OPEC+: Production cuts of ~8mnbopd to continue for Apr’21
* OPEC+, in its latest meeting, agreed to extend production cuts till Mar’21 to Apr’21. Saudi Arabia would continue its voluntary cuts of 1mnbopd (total cuts: ~2.9mnbopd), while Russia and Kazakhstan would be allowed to ease cuts by a total of 150kbopd. Thus, total OPEC+ production cuts still stand at ~8mnbopd (v/s pre-COVID levels).
* Brent oil prices have spiked on the back of this extension, against the expected easing of production cuts by 0.5mnbopd, along with Saudi Arabia rolling back its voluntary incremental cuts of 1mnbopd.
* OPEC+ compliance for Feb’21 reached ~103% (v/s 99% in Dec’20 and Jan’21) as Nigeria aligned its production and met the agreed cuts. However, we do not expect such high compliance to sustain as the group has a history of engaging in market share fights and eventually increasing production (especially at higher favorable crude prices).
* We revise up our Brent price forecast to USD55/bbl (in line with EIA’s estimates) as we do not believe the current high crude prices would sustain, given a) OPEC+ normalizing production to pre-COVID levels and b) an increase in shale oil production.
* We value ONGC at 10x (factoring in upcoming gas production) FY23E adj. EPS to reach Target Price of INR135/share; and value Oil India at 8x (considering an increase in debt post the acquisition of NRL) FY23E adj. EPS to reach Target Price of INR170/share.
Impact of Arctic blast in the US
* The Arctic blast in the US wreaked havoc, with temperatures holding below subzero levels for the longest stretch in the last 11 years.
* This resulted in huge disruption in crude oil production (of ~4mnbopd) and led to refinery outages (of ~2.6mnbopd). Thus, Brent prices averaged higher at ~USD62.4/bbl (up ~USD8/bbl MoM) in Feb’21.
* As per S&P Platts, ~90% of the lost crude oil production has come back on stream, while refinery outages are taking much longer to rebound. This recovery in US shale production would further put downward pressure on prices.
Overhang of global product inventory to continue
* As per EIA, global petroleum stocks have fallen ~600mbbls since May 2020, translating to an inventory drain of ~2.2mnbopd – on continued higher production cuts. Although, the drawdown is only half of what was built in the first five months of the year. Global petroleum stocks rose over 1.2bnbbls amid the COVID-led lockdown.
* EIA expects 2021 ending inventory to be higher than that at the end of 2019 – thus, the inventory buildup would cap the upward move in crude oil prices.
* The US rig count has been increasing gradually WoW, however the current rig count of 402 is at only 50% of last year’s level. Historically, the rig count has responded with a lag of 4–6 months to increase in crude oil prices.
* Current high crude oil prices hugely favor the economics of US shale (which has breakeven of USD48–54/bbl). Various reports suggest that due to recent costcutting initiatives by oil companies, the breakeven has fallen further.
Valuation and recommendation
* ONGC – development of new fields remains the key
➢ COVID has caused further delay in KG-DWN-98/2, with the peak production target to be achieved over 2023–24. Production is likely to rise to 2.5–3mmscmd in 1QFY22 (current production at ~0.3mmscmd) and reach ~3.5mmscmd/8.5mmscmd in FY22/FY23.
➢ ONGC is also expected to arrest the decline in oil production from age-old fields (accounting for 60–70% of the total oil production).
➢ For FY21/FY22, the company has guided for oil production at ~22.5mmt/23mmt (flat YoY), while gas production is set to increase to ~23bcm/25bcm (+8% YoY).
➢ For ONGC, cash flow breakeven stands at USD50–55/bbl for oil and USD3– 3.5/mmbtu for gas. Although variable cost of production is low, the domestic gas price ceiling would not affect production at the KG Basin.
➢ ONGC made a total of 12 discoveries in FY20 (seven onshore and five offshore) and has made 8 discoveries (five pools and three prospects) in FY21 thus far.
➢ ONGC is trading at 3.4x FY23 EV/EBITDA and 4.8x FY23 P/E. We value the company at 10x FY23E adj. EPS of INR10.3 and add the value of investments to arrive at Target Price of INR135/share. Reiterate Buy.
* Oil India – concerns over production decline continue
➢ We expect no incremental change in production volumes for oil & gas in the near term. The company intends to raise gas production to ~10mmscmd over 2024–25 (from ~7.5mmscmd currently), increase oil production to 4mmt (from ~3mmt currently) by FY25 from five fields. Gas production at the Baghjan field stands at 1.5mmscmd, which may rise to 5mmscmd.
➢ The stock trades at 4.6x FY23 EV/EBITDA and 5.3x FY23 P/E. We use an SOTPbased fair value of 8x FY23E adj. EPS of INR20.1 and add investments to arrive at Target Price of INR170. Maintain Buy.
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