The wait is over. Last week, the cabinet committee on economic affairs (CCEA) gave its approval for increasing the price of gas to $8.4 per million metric British thermal unit (mmBtu). The current price is $4.2 per mmBtu for gas producers. The new guidelines will be applicable from 1 April 2014 for five years.
The increase is obviously good for the sector. For one, it will incentivize investments in the sector and lead to an increase in production, albeit with a substantial lag. The key beneficiaries of this development are Oil and Natural Gas Corp. Ltd (ONGC), Oil India Ltd (OIL) and Reliance Industries Ltd (RIL). No wonder that the stocks of these companies increased in the past two trading sessions. Stocks of ONGC and RIL went up by 7% while the OIL scrip moved up by 2%.
After this development, brokerages have rushed to increase their earnings estimates for these companies. “If we assume a gas price of $8.4/mmBtu for ONGC and OIL, it will have a positive impact of 33-34% on FY15e EPS (earnings per share) and 37-39% on NAV (net asset value). Again, if we assume a gas price of $8.4/mmBtu for RIL, it will have a positive impact of 1% each on FY15e EPS and NAV,” wrote analysts from Deutsche Bank.
But there’s also some scepticism. Analysts worry whether ONGC and OIL will be allowed to reap the full benefits from this development. As analysts from Nomura Equity Research point out, “When APM (administered price mechanism) gas prices were raised last in June 2010 (from $ 2/mmBtu to $4.2), not much benefit stayed with the upstream producers. The effective subsidy share of upstream was increased from near 1/3rd level earlier to nearly 40% in FY11 and FY12. Assuming that all of the impact of a higher subsidy is passed on to ONGC/OIL, the benefits would be rather modest at only 7–8%, in our view.”
A note from IDBI Capital says, “The key thing to watch would be (how) much the government allows ONGC and OIL to benefit from the gas price hike. In 2009 also, APM gas price hike was followed by a sharp rise in royalty, which had almost negated the positive effect of higher gas price.”
For RIL, declining production from the Krishna-Godavari D6 block may mean that any gains from the higher prices could be restricted in the earnings per share for fiscal year 2015-16. Nevertheless, analysts expect considerable improvement in RIL’s earnings when production increases eventually when the company starts investing in the development of gas discoveries at the NEC 25 blocks and the D6 satellite fields.
Meanwhile, shares of ONGC and OIL have outperformed the benchmark Sensex index since the beginning of this calendar year, thanks to the reforms in the sector such as diesel deregulation news flow and the expectation of a gas price hike. The increase in shares of ONGC and OIL suggests that investors seem to be capturing most of the positives. On the other hand, the outlook for RIL stock appears weak in the near term as the prospects for its operating businesses are not too bright. Refining margins are expected to be weaker than last year and demand for petrochemicals is expected to be soft. RIL’s oil and gas business is anyway facing problems that are well known.