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ONGC’s Big Plans Belie Needed Changes

India’s leading oil explorer, Oil and Natural Gas Corp (ONGC), which has significant representation in PowerShares India ETF (AMEX:$PIN), has decided to purchase ConocoPhillips’s (NYSE:$COP) 8.4% stake in the Kashagan, Kazakhstan oil field for ~$5 billion in a deal the  company hopes will increase its output to fuel India’s growing economy. 

The Kashagan oil field has 30 billion barrels of oil out of which nearly 40% can be extracted with relative ease, making it one of the biggest oil fields in the world capable of increasing ONGC’s output by 20,000 bpd for the next 25 years. However, development of this field has run into numerous delays which have caused analysts to significantly increase their estimations of development costs which now stand at $46 billion. The location of Kashgan, in the northern Caspian Sea, has also made it less attractive to most developers since the area freezes hard in the winter considerably increasing the cost of drilling. According to the latest estimates, production from Kashagan should start from 2013.

In their attempt to clean up their asset portfolio, ConocoPhillips, with a total debt-to-asset ratio of more than 20%, is happy to get out from underneath what could turn into a serious money-sink, especially with the opening up of more assets closer to home in North America.  Their debt position is nearly five times higher than that of the market leader Exxon-Mobil’s (NYSE:$XOM) 3.7%.  Ultimately, U.S. oil firms are pulling out, slowly, of central Asian assets after more than a decade of aggressive foreign policy decisions to support the acquisition and exploitation thereof.  The region’s instability is proving greater than the potential reward for U.S. firms.

The main reason for the company’s problems is the falling crude and natural gas prices. As I have pointed out before, the company has rightly been disposing off its non-core assets and restructuring. Part of Conoco’s decline in price can be attributed to spinning off of its marketing and refining units to create Phillips 66 (NYSE:$PSX).  

Conoco had valued its Kashagan asset at $5.5 billion but the price it got in return is at the higher end of analysts’ expectations. However, there are still a number of hurdles the deal will have to clear before finalizing. But, if it does, it puts Conoco in a better position to purchase new assets.

On the other hand, ONGC has planned to partner with other international firms to increase its output amid mounting domestic criticism over its poor performance. In May this year, ONGC signed an agreement with Colombia’s Ecopetrol SA (NYSE:$EC) which was followed by a joint-venture announcement in June with China National Petroleum Corp to work on hydrocarbon and other projects.  Currently, ONGC is looking to partner with Conoco for shale gas exploration in India.

Until March, India had been importing 80% of its oil requirements daily – around 2.7 million bpd out of 3.4 million bpd total demand. The country’s own production from all the Indian oil firms was just 761,800 bpd until 2011. The burden of these imports falls on the consumer though ONGC which accounts for 62% of crude oil and 49% of natural gas output. Moreover, the huge proportion of imports is at the heart of the Rupee’s weakness, as the Indian government’s subsidizing diesel fuel and others has created demand that the treasury can no longer afford to support.   The sanctions against Iran and subsequent oil for Rupees deal cut between the two countries did help stabilize the Indian currency.

This structural trade deficit has made it tough on the entire oil and gas sector in India and meant the nation has to rely on foreign players to meet a significant part of its energy needs.  ONGC has now planned to double its production by 2030 by spending $200 billion dollars while the government is pushing through the beginnings of radical changes to their fiscal policies.


 

ONGC*

COP

PIN

Stock YTD

-2.42%

-22.90%

+7.91%

P/E

7.59

6.9

15.25

EPS

0.59

8.14

N/A

Yield

0.30%

4.70%

0.72

ROA

10.38%

9.79%

N/A

ROE

22.28%

21.36%

N/A

Net Flows YTD

N/A

N/A

+$78.61M

*Oil & Natural Gas Corporation Limited (NSE:ONGC)

However, there is a big question mark whether ONGC could actually achieve this because of its slow exploration rate and continuous decline in output over the last five years. Moreover, ONGC has also announced that it is going to miss its forecast for this and the next couple of years. With a depleted treasury, weak currency and economic reforms needed at the political level, there are a lot of issues weighing on India’s state oil and gas producer in the medium term.  Its quarterly profits reported earlier in November have slumped by 32% to $1.06 billion from a 13% fall in revenues to $3.56 billion. Its current performance has clearly shaken investor confidence and there is still doubt whether the world’s leading oil firms, who have largely shied from investing in Indian oil and gas sector, would be willing to partner with ONGC.   We recommend waiting until there are proven results after much-needed reforms.

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Peter Pham is a capital market specialist and entrepreneur.  With expertise as a Head of Institutional Sales and Trading he closely watches the market and probes for investment opportunities utilizing a unique blend of quantitative trading experience and macro trend analysis… (read more)

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