Time to rightly price APM gas
* The govt’s move to set up a panel for recommending floor/remunerative APM gas pricing is a crucial step. If not for the latest uptick in global gas prices due to winter demand-supply constraint, APM could have fallen by another 10-15% to USD1.6/mmbtu GCV in Apr’21.
* Alberta-Henry Hub prices are currently at USD2.5-3.0/mmbtu, NBP crossed USD5 and Asian spot LNG is also almost at USD7/mmbtu, compared to a trough of USD1-2/mmbtu 4-6 months ago. Hence, APM gas prices should bottom out at ~USD1.8/mmbtu this cycle.
* Due to acute seasonality, the sustainability of this increase is difficult to ascertain. Hence, a proper overhaul of the formula away from excess-supply hubs is required. However, against reports of pegging it to spot LNG, we believe that oil linkage is more preferable.
* While we are cautiously optimistic about the developments, there have been legacy issues in the nominated gas blocks. For now, we maintain our assumptions, estimates, TP and rating of ONGC and Oil India. We are EW on ONGC and UW on Oil India in EAP.
Gas prices touch decadal lows, near to cash costs: Domestic gas (APM) prices fell to USD1.79/mmbtu (GCV) for H2FY21, a level last seen in CY10, as Henry Hub-NBP benchmarks weakened to USD2-3/mmbtu. This brings realizations of ONGC/Oil India nearer to cash opex levels of USD1.3/1.1/mmbtu though recent seasonality and supply issues have led to a spike in the benchmarks, which implies ~USD1.8 to be bottom in this cycle. Though the nominated block business would continue to be EBITDA positive, if an oil price recovery going ahead and recent surge in global gas prices lead to an excess gas supply response, APM rates may re-test lower levels. Hence, as suggested by media quoting Govt sources and industry officials, the formation of a panel by MOPNG to look into floor and remunerative prices is crucial. ONGC and Oil India spend substantial capex in arresting output decline and the nominated blocks still command 90-100% of total production. With oil prices at USD40/bbl, their normalized capex run-rate of Rs300/40bn would remain unfunded, leading to higher debt.
APM gas had legacy issues but oil linkage is preferable: APM gas had legacy issues as being associated with oil fields, it was more like a byproduct with unclear capital employed. Hence, even after officially dismantling APM in CY02-03 for petroleum in general, gas prices were arbitrarily fixed at USD1.79/mmbtu in CY05, which was in the same way revised up to USD4.2 in CY10 after RIL’s KG-D6 came to picture. The UPA govt did warm up to the Rangarajan Committee’s LNG-linked formula but the incoming NDA govt in CY14 changed it to the current global formula. Media reports have stated pegging APM pricing to JKM LNG. We believe that linkage to spot LNG may not be prudent, given the volatility. Ideally, APM should also have arm’s length bidding though an oil-linked formula with a fixed slope can be adequate. The govt can take cues from private auctions. RIL-BP’s R-Cluster bidding yielded an 8.5% slope to Brent. At USD40/bbl, assuming even a 7% slope, implies USD2.8/mmbtu price for ONGC/Oil India, which is still decent with almost USD5/bbl of oil equivalent.
Remain cautiously optimistic; no change in estimates and TP of ONGC/Oil India: We will continue to monitor the developments and remain cautiously optimistic at this juncture. We have a Buy/Hold rating on ONGC/Oil India, with EW/UW stance.
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