Moneycontrol
Nov 24, 2016 11:51 AM IST | Source: CNBC-TV18

Fuel demand to ring-fence oil & gas biz; BPCL top pick: Citi

The government’s currency overhaul, or demonetisation drive, is unlike to impact oil and gas businesses in the near term as fuel demand look good, according to Citi Group. Saurabh Handa, oil and gas analyst at Citi Group said that he is quite positive on the sector and stock valuations are reasonable.


The government’s currency overhaul, or demonetisation drive, is unlikely to impact oil and gas businesses in the near-term as fuel demand looks good, according to Citi. Saurabh Handa, oil and gas analyst at Citi, said that he is quite positive on the sector and stock valuations are reasonable.


While BPCL remains his top pick among oil and gas stock, Handa said he is positive on Indraprastha Gas Limited, Petronet LNG and Gujarat State Petronet Limited. Pickup in organic earnings and strong cash flows make BPCL a good bet for investors, he added.

Citi has been structurally positive on the gas space for a year; gas consumption in India is picking up and global cues have been supportive, Handa said. Going ahead, higher fuel consumption is positive for downstream companies, he added.

Below is the verbatim transcript of Saurabh Handa’s interview to Latha Venkatesh, Anuj Singhal and Sonia Shenoy on CNBC-TV18.

Latha: Whatever the issues, demonetisation, Trump, would your space, oil and gas, be an island of relative performance, you are bullish on it?

A: We are quite positive. If you look at the demonetisation impact, the first order impact should be fairly limited. In fact fuel is not really a discretionary product, so, fuel demand actually saw a bit of a spike post demonetisation. So, that is not obviously recurring, it will normalise; I think it should have normalised already by now. However, the key is that on the businesses there should not be so much impact at least in the near term because fuel demand should remain quite okay.

The second order impact, if you start seeing a broader economic slowdown and over an extended period of time there is an impact on say vehicle demand, etc. then that could have an impact but near term it looks quite unlikely. So, businesses stay okay. As far as stocks are concerned, that has also been fairly comfortable because valuations there are quite reasonable. So, compared to other sectors and stocks which have seen a bit of a de-rating, given valuations in this sector are already quite benign, the downside should be fairly limited and we have already seen in the last two weeks that they have outperformed. So, we remain quite positive, in fact, our strategist has raised wait on the sector recently.

Latha: Lately in the past year, it is gas stocks that are more interesting than the oil stocks which are more predictable in their move. How are you looking at this sector, are you overweight on Petronet’s and the GAIL’s and the GSPL’s, is there a lot of business coming, how should we understand that sector?

A: We have been structurally positive. We became positive over a year back on the gas space. So, there are three or four key emerging themes which we are seeing which will play out and which we have already started seeing are playing out. One is gas consumption in India is picking up. Secondly, the global factors are very supportive because of a lot of LNG supply globally, LNG prices are coming down. Thirdly, the regulatory risks that we saw in the gas sector have now actually reversed and there are now a bit of regulatory tailwinds happening. Lastly, there are also environmental concerns as we are seeing in the case of Delhi which is supportive for gas usage. What we have seen from the government also is repeated statements that they want to increase India’s overall gas consumption.

So, we like the space; we would be a little more selective. So, the stocks that we like are the ones where we believe the risks are on the lower side and the visibility on volumes is better. So, we like IGL, Petronet LNG, and GSPL. Where we are a little concerned is stocks which have taken the commodity risk. Stocks like GAIL where there is a bit of concern on some of their LNG contracts and also because almost 60 percent of earnings comes from the non-gas business such as LPG, petrochemicals and even trading which is a little volatile. So, we would advice investors to probably play these through Petronet, IGL, and GSPL.

Anuj: The last two years have belonged to the oil marketing companies (OMCs). We have seen goldilocks scenario play out for all these downstream companies. Upstream companies of course saw 52 week lows before bouncing back. From here on, what is your preferred play, upstream, downstream or are you looking at them stock wise?

A: Currently our preference is still downstream over upstream. That has been the case for the last year or so and the reason why we would continue with that is because oil prices are still fairly benign globally. We are seeing positive demand impact of low oil prices, so, fuel consumption has been very strong in India which is benefitting the downstream marketing companies. Post decontrol of petrol and diesel, the key thing has been the government’s role which has been fairly non interfering as far as setting of prices is concerned which we view as quite positive.

Refining outlook is fairly benign. In fact we are quite sanguine on the refining outlook. So, overall I think it is a space which is still worth investing in. Also, fuels like LPG and kerosene which in the past, a lot of governments were not too keen on touching because they were considered fairly politically sensitive, this government is trying to make some moves even on that front. So, overall, I think OMCs still look quite decent.

On upstream, we are still not over positive. We still prefer the downstream pack even though we have a slightly constructive oil view. So, Citi sees oil averaging around USD 60 next year. However, even on that, we don’t see too much upside for the upstream names. We think risk reward is not that favourable right now. The other thing is that the upstream companies have a bit of asymmetric leverage to oil prices. On the downside they get hit but on the upside, the subsidy uncertainty comes in. So, we would still prefer to play the OMCs over the upstream pack.  

Sonia: Within the OMCs, BPCL has been the big performer. It is up 50 percent this year and it has the Kochi refinery capacity expansion that will come on stream by the end of the fiscal as well. So, that trigger is there. Do you think it will continue to outperform its peers?

A: Yes, that is our call. So, BPCL is our top pick amongst the OMCs. There are three to four key factors there. One you rightly pointed out, there is an organic earnings kicker coming in, in the form of Kochi expansion which is just round the corner. By Q4 of FY17 that should start contributing to earnings. Secondly, BPCL has seen its capex peaking this year. Their capex intensity should start coming off over the next few years. For the peers actually capex will start going up because they are now getting into a lot of refining, expansion and modernisation plans. So, that helps from a cash flow perspective.

Thirdly, in a rising crude price environment, we believe BPCL becomes a bit of a better hedged play because it has the Exploration and Production of Hydrocarbons (E&P) upstream exposure particularly through Mozambique. Also, BPCL has been making some steps towards non-fuel retail which is going to be a thing of the future for some of these companies because as competitive intensity rises in a  decontrolled environment, you have to look at other alternatives to stem your market share. So, BPCL has sort of been the first off the block there and which is one of the reasons also we continue to like it.

Latha: You have some of the best experts globally on oil and gas, what is the sense you are getting on gas? Will we continue to have this cheap gas advantage even as other energy prices, crude for instance, has bottomed out, will India continue to be able to benefit from that?

A: Yes, in fact, I think what we have seen playing on the oil side could actually play out on the gas side over the next few years. So, we have seen this year is that the gas over supply or the LNG oversupply is actually yet to hit the market. So, over 2017 to 2222, Citi’s house view is that there is going to be a huge LNG glut globally. So, you have a lot of new projects coming up in Australia and the US which are only now kicking in. That is happening against the backdrop of demand in big LNG importers such as Japan, Korea, etc peaking out and not growing very sharply.

So, India is actually becoming one of the lone or the big drivers of LNG demand globally. So, this actually is a pretty sweet spot that India is in. It could be four or five years when this over supply lasts but what could happen in such a scenario is that the traditional linkage of LNG prices to oil might break down. So, even in 2016, we have seen spot LNG has traded at a 10-15 percent slope to oil and that potentially could sort of come under risk if there is an excess LNG in the market which also drives our positive view on the gas value chain and companies like Petronet, GSPL, etc.

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