Oil & Gas: Upstream pain; CGDs gain

10 Apr 2023 , 12:09 PM

From Q1FY24, government has changed the pricing formula for APM gas. The effective realisations for ONGC/OIL will fall by 24%, leading to 8-9% cut in FY24 PAT. CGDs will see input costs falling when the outlook on volume growth is strong. IGL stands out well vs MGL, given the volume-driven earnings growth + reasonable valuations (18x FY24). MGL is cheap; GAIL will also see 4% upgrade to FY24 PAT (LPG).

APM gas formula tweaked: 

The price of gas produced from nomination basis blocks (APM), will now: 1) Be pegged to 10% of the average monthly Indian crude basket prices. 2) Have a floor and cap of U$4/mmbtu and US$6.5/mmbtu respectively. 3) Price cap will be applicable for two years. 4) Increment of US$0.25/mmbtu thereafter. The gas produced from non-nomination basis blocks will have 20% premium to APM price. Pricing of gas from NELP blocks (bid out) will remain unaltered; gas produced post 2022 to be sold through transparent auction (no change). Analysts at IIFL Capital Services note that the government had set up a committee under Dr Kirit Parekh, so as to recommend changes in gas pricing.

Upstream pain; CGDs gain: 

The new pricing formula adversely affects ~95% of ONGC’s and OIL’s overall domestic gas production, resulting in a cut of 24% in their realisations. Pari-Passu, we cut FY24/25ii PAT forecasts by 8-9%, and note that these forecasts are very sensitive to underlying oil prices. US$5/bbl change in oil leads to 7-8% swing in PAT, and to that extent, we will progressively track the assumptions. The CGDs will see gas costs fall by ~18-20%, which will be passed on to consumers to improve the attractiveness of CNG vs auto fuels. Lower prices and stability thereof bode well for their businesses, in general. GAIL will also gain from reduction in APM prices for LPG business (4% upgrade).

IGL best-placed: 

Valuations of CGDs relative to their earnings growth, return ratios and cashflows are cheap. For example — IGL and MGL trade at 18x/13x FY24 EPS, at a time when the outlook on volume growth is robust, and pressure on input prices is easing. On the back of better volume growth (>10% pa), opportunity landscape (10 GAs) and management bandwidth, analysts at IIFL Capital Services prefer IGL over MGL. GGAS, which sells predominantly to industries, will also gain for ~25- 30% of its portfolio. GAIL valuations are also cheap; improvement in capital allocation can re-rate its stock materially. Upstream companies offer 8-10% yields (post EPS cut), and can be defensive allocations in volatile markets.