Oil and Natural Gas Corporation (ONGC) is struggling with challenges arising from oil price fluctuations and risks associated with windfall taxes, potentially putting it at the cusp of what one securities firm calls a “no-win zone.”
At a time when most analysts have a buy call on the state-run explorer’s stock, concerns are mounting about the ONGC’s limited upside potential coupled with downside vulnerability.
ONGC’s profitability is directly linked to oil prices. Yet, above the critical threshold of around $75 per barrel, any gain from rising oil prices is significantly offset by an equivalent increase in windfall tax obligations.
“We feel ONGC is entering a no-win zone,” said Nuvama Institutional Equities, which sees a downside of around 10 percent in the stock from current market price of Rs. 157.95.
While above the oil price threshold of about $75 per barrel, its upside is offset by the resultant windfall tax, its downside is unlimited below $75, explained the securities firm.
Profit drag
ONGC shall be deprived of any incremental benefit arising on high crude prices with the levy of windfall tax, which will drag down near-term profits, Nuvama warned.
Two weeks ago, the government cut windfall profit tax on domestically produced crude oil to zero from Rs 4,100 per tonne in line with softening international oil prices. The nil tax came into effect on May 16.
Besides, the Kirit Parikh committee on fair pricing of natural gas has recommended imposition of a dynamic ceiling and a fixed floor on gas prices under the Administered Price Mechanism (APM). It suggested $6.5 per MMBtu to be set as the first ceiling price, which shall increase by $0.5 every year until January 2027, and thereafter be fully deregulated. The panel also recommended a fixed floor price of $4 per MMBtu. It suggested a 10 percent slope on previous months’ average import price of Indian crude basket. The actual price shall fluctuate between floor and ceiling prices.
Read more | ONGC plans Rs 30,125 crore capex, sees output increasing in FY24
In short, APM gas prices are now pegged at a 10 percent slope to Brent with a ceiling and floor price of $6.5 and $4 per MMBtu.
The implementation of the Parikh committee's recommendations from April 2023 has provided a much-needed respite to ONGC because it had to sell gas below the cost of production in the past.
Stock ratings
Even so, this, according to Nuvama Institutional Equities, caps any potential super-normal profits arising amid higher crude prices (>$65 per barrel). The securities firm said that a $2 per MMBtu cut in APM prices shall have a 20 percent impact on ONGC’s FY24 earnings.
Nuvama Institutional Equities has downgraded its rating on the stock to ‘reduce’ from ‘hold’ on a weak outlook and slashed its Earnings Before Interest, Tax, Depreciation and Amortisation estimate for FY24 and FY25 by 7 percent while trimming its target price on the oil and gas company’s stock by 10 percent to Rs 143.
ICICI Securities said stronger long-term price assumptions and cash flows can drive a material uptick in the share price of ONGC, which prompted it to set a target price of Rs 218 with a ‘buy’ recommendation on the stock.
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Even JM Financial Institutional Securities has retained its ‘buy’ call on ONGC shares owing to the strong dividend play of 6-8 percent. The rating stance is also because the current market price is discounting only about $55-60 per barrel of net crude realisation while its target price is based on FY25 net crude realisation of $65 per barrel. Yet, the securities firm has cut its target price to Rs 200 from Rs 220.
Motilal Oswal Financial Services has also retained its ‘buy’ rating on the stock with a target price of Rs 215.
Provisions hit profit
On a standalone basis, ONGC reported a net loss of Rs 248 crore for the quarter ended March 2023, compared to a Rs 8,860 crore net profit recorded a year ago. Gross revenue increased by 5.2 percent to Rs 36,293 crore from Rs 34,497 crore a year-ago.
The company said that its profit was hit by a provision of Rs 12,107 crore made in the quarter to cover possible liabilities arising from ongoing royalty tax proceedings with tax authorities. The company said the provision includes service tax and Goods and Services Tax on royalty and interest on it in the period between April 1, 2016 and March 31, 2023. This has been done as a prudent practice, the company added.
ONGC dominates India’s oil and gas production with a more than two-third share of the country’s production of oil and oil equivalent gas. It contributes around 78 percent and 73 percent to total oil and gas production, respectively.
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