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ONGC Rescues GSPC From Drowning In The Deep-Water?

Is ONGC bailing out GSPC? 

Source: Gujarat State Petroleum Corporation
Source: Gujarat State Petroleum Corporation

India’s largest oil and gas producer, the central government-owned Oil and Natural Gas Corporation Ltd., has decided to acquire an 80 percent participating interest and operatorship in a deepwater gas block in the Krishna Godavari (KG) basin off the coast of Andhra Pradesh. The stake is currently held by Gujarat government-owned Gujarat State Petroleum Corporation. On the face of it, the transaction value is lower than GSPC’s investment in the field, but it’s not quite the steal it looks like.

The Deal Details

The KG block comprises nine gas discoveries – three in the south-western area, commonly known as Deen Dayal West (DDW), and six others. The three discoveries in DDW have been under trial production since August 2014, while for the remaining six GSPC has been working to finalise an investment plan and bring them to production, according the company’s annual report for financial year 2016.

The approved field development plan suggests that the gas in place for the three DDW fields is approximately 1.952 trillion cubic feet (tcf), of which only 1.0596 tcf is producible. The gas in place for the remaining six discoveries in the KG basin is still not known.

ONGC has acquired the three discoveries in DDW for $995.26 million (Rs 6,750 crore) and will pay another $200 million (Rs 1,356 crore) as advance for the six other discoveries.

Along with the balance payable to GSPC, ONGC will also have to bear the development costs of these six discoveries.

Besides GSPC’s 80 percent stake, two private companies, Jubilant Enpro and Geo Global Resources, own 10 percent each in the nine discoveries. According to an audit report by the Comptroller and Auditor General of India published in March 2016, the consortium (of GSPC, Jubilant Enpro and Geo Global) had invested Rs 17,025 crore in the DDW fields, of which GSPC’s investment works out to Rs 13,620 crore. GSPC is yet to respond to BloombergQuint’s query.

ONGC In Deep Water?

At approximately Rs 6,750 crore, ONGC has acquired the three DDW gas fields at a price much lower than GSPC’s Rs 13,620 crore investment in the fields.
But the merits of this acquisition as well as the purchase of majority interest in the additional six fields are unclear, due to non-stabilisation of production and unresolved technical issues in the acquired fields, says brokerage firm Kotak Securities.

We remain cautious on the acquisition given techno-commercial challenges and uncertainty on future prospects, even as the acquisition price seems to be lower than the amount invested by GSPC in the block.
Kotak Securities Report

ONGC, in its media statement, justifies the consideration paid to GSPC for the three DDW fields on the grounds that the fields have developed infrastructure such as well head platforms, an export pipeline and an onshore gas terminal.

But despite this infrastructure there is no commercial production of gas, even though it was slated to have begun in December 2011. Moreover, they are deepwater fields, generally considered to be technologically challenging and the kind in which ONGC has little experience.

Considering these uncertainties and current energy prices, ONGC’s multi-million-dollar acquisition may fail to deliver positive returns, says the Kotak report.

In our view, the continued uncertainty around production amid time and cost overruns may put to risk the economic viability even at government’s approved ceiling price for difficult fields.
Kotak Securities Report

Currently, the gas price ceiling notified by government for difficult fields stands at $5.3 per million British Thermal Unit and even the CAG report doubts the financial viability of the project at gas prices below $5.7 per MMBtu.

The fact remained that prices were below the FDP (field development plan) estimate of $5.70/MMBtu based on which the project was considered as financially viable. Thus the viability of the project even after commercial production of gas is doubtful.
Comptroller & Auditor General of India’s Audit Report (2015)

Valuation

In 2011, Reliance Industries sold a 30 percent stake in 23 oil and gas blocks, including blocks in the KG basin, to British Petroleum PLC. for $7.2 billion. At the time, BP had estimated the gas resources of the fields at 15 trillion cubic feet (tcf), of which BP’s share would be 4.5 tcf.

The Reliance-BP deal is not quite comparable with the ONGC-GSPC acquisition because most of Reliance’s blocks had begun commercial production at the time of BP’s purchase, whereas only trial production is on at the three DDW fields. Yet, it’s useful to know that BP paid approximately $1.6 billion per 1 tcf of gas in running fields, whereas ONGC is paying $995.26 for 0.8 tcf of gas in fields yet to start production.

Who Gains?

Wire agency PTI in a recent news report quoted sources as saying that GSPC has since 2014 been seeking to sell its stake and operatorship in these assets to ONGC, to avoid defaulting on loans. The report says that ONGC was initially not keen on the deal as it believed the block had reserves far less than what GSPC was claiming.

GSPC has made large upstream investments mainly via borrowings and that has stressed the company’s financials



ONGC Rescues GSPC From Drowning In The Deep-Water?

As of March 31, 2016, GSPC’s consolidated debt stands at Rs 28,900 crore and the annual interest outflow at Rs 1,885 crore.

Selling the fields to ONGC will help GSPC raise money to repay debt, but it will also lead to a significant net worth erosion, as the stake is being sold for Rs 6,750 crore against a book value of Rs 13,620 crore. This will result in large carry-forward losses and GSPC may or may not pay tax for the next many years as it writes these off.

On the other hand, ONGC’s cash balance will take a 63 percent hit, dropping to Rs 4,800 crore, for an acquisition that may not add any value or at the least will be challenging to monetise.

We see limited merit in ONGC’s strategy of acquiring discovered/under-developed assets. In our view, this acquisition may not create meaningful value, given their typical low internal rate of returns.
Kotak Securities Report