gas, is sold at less than the breakeven cost.

The oil and gas explorer is upbeat on the government agreeing to a fair and remunerative gas pricing, which should at least cover the production cost of $3.5-3.7 per metric million British thermal units, Emkay Shares and Stock Brokers said in a note dated Feb. 18.

The brokerage said for every $1 per MMBtu rise in rates under the administrative price mechanism for natural gas, the earnings per share of the company can increase by Rs 2.6 apiece.

• Emkay s ONGC at four times its FY23E enterprise to Ebitda multiple to arrive at a target price of Rs 130.
• At $60 per barrel of Brent crude, gas priced at $3.5 per MMBtu and ramp-up at Krishna Godavari-DWN-98/2 field, the brokerage’s fair for ONGC is at Rs 170 per share.

ONGC is cheaper compared to its peer Oil India. At current prices, it trades at roughly 9-10 times its estimated earnings for FY23 against Oil India's 12-13 times.

Oil India, too, is grappling with the same issues of lower output, even as it’s optimistic about its oil and gas production over the next three to four years. It projects oil production to improve by 10% annually by FY24 after factoring in decline from older fields, while gas production is expected to almost double to nearly 12 million metric standard cubic metres per day by FY24E from current levels.