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An energy security play with rising volumes and a solid dividend yield

* Upgrade ONGC to BUY…: Our upgrade is premised upon a combination of inexpensive valuations, decent volume growth pick-up, and ONGC being a beneficiary of a multi-year government focus to turn around the sector. While a peace MOU has been reached in West Asia, according to forecasts by the US EIA and our view, OECD commercial inventories of crude oil and liquid products are unlikely to normalize for CY26 and 1HCY27. This is likely to keep crude prices elevated, and we raise our Brent price assumptions to USD84.2/ USD75 per bbl for FY27/FY28 from USD75/USD65 per bbl earlier.

* TP of INR288: This revision leads to a 9%/18% rise in ONGC’s FY27/ FY28 Consol PAT. We model ~2.6% volume growth overall (Oil: 1.6%, Gas: 3.7%) and value the standalone business at 6.5x Dec’27 EPS, investments at a 25% discount to CMP, and OVL stake at 0.5x FY25 BVPS to arrive at our TP of INR288

After a 10-year hiatus, upstream back in favor for capital allocation

* Globally, capital allocation is shifting toward upstream oil & gas after a decade of underinvestment amid declining oil & gas production and elevated crude prices over several years. Further, notwithstanding the recent weakness in Brent prices, the recent West Asia crisis has brought to the fore the need for countries to

1) Refill depleted inventories

2) Expand strategic crude reserves.

* Domestically, for both ONGC and Oil India, there has been an increased focus on

1) Finding new reserves 

2) Monetizing existing discoveries on a fasttrack basis (e.g., the Daman Upside Development Project (DUDP) for ONGC). Exploration and development efforts in overseas assets have also received a renewed lease on life and can unlock value due to elevated crude prices.

Energy security could be a decade-long theme with multiple facets:

* We believe that energy security as a theme will remain a key focus for many years due to the following reasons:

1) India’s crude oil imports at ~90% of total demand are unsustainably high (vs. Gas: ~50%; LPG: 60% fare only slightly better)

2) India has under-invested in the upstream sector over the past decade, but the government now aims for domestic companies to take the lead with new initiatives such as Samudra Manthan.

* The focus on energy security is also evident from:

1) The recently announced coal gasification policy (link), which aims to gradually reduce dependence on imported natural gas.

2) Reports that a similar policy for compressed bio-gas (CBG) may be in development.

3) The govt’s plans to expand strategic crude and petroleum reserve capacity, with ONGC tasked to invest INR150b.

Modeling 2.6% volume growth; ~6% dividend yield

* Our rating upgrade is premised upon a combination of inexpensive valuations, a modest pick-up in volume growth, and greater operational freedom amid multiyear government focuses on energy security (e.g., following the technical services provider (TSP-1) contract for Mumbai High, ONGC and BP have signed a new contract for fields in the Western Offshore Basin).

* We are modeling only a 2.6% volume CAGR for ONGC, aided by the start of DUDP, KG-98/2, and Samudra Manthan.

* We are building in ~40% dividend payout in FY27, which implies a ~6% dividend yield at CMP. ONGC's gas price realization (unlike Oil India’s) will continue to see an uptick as ~7-8% of volumes every year qualify for higher new-well gas prices. With HPCL's capex cycle nearly over and gross marketing margins normalizing higher, we see limited investor concerns on that front

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