Indian oil & gas upstream sector outlook: ICRA

Domestic oil and gas production dipped 5% year on year to 86 million metric tonnes of oil equivalent (MMTOE) in FY 12 on the back of 9% degrowth in gas production to 47.55 billion cubic metres (BCM) following disappointments in Reliance Industries Limited’s (RIL) flagship KG D-6 block and tepid 1% growth in crude oil production to 38 million metric tonnes (MMT). Oil and Natural Gas Corporation Limited (ONGC) continues to dominate India’s exploration and production (E&P) landscape, accounting for approximately 55% of total oil and oil equivalent gas (O+OEG) production while Oil India Limited (OIL) accounts for 8% and various private companies/joint ventures (JVs) together account for 37% (FY 12).

Notwithstanding the expected modest increase in domestic crude oil production over the medium term, driven mainly by ramping up of scale by Cairn India Limited (CIL) at its Barmer block in Rajasthan and commercialization of small to marginal other discoveries, India is expected to remain an energy deficit country with imports accounting for 76-77% of total domestic crude oil demand. The import bill on account of crude oil swelled to US$98 billion in FY 12 from US$64 billion in FY 11 due to spiraling crude oil prices and increase in volume of imports; and was the main driver of the sharp increase in the country’s trade deficit. Given the inelastic demand for crude oil, the global energy price scenario would continue to remain a key determinant of the country’s import bill and in turn its trade deficit.

Following the dip in RIL ’s KG-D6 gas output, the Indian market has become gas starved resulting in increase in imports of regassified liquefied natural gas (R-LNG) despite the high costs thereof (average LNG rates of US$15-16/MMBTU vis-à-vis domestic gas prices of US$6-7/MMBTU on landed basis). Considering the high potential demand of gas from various sectors particularly power; fertilizers and petrochemicals and the modest expected domestic supply additions, the gas deficit in the Indian market is expected to further balloon over the medium to longer term part of which can be catered to by increased LNG imports while a larger portion is likely to remain unfulfilled due to high price sensitivity of certain end user sectors.

Policy environment for the E&P sector remains not so favourable with prevailing uncertainties on the role of the regulator in areas of pricing and allocation of hydrocarbon resources; granting of approvals and various clearances; and interpretation of the terms of the production sharing contracts (PSCs) and other framework agreements. These factors have led to a dampened investment climate which is already facing challenges of increasing capital costs; increasing risks due to more complex and difficult geology and high operating cost pressures. Efforts on development of non conventional hydrocarbon resources like coal bed methane (CBM) and shale gas have also been uninspiring and with various structural uncertainties still existing, these are unlikely to become major contributors to the country’s energy security in the foreseeable future.

The buoyancy in global crude oil prices and linkage of domestic crude oil realizations to international oil price movements has translated to superior profitability and high cash generation for the private sector E&P players. Their public sector counterparts namely ONGC and OIL have however been unable to capitalize on this upside fully due to the large under-recovery sharing burden imposed on them by the Government of India (GoI). The under-recovery burden for FY 12 stood at Rs. 1385 billion, up sharply by 77% from the level in FY 11. Notwithstanding the recent softening, crude oil prices are likely to remain at elevated levels over the foreseeable future which will keep the under-recovery burden high. The extent to which this would have a bearing on the profitability and cash flows of public sector upstream companies shall continue to be a function of GoI policies with respect to under-recovery sharing.

Disclaimer: The views and investment tips expressed by investment experts/broking houses/rating agencies on moneycontrol.com are their own, and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.