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The curious case of rising capex among O&G PSUs

O&G PSUs’ capex has increased at a rapid pace, and was up over 3X during FY2019-24 (versus FY2005-09). However, returns have been weak. In upstream, despite large capex, oil/gas production and reserves are declining. In refining, there is surplus capacity, and creation of new capacity is questionable. Petchem is a new focus area for PSUs, but their track-record has been dismal. High capex has led to low FCF relative to PAT for PSUs. Recently, PSUs have benefited from higher realizations, yet FCF remains weak. The market seems to be giving generous multiples to near-term elevated earnings and ignoring large capex with likely weak returns. Maintain cautious view on oil PSUs.

Capex of O&G PSUs: On a continued upward trajectory

Oil & gas PSUs’ large and rising capex is one of key reason for our cautious stance. Conventional O&G is a sunset sector, and returns have been low. With pricing interventions, and weak outlook, the private investment has slowed. However, PSUs’ capex continues to rise. Compared with the average annual capex of Rs340 bn over FY2005-09, top 10 O&G PSUs’ capex rose 2X to ~Rs700 bn in 2009-14, 2.7X to ~Rs930 bn over FY2014-19 and 3.2X to Rs1.1 tn in FY2019-24. With plans aggressive in core areas, most are diversifying into petchem, renewable, and new energy, where returns will be weaker. Thus, capex will likely keep rising, while returns will likely get weaker for O&G PSUs.

Market giving high multiples to elevated ST earnings, ignoring large capex

Most PSUs have benefitted recently with higher prices, realizations or margins.

* Upstream: Net crude oil realizations (post wind-fall tax, royalty, cess) for FY2022-24 are ~50% higher versus FY2016-21 average. Similarly, APM gas prices are nearly 100% higher versus FY2016-22 average.

* OMCs: GRMs have been a puzzle and too good to believe. Reported GRMs have been at very high premium to benchmarks, or what their product slate suggests, accounting for Russian crude and better distillate cracks. While prices of petrol/diesel are frozen, the OMCs marketing margins have been elevated.

* GAIL: GAIL is realizing ~15% higher-than-approved tariffs for its integrated pipeline. In addition, due to elevated spreads on ~50% of HH linked US LNG, sold on oil-linked basis (primarily to fertilsers companies), earnings have been elevated.

Our near-term earnings estimates are optimistic (and not much below consensus estimates), as we assume generous prices/margins. However, in the past earnings have been volatile both on macro environment and government policies. Despite the strong run-up of PSUs, the Street seems to be giving high multiples, and, in our view, ignores large capex with likely weak returns.

Maintain cautious view on oil & gas PSUs and Petronet LNG

We have a cautious view on oil & gas PSUs. We have SELL ratings on IOC, BPCL, HPCL, GAIL and Oil India, with a REDUCE rating on ONGC. For Petronet LNG as well, we have a SELL rating. We have kept our ratings and FVs unchanged.

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