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Rising from a slumber

ONGC and Oil India to benefit from the rise in crude oil prices

* Due to the COVID-19 outbreak, Brent Crude oil prices registered a sharp decline to USD29/bbl in 1QFY21 from USD61/bbl in FY20. Continued COVID-related restrictions, combined with low oil prices and self-imposed production quotas, resulted in a decade low upstream oil capex of USD220b in CY20, with the same rising marginally in CY21.

* As a result, global oil and gas discoveries stood at the lowest level (~5bboe) since CY46 v/s 12.5bboe in CY20.

* Although OPEC+ is yet to roll back its 3.4mbopd of production cuts initiated in Apr’20, fast recovery in oil demand, switch from high cost gas to oil, and low inventories resulted in Brent touching a seven year high at USD89/bbl recently. As a result, we raise our FY23E/FY24E assumptions for Brent Crude oil by USD5/bbl each. We reiterate our Buy rating on ONGC and Oil India, with a revised TP of INR210 and INR320, respectively.

Investments bear the brunt in CY20 and CY21

* After touching a decade low in CY20, upstream oil investments stood at USD233b in CY21 and are likely to rise by 9% to USD253b in CY22E. The total global rig count stands at 1,563 in Dec’21 after touching a low of 1,016 in Oct’20.

* Global shale investments are expected to rise by 18% in CY22 to USD102b. Total rig count in the US has touched 604 in the week of 21st Jan’22 from 378 in the week of 22nd Jan’21.

* If oil prices remain strong, CY22 is likely to witness strong approval in upstream projects globally, mainly in North America and the Middle East, thereby putting pressure on oil prices subsequently.

Lowest oil discoveries since CY46

* Poor investments have resulted in a major decline in global upstream discoveries to ~5bboe in CY21 from 12.5bboe in CY20.

* Liquids continue to dominate with a 66% share of discoveries.

* Most of the discoveries in CY21 have been small in size. The largest one – Yoti west – has recoverable resources of 75mboe only.

Valuation and view

* Commercial inventories of US oil and liquids have declined to 1.18bnbbl in Dec’21 from 1.34bnbbl in Dec’20. Commercial oil and liquid inventories in OECD have also declined to 2.7bnbbl in Dec’21 from 3bnbbl in Dec’20. The fall has been led by a sharp rise in oil demand, delays in the ramp up of newly discovered fields, and lack of adequate supply from OPEC+.

* Although we expect crude oil prices to hover at USD60-70/bbl in the long run, the prevailing strength makes us raise our FY23E/FY24E forecasts by USD5/bbl each to USD70/USD65 per bbl.

* We also rationalize Brent Crude oil prices at USD85/bbl for 4QFY22E. We build in domestic gas prices at USD6.6/USD4 per mmBtu for FY23E/FY24E.

* Change in our assumptions result in a 27%/15% rise in ONGC’s FY23E/FY24E EPS. The same for Oil India has risen by 14%/2%.

* ONGC: Although the ramp up in oil and gas production has been a sore issue for investors, the rise in oil and gas prices is likely to result in FY24E adj PAT being 1.7x that of FY21. We value ONGC at 10x FY24E adj standalone EPS, add the value of investments, and recommend a Buy on the stock, raising our TP to INR210 from INR195/share. Ramp up of production from the KG basin could be another positive trigger for the stock.

* Oil India has been battling a similar fate as ONGC in terms of a production ramp up. We value the company at 8x adj FY24E EPS, add value of investments and recommend a Buy on the stock, raising our TP to INR320 from INR315.

* A USD5/bbl rise in Brent Crude oil prices would change the FY23E EPS of ONGC/Oil India by 7%/12%. The biggest risk to our call remains large lockdowns affecting oil demand.

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