ONGC: Surge in oil prices & expected increase in production to bolster growth

ONGC is the largest crude oil and natural gas company in India, contributing around 71 per cent to Indian domestic production.

Oil will jump 28% in 2023, with another energy crunch set to push prices higher, Eurasia Group says, oil prices will spring back above $100 a barrel in 2023 as tight supply meets growing demand, the political research and consultancy firm Eurasia Group said in its list of top risks this year. That would represent a 28% increase in the price of international benchmark brent crude, which traded around $77.90 a barrel on Wednesday.

Calculating for West Texas Intermediate crude, the increase would be 37% from $72.80 a barrel. The oil market is poised to experience shocks this year on the back of a faster-than-expected economic recovery in China after the country's sudden exit from zero-COVID policies along with a shallow recession in the US that won't sink demand, wrote Ian Bremmer, president and founder of Eurasia Group, and Cliff Kupchan, the firm's chairman and head of global macro coverage. 

They said those two factors would bolster demand growth for crude oil and expose an acute lack of new supply.

Oil and gas production to improve 10% and 20% from mid-CY23, respectively The Great Conjunction is a rare conjunction of the naked-eye planets – Jupiter and Saturn. It is an event that roughly occurs every two decades when Jupiter overtakes Saturn in its orbit.

As Mother Aughra in the 1982 cult classic – The Dark Crystal – says, “The Great Conjunction is the end of the world or the beginning sometimes good, sometimes bad”, the year 2023 is likely to be a defining year for ONGC with two prominent triggers. These are –

1. A rise in domestic oil & gas production.
2. Possible floor on gas realisation. Both are likely to play out in favour of the company, an outcome that makes us pitch ONGC as the top idea for 2023 in the sector.

Long awaited production growth in sight

For the past 10 years, the company has spent ₹2,874b in its exploration projects. Hence, ONGC’s RRR (2P) – an indicator of sustainable production – has remained above 1x continuously.

However, its oil/condensate production from domestic fields (ex-JVs) declined to 19.5mmt in FY22 from a peak of 26.5mmt in FY05. Similarly, gas production from domestic fields (ex-JVs) reached a peak of 24.7bcm in FY19, but that too decreased steadily to 20.6bcm in FY22.

However, the much-awaited KG-DWN-98/2 is forecasted to reverse this trend from May '23 by adding peak oil production of 40-45k copd and peak gas production of 10-12mmscmd (both by FY25). At the peak, this field would add ~10% to ONGC’s domestic oil production and ~20% to its current domestic gas production.

Since the implementation of the existing gas price mechanism from Nov '14, domestic APM gas prices have remained below USD3/mmBtu (NCV) for 10 quarters due to the high weightage of Henry Hub in the pricing formula. For another eight quarters, domestic gas prices have remained below USD3.5/mmBtu. Comparing these with ONGC’s gas production cost of ~USD3/ mmBtu leads us to infer that it has been severely impacted by low gas prices.

The Kirit Parikh Committee recommendations of a price floor of US$4/mmbtu and a cap of US$6.5/mmbtu for APM gas, retaining premium for difficult fields and proposing a gradual movement to free pricing in 3 years (annual escalation of US$0.5/mmbtu till then) is a material positive. ONGC has a production and development cost of only US$3.5/mmbtu for most of its legacy fields and has seen an average blended realisation of only US$3.7/mmbtu over FY15-22.

Considering the above, the recent recommendations of Kirit Parikh, valuing domestic APM gas prices to 10% of Brent could be a boon, if implemented. The recommendations also include a floor of USD4/mmBtu, which would protect the profitability of ONGC’s gas segment. To incentivize production from the age-old nominated fields, the Committee also proposed a 20% premium over the prevailing APM gas price for incremental gas production.

In addition to the great conjunction of production growth and better gas segment profitability, this implies a strong dividend yield of 13.6% for FY23.

Mozambique could spring another surprise: Fueled by high LNG prices, Mozambique commenced its first LNG exports from the Coral field in mid-CY22. Already delayed, the Mozambique project in which ONGC has 16% stake, may see progress in 2023.

KG-DWN-98/2 came to the rescue: The decline in oil and gas production came in the backdrop of delays, especially in KG-DWN-98/2. However, with its completion standing at 76% as of Oct '22, the visibility of first oil from KG-DWN 98/2 and rise in gas production appears much stronger.

Against the envisaged ₹340b, the company has already spent ₹200b on KG DWN-98/2. Three wells are already producing 1.7mmscmd of gas. By May’23, the field is expected to produce first oil, peaking at 45k bopd in FY25. Along with that, the gas production is forecasted to reach a peak of 10-12 mmscmd in FY25.

Daman upside

Additionally, the company envisages a total expenditure of ₹41.4b on Daman Upside and is likely to add

13.9 mmtoe (mainly gas) over the lifetime of the project. The project is expected to be completed by Oct '25. Capex outgo in FY23 is projected at ₹2b and will jump to ₹8.5b in FY24E.

Mumbai high north redevelopment project

Total expenditure is likely to stand at ₹40b, out of which ₹30b has already been spent. The production has already been ongoing since Feb’18 from a few wells. About 80% drilling has already been completed and the project is forecasted to add 4.69 mmtoe over the lifetime of the project. The above are included in a basket of 23 projects worth ₹610 b that are forecasted to add 97 mmtoe of total production (37.4 mmt of oil and rest gas).

Key risks

• Sharp reversal in oil & gas price trends.
• Further delays in start of production from KG basin.
• Regulatory setbacks.
  
  Shuchi Nahar is a Certified Research Analyst. She can be found on Twitter at @shuchi_nahar

Note: This article is for informational purposes only. Please speak to a SEBI-registered investment advisor before making any investment related investment-related decision.