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Meaningful recovery in oil realizations key for ONGC’s earnings growth
There may be a ray of hope for ONGC as a rise in oil prices may support its net oil realization and, in turn, the oil producing company’s earnings. Volatility in crude prices during 2020, owing to pandemic-led disruptions had a significant impact on ONGC’s earnings prospects. Crude prices now are close to an 11-month high, which is improving the outlook for ONGC. However, sustaining these price levels remains crucial.
Brent crude oil future prices, which ranged $37-40/barrel at the start of the December quarter, though volatile, moved to around $52/barrel towards the end of the quarter. The start of January has seen a further tightening of supplies by oil-producing nations. Thus, crude prices remain firm and Brent crude oil futures are now trading around $56 a barrel. This has improved realisations outlook for upstream oil producing companies such as ONGC further. This has been reflected in stock prices as ONGC has gained about 60% since October lows.
ONGC is expected to report net realisations of $44 a barrel in the December 2020 quarter, an improvement from $41 a barrel in the September quarter. However, the expected net realisation is still 26% lower than that seen during the quarter ending December a year ago.
For net realisations to improve further, crude needs to sustain the higher levels. Production discipline by oil-producing nations and continued improvement in global oil demand will thereby be watched for.
An uptick in oil realisations is also necessary since the production is likely to maintain a flat trajectory. Though some promises are offered by fresh oil and gas discoveries, analysts at Motilal Oswal Financial Services model in flattish oil production for the next two years.
Meanwhile, gas sales and prices also remain under pressure for ONGC. Natural gas sales volumes are to decline 3% year-on-year (YoY) to 4.7 billion cubic meters (bcm) during the December quarter (as per Kotak Institutional Equities estimates) reflecting lower production in the recent months. The earlier expectations of rising gas production boosting earnings growth have been dashed, with delay in demand and production ramp-up due to the pandemic.
Meanwhile, gas prices are also under pressure. Domestic gas prices had been cut by 25% for the second half of FY21 looking at weak international prices. The same will only be reviewed at the end of March despite some uptick in spot gas prices being seen currently. Hence, gas segment contributions in the near-term may not provide a meaningful upside to earnings.
So, while valuations remain attractive (about 3.2x FY22 estimated EV/Ebitda) and there is some improvement in prospects for the company being led by rising crude prices, more may be needed.
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