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Warming up to the winter ahead…

…Oil price rally may strengthen, although temporarily

* OPEC+ in its Oct’21 meeting reaffirmed its stance of continuing to easing production by a mere 0.4mnbopd per month. It would review the oil market environment at its next monthly meeting on 4th Nov’21.

* Brent prices continue to record an uptick (and have reached USD82/bbl over the last one week from an average of USD74/bbl in Sep’21) owing to power outages in China, further aided by substitution demand from gas and coal, for which the prices are all at multi-year highs currently.

* Recent chain of events like hurricanes in the US and offshore platform fire in Mexico have taken out over 25mnbbl of oil production. Continued lower supply from OPEC+ (production cuts still ~4.5mnbopd), along with supply disruptions in Angola and Nigeria, against high demand on the back of robust global growth has resulted in inventory draws (refer exhibit 2), thus translating to higher oil prices.

* Lower Brent production has translated to lower production of associated gas, weighed by expectations of a severe winter (Exhibit 5) combined with Chinese ban on import of Australian coal. Gas prices at international hubs are trading at multi-year highs.

* Factoring in the current global demand-supply abnormality (which will likely achieve the balance in 4QFY22 – refer Exhibit 1), we revise our Brent price assumptions (upwards to USD69/65/60/bbl for FY22E/FY23E/FY24E from USD65/USD60/USD60) and gas price assumptions (to USD2.6/USD5/USD4/mmbtu for FY22E/FY23E/FY24E) and reiterate a Buy on ONCG and Oil India.

Realigning our Brent and Gas price assumptions

* We continue to believe that the oil prices in the medium term (FY23-24E) would return to its long term average (of USD60-70/bbl; highlighted in Exhibit 5), as:

* OPEC+ gradually lifts its current production cuts of ~4.5mnbopd (as per the aforementioned plan till Apr’22) – refer Exhibit 4.

* Demand for Brent as a substitute fuel subsides as gas and coal prices normalize post winter (i.e. in 4QFY22).

* Production lost to hurricanes is revived back in the US (by Dec’21; Exhibit 3).

* Revision in our assumptions has resulted in an EPS change of 17-42%/20-30% for ONGC/Oil India for FY22-24E. Every USD5/bbl increase in Brent prices would result in an EPS change of 8-11% for ONGC standalone and Oil India - translating to a higher share price.

Valuation and recommendation

* ONGC (Buy): Delay in production at the KG-DWN-98/2 field continues, amid restrictions on international movement due to COVID-19 pandemic. Despite continued delays, ONGC’s gas production is likely to clock 7% CAGR over FY21- 24E, with efforts to arrest the decline in oil production. OPAL’s performance is steady and ONGC is improving process efficiencies to keep its profits positive. Valuing the stock at 10x Sep’23E adj. EPS, we arrive at a TP of INR190/share.

* Oil India (Buy): The company is targeting ~5mmscmd of gas from the Baghjan field (up from 1.6mmscmd currently) over the next 3-5 years. It has started working on three more drilling wells, while one well was completed recently in the Baghjan field. In FY21, OINL acquired four blocks in OALP Round-V, increasing its acreage by 13%. Valuing the stock at 8x Sep’23E adj. EPS and adding investment in NRL of INR87/share, we arrive at a TP of INR310/share.

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