BackRIL: limited benefits from shale gas
RIL: limited benefits from shale gas
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Reliance Industries Ltd (RIL) has underperformed the Sensex by 30% in the past 18 months. A reason for this prolonged underperformance is the lack of positive triggers in any of its business segments.
Also See | Subdued show (Graphic)
Earlier this year, when the firm announced its entry into the shale gas business through a joint venture with Atlas Energy Inc., investors were enthused that the company’s large cash hoard is being utilized for inorganic growth.
The firm made subsequent investments in shale gas assets and its total investment in this is quite substantial. But based on where natural gas prices are currently, these investments may not add meaningfully to the company’s total profit and valuations.
On the Chicago Mercantile Exchange, natural gas futures are quoting at $4.4 (Rs199 today) per million British thermal unit (mmBtu) for the January 2011 contract. The 12-month futures are around $5 per mmBtu and even contracts as far out as November 2016 are quoting at less than $6 per mmBtu.
According to a recent report by IIFL Capital, based on the prevailing prices in the futures market, RIL’s shale assets would contribute only $308 million to its earnings before interest and tax (Ebit) in 2013. By fiscal 2012-13, the broker expects RIL’s total Ebit to cross $11 billion, based on current exchange rates.
In other words, the shale assets would add less than 3% to profits in 2013. If gas prices are at $7 per mmBtu, the contribution to Ebit from the shale assets would rise to $537 million. This works out to around 5% of total profit. Evidently, the contribution depends largely on natural gas prices.
There are good reasons for the subdued trend in natural gas prices. The main one is that supply has been high. IIFL’s report notes, “Shale gas drilling has remained high in 2010 owing to lease obligations and a surge in the number of joint ventures with drilling commitments. Besides technological advances have sharply reduced drilling costs, lowering break-even levels."
Given the large number of joint ventures firms such as Reliance have set for drilling shale acreages, supply can be expected to stay high and prices, as a result, should remain subdued.
Graphic by Yogesh Kumar/Mint
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