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Lingering geopolitical tensions put ONGC & GAIL in a sweet spot

Brent crude price has spiked to +USD 125/bbl as US and European allies are considering banning crude oil imports from Russia in response to its ongoing aggression in Ukraine. Russia is the world’s largest producer of crude at ~10mmbpd; of this, it exports ~4.7mmbpd of crude and 2.8mmbpd of oil products. OPEC+ currently has a spare capacity of ~5.0mmbpd – however, this will not be able to entirely replace Russia’s oil exports, posing the risk of sustained high crude prices in the event of such a ban.

As highlighted in our earlier notes (in Jan’21, Mar’21, Sep’21, Feb’22), we reiterate BUY on ONGC (TP INR 230), Oil India (TP INR 300) and GAIL (TP INR 190) as they are the key beneficiaries of rising crude prices. At CMP, ONGC/Oil India is discounting USD 60-65/bbl Brent — every USD 1/bbl rise in crude realisation implies a 2-4% increase in EPS of ONGC and Oil India. ONGC and Oil India will also benefit from the likely jump in domestic gas price in FY23. Moreover, higher crude price improves the earnings visibility for GAIL’s gas trading and downstream businesses.

Russia exports ~4.7mmbpd of crude and 2.8mmbpd of oil products – ban on Russia oil poses risk of sustained high crude price: Brent crude price has spiked to +USD 125/bbl as the US and its European allies are considering banning the import of crude oil from Russia in response to its ongoing aggression in Ukraine. Russia is the world’s largest producer of crude at ~10mmbpd; of this, it exports ~4.7mmbpd of crude and 2.8mmbpd of oil products. Industry reports suggest ~1.5mmbpd of Russian crude and 1mmbpd of its oil products are currently not able to make it to the market as traders are finding it difficult to sell Russian oil; last week, one Russian oil cargo was sold last week at a steep USD 28/bbl discount to Brent. However, press reports suggest that Chinese refiners are paying for Russian crude using alternative payment methods, as banks shy away from financing because of sanctions. OPEC+ currently has a spare capacity of ~5.0mmbpd (Exhibit 6) – however, this will not be able to entirely replace Russia’s oil exports, posing the risk of sustained high crude prices in the event of a ban on crude oil imports from Russia.

ONGC and Oil India are key beneficiaries of higher crude prices: As highlighted in our Dec’20 upstream PSUs upgrade note, ONGC and Oil India are the key beneficiaries of higher crude prices as every USD1/bbl rise in crude price results in our valuation rising by 2-4% - Exhibit 15-18. At CMP, ONGC/Oil India is discounting USD 60-65/bbl Brent; hence we reiterate BUY on both ONGC (TP: INR 230) and Oil India (TP: INR 300). Further, higher domestic gas price is positive for ONGC and Oil India; every 10% hike in domestic gas price has a positive impact of 2-5% on ONGC/Oil India’s valuation (Exhibit 20-21). At CMP, ONGC trades at 5.2x FY23E EPS and 0.9x FY23E BV (3-year avg. of ~0.6) while Oil India trades at 5.8x FY23E EPS and 0.9x FY23E BV (3-year avg. of ~0.6x)

High crude price improves earning visibility for GAIL’s gas trading and downstream businesses: Higher crude price has improved the earnings visibility for GAIL’s gas trading due to rise in competitiveness of its US LNG portfolio vs. oil-linked LNG contract (Exhibit 23); it also improves the profitability of its downstream Petchem and LPG businesses. The gas trading and downstream businesses constitute 40-50% of GAIL’s overall EBITDA. We have a BUY rating on GAIL (TP raised to INR 190 from INR 185) due to steady growth visibility in its gas transmission business given the government’s target to boost the share of gas in India’s energy mix to 15% by 2030 (6.3% currently). At CMP, the stock trades at 10.0x FY23E P/E (3- year avg: 8.1x) and 1.2x FY23E P/B (3-year avg. 1.2x).

High crude price to raise OMCs’ working capital and pose risk to marketing margin: High crude price has led to a sharp jump in OMCs’ working capital needs; further, they are making gross margin of negative ~INR 21/ltr in diesel and petrol (vs. historical gross marketing margin of +INR3.5/ltr). Hence, OMCs need to hike diesel/petrol prices by INR 24-25/ltr to revert to normalised margins. However, there is scope for a cut in excise duty as it is still higher by INR 6-8/ltr vs. pre-Covid levels

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