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Clarity emerging on the realization of upstream companies

* Brent crude oil prices surged to USD107/bbl in Jan-Jun’22 from USD80/bbl in FY22, which led to the imposition of a windfall tax. Our research suggests that the average realization/bbl , after levy of a windfall tax, stood between USD75 and USD80 for ONGC and OINL.

* In our earlier report, we had assumed that the windfall tax will stay till Dec’22. However, with no end in sight in the Russia-Ukraine conflict and proactive quota management by OPEC+, we expect Brent crude oil prices to stay elevated ~USD100/USD90 per bbl in FY23/FY24, thereby possibly extending the windfall tax into CY23 as well.

* In this note, we highlight the impact of the extension of windfall tax beyond Dec’22. We reiterate our BUY rating on ONGC/OINL, with a TP of INR186/INR243. If the government continues to levy a windfall tax, these companies will at least enjoy realizations of USD75/bbl, till the time Brent crude oil prices stay elevated.

Aggressive production management by OPEC+ to keep Brent crude oil prices elevated

* Led by higher oil prices, O&G capex has significantly increased to USD450b in CY22/CY23. The global rig count has risen to 1,853 in Sep’22 from 1,563 in Dec’21. Wary of rising supply, amid recessionary pressures on demand, OPEC+ aggressively moved to impose 2mnbopd in production cuts, effective Oct’22.

* As per IEA, Russian oil production was expected to slide to 9.6mmbpd in 4QCY23 from 11.3mmbpd in 1QCY22 due to the ongoing sanctions.

* Factoring in the above, we keep our Brent crude oil price assumptions unchanged at USD100/USD90 per bbl for FY23/FY24.

Price realization stable despite fluctuations in windfall taxes

* The levy of windfall tax by the Centre appeared arbitrary at first, with fortnightly revisions raising concerns on the realizations of upstream companies.

* However, the windfall tax has been gradually reduced to ~INR8,000/mt in Oct’22 from INR23,250/mt in in Jul’22, in line with the decline in oil prices.

* Net realized prices, after the impact of windfall taxes, remained fairly stable at USD75-80/bbl, a trend likely to continue if Brent crude oil remains high in FY24

Valuation and view

* So far, we continue with our base case realization of USD90/bbl. However, if windfall taxes were to continue beyond Dec’22, we expect an EPS cut of 14%/20% for ONGC/OINL in FY24.

* ONGC (BUY): The stock is trading at 1.2x FY24E EV/EBITDA and 2.0x FY24E P/E. We value the stock at 3.5x FY24E adjusted EPS of INR43.5 and add the value of investments to arrive at our TP of INR186.

* OINL (BUY): The NRL expansion will be completed by FY24-25 at a capex of INR280b. We value the stock at a SoTP-based fair value of 2.5x FY24E adjusted EPS of INR53.8 and add investments to arrive at our TP of INR243.

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