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Gas realizations to follow rising oil prices; KG 98/2 ramp-up starts

* Oil prices near USD70/bbl and the rise in broader energy complex augur well for ONGC. Our FY22/23 earnings estimates and TP of Rs130 are based on assumption of USD55- 56/bbl Brent prices, and hence they have a material upside.

* We estimate a 58% increase in the domestic gas price to USD2.8/mmbtu GCV in Oct’21 as global gas benchmarks strengthen. Current Alberta-Henry Hub rates at USD2.5- 3.0/mmbtu and NBP near USD10 imply a spot realization of USD4.4/mmbtu for ONGC.

* ONGC’s bidding for 2mmscmd of KG 98/2 gas is underway. While the current ceiling is USD3.6/mmbtu, we estimate it to jump to USD6-7/mmbtu in Oct’21 (closer to 10.5% of Brent slope sought) due to the rise in prices of alternate fuels (naphtha-FO) and LNG.

* The 2mmscmd first 98/2 bidding round is likely to be followed by a larger 5mmscmd round toward the year end, thereby adding over 10% to current output. Hence, ONGC could enter a cycle of production growth along with higher realization. Retain Buy (OW stance).

Oil prices firm near USD70/bbl on global recovery, OPEC+ discipline:

Brent prices continue to hover near USD70/bbl, driven by the prospects of a global demand recovery and OPEC+’s production discipline. Positive near-term demand-supply balance with inventory destocking would provide support and unless the OPEC+ deal breaks down, a significant downside risk to oil prices is low. Our current Brent price assumption is USD55/56 for FY22/23, though there is an upside risk to the same. Every USD5/bbl increase in oil realization improves ONGC’s FY22E EPS by Rs3 per share or 22%.

Broad-based increase in gas prices expected based on current formula:

While we are cautiously optimistic on domestic gas pricing reforms, we estimate a 58% rise in formula prices due to the rise in global gas benchmarks. In fact current rates imply a USD4.4/mmbtu spot price, which it is 2.5x of prevailing USD1.79/mmbtu, GCV. Rise in prices of alternate fuels like naphtha, FO and coal and LNG implies that deep water HP-HT ceiling should also increase from USD3.6/mmbtu to USD6-7/mmbtu, GCV in H2FY22. This would boost KGDWN-98/2 gas realization for ONGC.

ONGC may see double-digit growth in gas output next year:

ONGC’s first tender of 2mmscmd of KG 98/2 gas is under bidding and supplies are expected to start by Jul’21. ONGC has sought 10.5% of Brent with a term of 3 to 5 years. As per media reports, this would be followed by a larger 5mmscmd offer by Dec’21. A total of 7mmscmd is over 10% of ONGC’s current gas output, thereby leading to a sizeable production growth in CY22. ONGC has envisaged 15mmscmd of peak output from 98/2.

Valuation:

We value ONGC’s standalone business at 4x FY23E EV/EBITDA and listed investments at a 50% holdco discount to arrive at a TP of Rs130/sh.

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