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1 Emkay Your success is our success July 3, 212 Rating Accumulate CMP Target Price Rs284 Rs327 EPS Chg FY13E/FY14E (%) NA Target Price change (%) NA Nifty 5,2 Sensex 17,143 Price Performance (%) 1M 3M 6M 12M Absolute Rel. to Nifty Source: Bloomberg Relative price chart Rs Aug-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 % ONGC Government action Inevitable ONGC s consolidated production to fare better as its IOR/EOR initiatives and marginal fields development bear fruit. Expect 6% CAGR over FY12-15E to 73mtoe Declining crude oil price scenario augurs well for ONGC as it has a positive impact on its oil net realization. Expect ONGC s net realizations to improve to US$55.7/bbl in FY13 and US$58.5/bbl in FY14 Current government finances point towards fuel price hikes as the only solution. Declining oil prices to further aid policy reforms to tackle the subsidy issue Given its improving production profile, lower oil prices and possibility of price hikes, we recommend Accumulate rating for ONGC with a PT of Rs327 Consolidated production to improve at 6% CAGR over FY12-15E ONGC is expected to have a consolidated production growth of 6% CAGR over FY12-15E in oil and gas over to 73mtoe on the back of new field development efforts, IOR/EOR efforts on existing domestic fields and increase in oil production from Rajasthan JV field. This is in contrast to its flat production at 61mtoe during FY7-12. ONGC to realize higher oil prices from decline in crude oil Initiating Coverage Source: Bloomberg Stock Details Sector Bloomberg ONGC(LHS) Rel to Nifty (RHS) Oil & Gas ONGC IB The current decline in crude oil prices is beneficial for ONGC as its realization on crude oil goes up. We have factored net realization of US$56/58.5bbl in FY13/14 as against US$54.7/bbl for FY12. At 4% share of upstream share in subsidies, ONGC s net realization on crude oil ranges between US$64/bbl-US$53/bbl for a crude oil price range of US$8/bbl-US$12/bbl Equity Capital (Rs mn) 42,777 Face Value(Rs) 5 No of shares o/s (mn) 8, Week H/L 34/ 24 Market Cap (Rs bn/usd mn) 2,428/ 43,171 Daily Avg Volume (No of sh) 2,697,589 Daily Avg Turnover (US$mn) 12.8 Shareholding Pattern (%) Jun12 Mar12 Dec11 Promoters FII/NRI Institutions Private Corp Public Government likely to take up policy measures to tackle subsidies Given the precarious financial status of the government, it has no choice but to take up policy measures to tackle subsidy issue. The recent decline in crude oil prices provides government an opportunity to bring in favorable policy measures to tackle subsidies. We expect oil prices to remain subdued ahead on the back of weak oil demand fundamentals globally. Any price hike will have a substantial impact on ONGC and provide valuation upsides. Valuations We initiate coverage on ONGC with Accumulate rating given its production growth ahead and likely government action on the fuel subsidy front. Our target price for ONGC works out to Rs327/share, with the standalone business contributing Rs224/share at 4xEV/EBIDTA and OVL, Rs68/share at 5xEV/EBIDTA on FY14 estimates. The balance contribution comes from MRPL (Rs9/share) and cash and investments of Rs26/share. ONGC also offers an attractive dividend yield of ~3.5%. Source: Bloomberg Jagdish Meghnani jagdish.meghnani@emkayglobal.com Dhaval Joshi dhaval.joshi@emkayglobal.com Rohit Gupta rohit.gupta@emkayglobal.com Financial Snapshot (Standalone) (Rsmn) YE- Net EBITDA EPS EPS RoE EV/ Mar Sales (Core) (%) APAT (Rs) % chg (%) P/E EBITDA P/BV FY11A 1,176, , , FY12A 1,463,76 577, , FY13E 1,581,27 575, , FY14E 1,633,93 623, , Emkay Global Financial Services Ltd. 1

2 Investment Rationale ONGC to witness 6% CAGR in own domestic production over FY12-15E IOR/EOR efforts and new field development to bear fruit and drive production growth ahead Unlike its dismal performance over (1.9% CAGR decline in domestic oil production and.8% CAGR in gas production), we expect ONGC s domestic oil & gas production to grow from here on. Our confidence on the same stems from ONGC s efforts in IOR/EOR/Redevelopment projects and development of new fields. We estimate ONGC s own production to grow at a CAGR of 6% over E to 56mnboe. While oil production is expected to witness a growth of 7% over E reaching a production level of 29MMT by 215, gas is estimated to witness growth of 5% over the same period to 27BCM. We also estimate growth in NGL production, aiding production of value added products (VAP). Exhibit 1: ONGC s own domestic oil production FY7 FY8 FY9 FY1 FY11 FY12 FY13E FY14E FY15E Oil mntons Exhibit 2: ONGC s own domestic gas production FY7 FY8 FY9 FY1 FY11 FY12 FY13E FY14E FY15E Gas BCM aided by IOR/EOR initiatives ONGC is currently undertaking 6 IOR/EOR projects at a total cost of Rs21bn and expects to recover 89mtoe of oil & gas. ONGC has initiated development/redevelopment of various fields to arrest their natural decline in the coming years. 14 major fields, which contribute about 7% of total oil and gas production for ONGC, have an average age of 3 years. If not for the various development/redevelopment initiatives undertaken by ONGC, these fields would have witnessed a decline of 7-8% per year. Past efforts by ONGC have resulted in the recovery factor increasing from 28% in 2 to 33.5% in 211. It has completed 15 of the 21 IOR/EOR projects and six are under implementation. For FY11, it made an incremental gain of 8.5MMT, with cumulative gains of around 66MMT. Upto FY11, ONGC has invested Rs258bn. The six on-going projects entail an investment of Rs217bn. Total estimated recovery from the 6 IOR/EOR projects is estimated to be about 67MMT of oil and 12.3BCM of natural gas. The projects are expected to be completed by Emkay Research July 3, 212 2

3 Exhibit 3: IOR / Redevelopment projects Project Project cost (Rs bn) Heera & South Heera Redevelopment 23.1 MHS Redevelopment Phase-II 88.1 MHN Redevelopment Phase-II 71.3 IOR Lakwa-Lakhmani 6.6 IOR Geleki 16.7 IOR Rudrasagar 4.4 Total 21.3 Source: Company ONGC is currently implementing development of 1 new fields at a total cost of Rs455n and expects to recover 96mtoe of oil & gas. and development of marginal fields/clusters Besides IOR/EOR initiatives, the company is also monetizing its marginal fields (marginal fields have low oil and gas reserves that are economically viable when produced with low capital costs and overheads). ONGC has undertaken development of 1 new fields at a total investment of Rs25bn. The projects are estimated to be completed by 213. Total estimated recovery from the development of new fields is about 41MMT of oil and 55BCM of natural gas. Exhibit 4: New Field Development Project Project cost (Rs bn) Development of C-series Fields Phase I Development of B-22 cluster fields Development of B-46 cluster fields Development of B-193 cluster fields Additional Development of D-1 field North Tapti Gas field Development 7.55 G-1 & G-15 Development Development of Cluster - 7 fields Development of WO - 16 Cluster Development of BHE & BH - 35 Area 3.72 Total Source: Company Exhibit 5: Total Production from IOR/EOR and marginal field development Total Production is expected to touch peak production in 2 nd year itself and remain so for about 3-4 years New & marginal fields IOR/Redevelopment Oil Mn tons Gas BCM Consistently improving its Reserve Replacement Ratio (RRR) ONGC has consistently improved its reserve replacement ratio (RRR) in the last eight years. For FY11, it achieved an ultimate reserve accretion of 83.6Mtoe (RRR of 1.76x) in domestic fields, highest in the last two decades. This was achieved with the help of 24 discoveries - 15 new prospects and 9 new pools. Emkay Research July 3, 212 3

4 Exhibit 6: Reserve Replacement Ratio ONGC has been able to improve its reserve replacement ratio to well above one in last couple of years (x) FY1 FY12 FY13 FY4 FY5 FY6 FY7 FY8 FY9 FY1 FY11 RRR Ultimate Reserve Accretion (MTOE) MTOE Increase in JV production aided by Increase in Rajasthan production to help increase domestic production ONGC s JV production to witness 8.5% CAGR over FY12-15E ONGC s share of oil and gas production from the JV fields stood at 5.4mnboe for FY12. We estimate this to increase to 6.9mnboe at a CAGR of 8.5%, aided by increase in oil production from Rajasthan field, in which ONGC has 3% stake. We estimate Rajasthan production at 2/215/235 kbpd for FY13/14/15. As against this, ONGC s JV gas production is expected to witness a decline to 2.1BCM in FY15 from 2.2BCM in FY12. This is on account of a decline expected in PMT and Ravva fields, where ONGC has a share of 4% each. Exhibit 7: ONGC JV oil production FY7 FY8 FY9 FY1 FY11 FY12 FY13E FY14E FY15E Oil mntons Source: Emkay Research, Company Exhibit 8: ONGC JV gas production FY7 FY8 FY9 FY1 FY11 FY12 FY13E FY14E FY15E Gas BCM Source: Emkay Research, Company ONGC s total domestic production to touch 63mtoe in 215 With growth expected in ONGC s own production (led by IOR/EOR efforts and development of new and marginal fields) and also from JV production, its overall domestic production is expected to touch 63mtoe by 215, implying a CAGR of 6.5% over FY12-15E. This is as against flat production during the period FY7-12, which remained at 52mtoe. Emkay Research July 3, 212 4

5 Exhibit 9: Total domestic production of ONGC Total domestic production to increase at a CAGR of 6.5% to 63.2mtoe over E FY7 FY8 FY9 FY1 FY11 FY12 FY13E FY14E FY15E Oil mntons Gas BCM Source: Emkay Research, Company OVL near term production to take hit from projects in Syria and Sudan. However, expect production to normalize for FY14 OVL Near term production to take a hit OVL s near term oil and gas production is likely to get hit on account of uncertainties surrounding projects in Syria and Sudan, which account for 23 per cent of OVL s production abroad. Company estimates OVL production to remain flat at 6.2mntons and 2.5BCM for oil and natural gas for FY13. We believe OVL s oil production could take a larger hit as about 2mntons of production comes from Sudan and Syria together. We estimate FY13 oil production at 5.5mntons and gas production at 2.4BCM. For FY14, we estimate OVL production at 6.8mnton of oil and 2.7BCM of natural gas, with growth coming in from commencement of production from Myanmar and Carabobo, Venezuela. Over FY12-15E, OVL production is expected to increase at a CAGR of 3.5% to 9.7mtoe. Exhibit 1: Impairment provision on Imperial Energy What to expect ahead? Impairment provision on Imperial Energy What to expect ahead? In March 12 quarter, OVL made impairment provision on Imperial block owning to their decision to defer any production ramp up till clarity at some fiscal benefits from Russian government emerged. As of now, about 6% of revenues go to the Russian government in the form of taxes and levies. OVL has conducted an impairment test based on the certified reserves on account of delayed production. Based on that, the value came to US$1.6bn, so a provision of about US$4mn has been provided. Going ahead, it will review it on a regular basis and depending upon the developments in the asset, make necessary adjustments to the provision. The write/off has been on a conservative basis and the company does not expect further write offs. For details on status of OVL s exploration projects, refer Annexure A Exhibit 11: OVL s oil production As against company estimates of 6.2mnton, we factor in 5.5mnton of oil production for OVL in FY FY7 FY8 FY9 FY1 FY11 FY12 FY13E FY14E FY15E Emkay Research July 3, 212 5

6 Exhibit 12: OVL s gas production FY7 FY8 FY9 FY1 FY11 FY12 FY13E FY14E FY15E Syria and Sudan account for 32% of OVL s oil production Exhibit 13: OVL block-wise production Oil Gas Oil Gas Oil Gas Oil Gas Oil Gas Oil Gas Block 6.1 Vietnam GNOP Sudan Block 5A Sudan Sakhalin-1 Russia AFPC Syria MECL Columbia Sancristobal Venezuela Imperial Energy Russia BC-1 Brazil Block 24 Syria Total Note: Oil in Mn tons, Gas in BCm OVL has been expanding its geographical reach and has 33 projects across 15 countries. While 9 of these are producing properties, 5 are discovered projects and 18 are in exploration stage. Across various producing properties of OVL, its share of production is about 6.2mntons of oil and 2.5BCM of gas. Of this, Sudan and Shakhalin account for about 23% and 28% of oil production and Vietnam and Shakhalin account for 72% and 24% of gas production. In these properties, OVL s share of oil reserves stands at 257-mntons and gas reserves at 145BCM. Of this, the Imperial block and Shakhalin block in Russia account for 38% and 18% of oil reserves and Shakhalin block accounts for 65% of gas reserves. Exhibit 14: OVL s producing properties OVL' share of 2Preserve Property Country OVL Share % Crude Oil (MMT) Gas (BCM) Block 6.1 Vietnam GNOP Sudan Block 5A Sudan Sakhalin-1 Russia AFPC Syria MECL Columbia Sancristobal Venezuela Imperial Energy Russia BC-1 Brazil Block 24 Syria Block A1 & A3 * Myanmar Carabobo 1 * Venezuela Total * Expected to start production in 213 Emkay Research July 3, 212 6

7 Myanmar and Carabobo discovered projects to start production from May 213 Of the 5 discovered projects of OVL, 2 projects in Myanmar Block A1 and A3 are likely to start gas production from mid-213. The FDP for these projects were approved in March 21. OVL holds 17% stake in these projects with its 2P share in natural gas reserves at 21.8BCM. Also, Carabobo-1, Venezuela in which OVL acquired a stake of 11 per cent in is expected to start production from March 212 quarter. OVL s share in 2P oil reserves stands at 53MMT. ONGC consolidated production to witness growth of 6% CAGR Aided by total domestic production growth of 6.5% and OVL production growth of 3.5%, ONGC s consolidated production is expected to touch 73mtoe in FY15. This is against almost a flat production profile over FY7-12 at 61mtoe. Exhibit 15: ONGC s consolidated oil and gas production ONGC consolidated oil & gas production to grow at 6% CAGR to 73mtoe over E Oil Gas Total Oil Gas Total Oil Gas Total Oil Gas Total Oil Gas Total FY11 FY12 FY13 FY14 FY15 ONGC OVL Note: Oil production in mntons, Gas production in BCM Decline in crude oil leads to better net realization for ONGC s crude oil ONGC s net realization on crude oil is inversely related to international crude oil prices. Decline in oil price benefits ONGC as its net realization on crude oil increases on account of decline in subsidy burden We expect crude oil prices to remain subdued on the back of weak global oil demand. IEA has cut global oil demand for CY12 five times since September 211. OPEC, in its latest report, estimates world oil demand to slow down in CY13 driven by Eurozone crisis, declining US economy and deceleration of growth in emerging markets. Also, any strengthening of rupee v/s dollar would provide a huge respite on the underrecovery front. We believe, going ahead, lower crude oil prices will aid the government in dealing with the oil subsidy issue. Net realization on crude oil for ONGC declines as international crude oil prices increase as incremental subsidy burden takes away any benefit of increase in gross realisation Exhibit 16: Sensitivity of crude oil prices and upstream share on net realisation Share of upstream (%) Crude oil (US$/bbl) Emkay Research July 3, 212 7

8 Exhibit 17: Changing IEA oil demand estimate IEA has frequently cut global oil demand estimates in the past one year July Aug Sep Oct Nov Dec Jan Feb Mar Apr May 211A 212E Source: IEA, Emkay Research Exhibit 18: Brent Crude, Indian Basket & Rs/$ $/bbl Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 May-12 Jun-12 Brent Indian Basket (LHS) Rs/$ (RHS) Government has no choice but to take up policy measures to tackle subsidies Policy measures only option to tackle subsidy issue as govt finance cannot sustain a higher subsidy burden The recent decline in crude oil prices provides government an opportunity to bring in favorable policy measures to tackle subsidies. We expect oil prices to remain subdued ahead on the back of weak oil demand fundamentals globally. Given the precarious financial status of the government, it has no choice but to take up policy measures to tackle subsidy issue. Emkay Research July 3, 212 8

9 As budgeted support can only be limited Exhibit 19: Budget Aggregates Rs bn Growth (%) =4/1 7=5/4 FY11A FY12BE FY12 (YTD Jan 12) FY12RE FY13BE FY12RE FY13BE 1 Revenue Receipts 7,885 7,899 5,491 7,67 9, Tax Revenue Net to centre) 5,699 6,645 4,586 6,423 7, Non-tax Revenue 2,186 1, ,247 1, Capital Receipts (5+6+7)$ 489 4,678 4, Recoveries of Loans Other Receipts (disinvestments) Borrowings and other Liabilities 3,736 4,128 4,349 5,22 5, Net market borrowings 3,254 3,58 4,74 4,364 4, Total Receipts (1+4)$ 11,974 12,577 1,2 13,187 14, Non-plan Expenditure 8,183 8,162 7,81 8,921 9, Non Plan Revenue 7,265 7,336 6,35 8,157 8, Interest Payments 2,34 2,68 2,5 2,756 3, Non-Plan Capital , Plan Expenditure 3,79 4,415 2,94 4,266 5, Plan Revenue 3,142 3,636 2,485 3,462 4, Plan capital , Total Expenditure 11,973 12,577 1,2 13,187 14, Revenue Expenditure (1+14) 1,47 1,972 8,835 11,619 12, % of total spending Capital Expenditure (12+15) 1,566 1,66 1,185 1,568 2, % of total spending Revenue Deficit (17-1) 2,523 3,73 3,344 3,95 3, % of GDP mp Fiscal Deficit {16-(1+5+6)} 3,736 4,128 4,349 5,22 5, % of GDP mp Primary Deficit (2-11) 1,396 1,448 2,299 2,464 1, % of GDP mp Source: Emkay Research As can be seen above, government finances cannot sustain a higher burden on subsidies with fiscal deficit touching 5.9% in FY12RE. Overall fiscal deficit for FY13E is expected at 5.1% with total subsidies on food, fertilizers and fuels pegged at Rs1,85bn, of which, oil fuel subsidies stand at Rs436bn. However, we believe that of this, about Rs4bn is spill over of FY12. This means government has not budgeted enough for oil subsidy in FY13, which would again have a spill over effect going ahead. Hence, in a scenario of no increase in fuel prices, government finances are likely to worsen from those budgeted as we stare at similar amount of about Rs1,4bn as under recoveries for FY13. Exhibit 2: Under recovery (Rs Bn) Post the decline in crude oil prices, under recoveries are expected to decline to about Rs1,4bn for FY13 1,6 1,4 1,2 1, MS HSD LPG SKO Source: Emkay Research, Bloomberg Emkay Research July 3, 212 9

10 Exhibit 21: Chronology of developments in fuel pricing policy US$/bbl Petroleum prices based on recommendations of Oil Price Committee, 1976 Indian economy opened MoPNG appoints 'R' Group to give recommendations to restructure oil industry Government decided to dismantle APM in phased manner based on R Group reccommendations Implementation of fuel pricing policy emerging as the need of the hour Fuel pricing policy in India has always faltered on implementation, although number of committees have been formed in the post-apm era. Till 22, India had Administered Pricing Mechanism (APM) in place, which ensured certain level of returns for PSU oil marketing companies. Prices of HSD, LPG and SKO were subsidized by levying higher taxes on MS. Although, APM was dismantled in April 22 and prices of MS, HSD, LPG and SKO were freed, high level of tax incidence on MS, which was meant to subsidize other fuels still continued. Administrated Pricing Mechenism dismantled in phased manner * Crude producers to get 75% of FOB price, in place of cost plus formula * Refiners to get import parity price in place of retention price * Marketing of naphtha/fo/lshs freed * Crude producers to get 77.5% of FOB price 2-1 * Crude producers to get 77.5% of FOB Period of high crdue oil prices during which free pricing mechanism broke down Full deregulation from 22 B K Chatturvedi Committee Report Kirit Parikh Committee Report * Crude producers to get 82.5% Dr C.Rangarajan committee The subsidy burden should be borne entirely and transparently in the Union Budget. The oil marketing companies should be freed from the burden of subsidy Jan-91 Jan-92 Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan- Jan-1 Jan-2 Jan-3 Jan-4 Jan-5 Jan-6 Jan-7 Jan-8 Jan-9 Jan-1 Source: Emkay Research Passing on higher energy prices to consumers the only way ahead as government ability to provide budgetary support is only limited While pricing of MS has been freed on paper, the implementation of that lacks political will. Freeing HSD prices will always remain a sensitive issue from macro economic point of view given the cost ramifications it has across the chain. The last increase in HSD/LPG/SKO price was in July11. However, in light of the rising fiscal deficit, we believe that government will have no choice but to work on implementing the fuel pricing policy and raise oil prices. Exhibit 22: Changes in petrol prices Petrol price were not revised since Dec 11 to May 12 despite Brent moving from US$18/bbl to US$126/bbl Apr-6 Aug-6 Dec-6 Apr-7 Aug-7 Dec-7 Apr-8 Aug-8 Dec-8 Apr-9 Aug-9 Dec-9 MS retail price Rs/litre Apr-1 Aug-1 Dec-1 Apr-11 Aug-11 Dec-11 Emkay Research July 3, 212 1

11 Exhibit 23: Changes in diesel prices Diesel prices last revised in Jul 211 when Brent was at US$116/bbl Apr-6 Aug-6 Dec-6 Apr-7 Aug-7 Dec-7 Apr-8 Aug-8 Dec-8 Apr-9 Aug-9 Dec-9 Apr-1 Aug-1 Dec-1 Apr-11 Aug-11 Dec-11 HSD Rs/litre Exhibit 24: Changes in domestic LPG prices Domestic LPG prices last revised in July 211 when Brent was at US$116/bbl Jan-8 Apr-8 Jul-8 Oct-8 Jan-9 Apr-9 Jul-9 Oct-9 Jan-1 Apr-1 Jul-1 Oct-1 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 LPG Rs/cylinder Exhibit 25: Changes in SKO prices SKO prices last revised in July 211 when Brent was at US$116/bbl Apr-6 Aug-6 Dec-6 Apr-7 Aug-7 Dec-7 Apr-8 Aug-8 Dec-8 Apr-9 Aug-9 Dec-9 Apr-1 Aug-1 Dec-1 Apr-11 Aug-11 Dec-11 SKO Rs/litre Recent government initiatives point toward conducive oil policy reforms Over the last few years, the government has set up various committees (like Rangarajan Committee, Chaturvedi Committee and Kirit Parikh) to find out a permanent solution for sustainable petroleum pricing. It has also taken bold steps in deregulating petrol price and hiking prices in other products (in last two years). The recent report by Nandan Nilekani, Chairman of the Unique Identification Authority of India,? Interim Report of the Task Force on Direct Transfer of Subsidies on Kerosene, LPG and Fertiliser, recommends the following: Kerosene: Direct transfer of subsidy The kerosene subsidy system, which resulted in large-scale pilferage and black marketeering, is likely to be among the first to be moved to the UID platform, which would help minimize leakages from the system and reduce under-recoveries. Under the UID scheme ("Aadhaar card"), the government aims to adopt a direct target subsidy mechanism for the poor. Emkay Research July 3,

12 LPG: Cap on consumption of subsidized cylinders and direct transfer of subsidy to customers. This is a near term option, which can be easily implemented including limiting the number of cylinders per household. Cap on LPG cylinder to lower under-recoveries significantly Domestic LPG is both heavily subsidized and available in unlimited quantity. The burden of subsidy can be reduced by either raising the price or reducing the quantity or both. Based on the above mentioned recommendations (cap on LPG cyl), we have calculated the under recovery by capping the cylinder per family. Here, we have observed that with a cap of 4/5/6 LPG cylinders per family, under-recoveries can easily reduce by Rs.155/19/64mn. As per our discussion with the OMC managements, the entire setup and infrastructure related to the cap on LPG cylinder is ready for implementation. They are just waiting for the green signal from the GOI. Exhibit 26: LPG Study Unit FY13E Total LPG Consumption Mn Cyl No of LPG consuming household Mn Average consumption of cyl/family No of cyl Under recovery on LPG Rs/cyl Cap of cyl per family No Total Under recovery by cap cyl per family Rs.mn Current under recovery on LPG Rs.mn Saving the total under recovery Rs.mn Source: Emkay Research Steps towards adoption of recommendations encouraging The GoI is actively considering the recommendations mentioned above and has also started pilot projects to assess nationwide feasibility. Some of the initial steps taken up by the OMCs and Government are: Pilot projects for direct subsidy transfer into the beneficiary's bank account are conducted. For LPG at Mysore, for Kerosene at Alwar district in Rajasthan. The Aadhaar platform has also been successfully used to validate PDS ration cards in Jharkhand. Declining oil prices gives government an opportunity to bite the bullet Various government authorities have time and again given indications of a firm step being contemplated by government to address the fuel subsidy issue. The recent decline in crude oil prices provides government an opportunity to get its act together in taking steps to tackle subsidies. We expect crude oil prices to remain subdued on the back of weak global oil demand. IEA has cut global oil demand for CY12 five times since September 211. OPEC, in its latest report, estimates world oil demand to slow down in CY13 driven by Eurozone crisis, declining US economy and deceleration of growth in emerging markets. Emkay Research July 3,

13 Exhibit 27: Changing IEA oil demand estimate IEA has frequently cut global oil demand estimates in the past one year July Aug Sep Oct Nov Dec Jan Feb Mar Apr May 211A 212E Source: IEA, Emkay Research Although part of the decline in crude oil prices has been offset by a weakening rupee v/s dollar, overall under-recoveries for FY13 are estimated to have declined to about Rs1,4bn from earlier estimate of close to Rs2bn. Exhibit 28: Brent Crude, Indian Basket & Rs/$ $/bbl Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 May-12 Jun-12 Brent Indian Basket (LHS) Rs/$ (RHS) Emkay Research July 3,

14 What can be done beyond price hike? Taxes still form a big part of retail prices Exhibit 29: Petrol price break up (Mumbai) Apart from reducing excise duty, central government should call upon state governments to reduce taxes Local takes 1% State taxes 2% Central taxes 19% Exhibit 3: Diesel price break up (Mumbai) Local takes 1% State taxes 2% Central taxes 5% In India, taxes still form a major part of retail fuel prices. These are higher than the world average. Taxes form 4 per cent and 26 per cent of retail selling prices for MS and HSD. We note that state taxes also form a substantial part of final retail selling price. Governments could reduce the proportion of taxes by reducing the state level taxes and excise duty on MS. Emkay Research July 3,

15 State governments should rationalize tax rates Government of Goa recently slashed its sales tax rate and passed on the reduction to the consumers. Central government should call for a consensus building for states to go for duty rationalization. State level taxes are as high as 33% on petrol in AP and 25% on diesel on states like Gujarat and Chattisgarh Exhibit 31: Sales tax rates in % across various states State City Petrol Diesel AP Hyderabad Karnataka Bangalore MP Bhopal Punjab Jalandhar Rajasthan Jaipur Maharashtra Mumbai Assam Guwahati Tamil Nadu Chennai West Bengal Kolkata Maharashtra Pune UP Lucknow Kerala Trivandrum Gujrat Ahmedabad J&K Jammu Chattisgarh Raipur Uttaranchal Dehradun HP Shimla Bihar Patna Haryana Ambala Nagaland Kohima Sikkim Gangtok Meghalaya Shillong Delhi Delhi Dadra & Nagar Haveli Silvasa Daman & Diu Daman Chandigarh Chandigarh Jharkhand Ranchi Mizoram Aizwal Arunachal Pradesh Odisha Bhubaneshwar Manipur Puducherry Puducherry Tripura Goa Panjim Source: Industry Envisage a roadmap for subsidy sharing mechanism With an inevitable price hike and the government's outlook on oil policy reforms, we do not rule out the possibility of a proper subsidy sharing mechanism ahead. We believe that any price hike will reduce the subsidy burden of the government and when the under recoveries are at a manageable level, the Government may also consider a concrete subsidy sharing mechanism. While the same will take time, any roadmap for subsidy sharing will be a big boost to companies like ONGC, who have been victims of the government's ad-hoc subsidy sharing mechanism. Emkay Research July 3,

16 Share of upstream companies has varied from 29.5% in FY4 to 4% in FY12 Exhibit 32: Allocation of under recoveries Total under Upstream -recoveries oil companies Downstream oil companies Central Government Year (INR/Bn) Total % Total % Total % * 1, , Total 5,629 2, , Exhibit 33: Allocation of under-recoveries among upstream companies ONGC GAIL OIL Total Year Rs Bn % Rs Bn % Rs Bn % Rs Bn N.A N.A Total 1, ,2 Variation in ONGC s net realization on crude oil widens at higher share of upstream in subsidy burden Exhibit 34: Sensitivity of upstream share in subsidy burden on ONGC s net realisation Share of upstream (%) Crude oil (US$/bbl) Exhibit 35: Sensitivity of ONGC FY13 EPS to Net Crude Oil Realisation Net realisation ($/bbl) EPS Sensitivity of exchange rate is Rs63bn for every Re1/$ and Rs31bn for every US$1/bbl change in oil prices Exhibit 36: Sensitivity of under recoveries to oil prices and $ (Rs bn) Rs/$ Crude oil ($/bbl) , ,6 1,187 1, ,233 1,373 1,512 1, ,533 1,685 1,837 2,65 Source: Emkay Research, Bloomberg Emkay Research July 3,

17 Expect ONGC/Oil India to get higher price post discount to compensate for higher cess of Rs45/ton Expect compensation for increase in cess on crude oil The government had increased cess on oil production from nominated fields from Rs2,575/ton to Rs4,635/ton earlier this year. This has increased ONGC s cess outflow by about US$5.5/bbl and reduced realization on crude oil to that extent. However, we expect government to compensate ONGC for the same by way of increasing its net realization on crude oil. Exhibit 37: ONGC s net realization pre and post cess increase 15 ONGC s net price realized after all expenses at mere US$11.6/bbl post the increase in cess to Rs45/ton $/bbl Pre- Cess Pre discount Price Post discount price Royalty Other (Sales Tax & Octroi) Net price realized Post cess Discount to OMCs Direct Cost of production (Operating cost) Cess & NCCD Overhead & Depreciation/Depletion Emkay Research July 3,

18 Financial performance Standalone earnings to grow at a CAGR of 2.8% over FY12-14 On standalone basis, we expect ONGC s earnings to increase by 2.8% CAGR over FY12-14E on the back of increase in oil and gas production. We expect ONGC to witness production growth coming from the IOR efforts and development of new fields. Expect 6% CAGR in production over FY12-15E to 56mnboe in FY15. Over the same period, JV production is expected to grow by 8.5% aided by increase in Rajasthan crude oil production. Exhibit 38: ONGC Standalone FY1 FY11 FY12 FY13E FY14E Revenues Statutory levies Other Expenditure EBIDTA DDA Interest cost Other Income PBT Tax Reported PAT Adj PAT Adj EPS , Bloomberg Exhibit 39: Standalone Assumptions Crude oil production FY1 FY11 FY12 FY13E FY14E Own (mntons) JV (mntons) Gas production Own (BCM) JV (BCM) Net Crude Realisation ($/bbl) Natural gas realisation ($/mmbtu) OVL earnings to take hit in FY13 on lower production from Sudan, Syria Expect OVL earnings to take a hit in FY13 on account of production being impacted at Sudan and Syria. In Sudan, the production stopped totally in Apr 12 after the processing facilities were damaged. Efforts are being made to connect the wells and start production. In Syria, although the production continues, there has been a delay in the information flow. Hence, the full year results would take into account Syria production only till Dec 11. As of now oil production rate is 6,bpd. For FY12, OVL profits took a hit on account of provision for impairment loss of US$4mn provided on Imperial Energy block in Russia. The provision was made on the basis of delayed production profile. Going ahead, it will review it on a regular basis and depending upon the developments in the asset, make further adjustment in the provision. The provision write/off has been on conservative basis and the company does not expect further write offs. Emkay Research July 3,

19 Exhibit 4: OVL FY1 FY11 FY12E FY13E FY14E Revenues Other Expenditure EBIDTA DDA Interest cost Other Income PBT Tax Reported PAT Adj PAT , Bloomberg Exhibit 41: OVL assumptions Production FY1 FY11 FY12E FY13E FY14E Crude oil (mntons) Natural gas (BCM) Crude realisation (US$/bbl) Natural gas realisation ($/mmbtu) MRPL earnings to grow on higher thruput Post the completion of the Phase III refinery expansion-cum-upgradation project, MRPL s refining capacity has increased to 15mtpa in Mar 12 from 11.82mntons earlier. Exhibit 42: MRPL earnings FY1 FY11 FY12E FY13E FY14E Revenues Other Expenditure EBIDTA DDA Interest cost Other Income PBT Tax Reported PAT Adj PAT , Bloomberg Exhibit 43: MRPL assumptions Assumptions FY1 FY11 FY12E FY13E FY14E Thruput (mntons) GRMs (US$/bbl) Emkay Research July 3,

20 ONGC consolidated profits to grow at CAGR 5.8% FY12-14 Exhibit 44: ONGC consolidated earnings Rs bn FY1 FY11 FY12E FY13E FY14E Revenues Other Expenditure EBIDTA DDA Interest cost Other Income PBT Tax Reported PAT Adj PAT EPS (Rs/share) Key Risks Delays in production from IOR/EOR/Redevelopment projects and new/marginal field development. Uncertainty in subsidy sharing mechanism Crude oil volatility & exchange rate fluctuations Valuations We value ONGC at Rs327/share on SOTP basis In a declining oil price scenario ONGC is well placed to benefit from any favorable policy measures by government to tackle subsidy issue. It also provides government higher maneuverability for fuel price changes and sharing subsidy burden. Given the precarious government financials, we believe concrete steps by government are in the offing. Initiating with an Accumulate rating our target price for ONGC is at Rs327/share with standalone business contributing Rs224/share at 4xEV/EBIDTA on FY14 numbers. We value OVL at Rs68/share at 5xEV/EBIDTA on FY14 estimates. The balance contribution comes from MRPL (Rs9/share) and cash and investments of Rs26/share. ONGC also offers attractive dividend yield of ~3.5%. Exhibit 45: ONGC fair value - SOTP EBIDTA EV/EBIDTA Value Value (Rs bn) (Rs bn) per share ONGC Standalone , OVL MRPL Sub-total 31 Net cash (FY13) Total 2, In the last three years, ONGC s EV/BOE has moved within a band of 3.7x 8.7x with an average of 6.6x on 1P reserves. The stock trades at EV/BOE of 6.3x at CMP and is at 7.5x on the target price. At our target price, the average EV/EBIDTA works out to 4.1x FY14 as against last 5 years average of 5.5x and a band of On P/B, the target price is at 1.7x FY14 as against last 5 years average of 2.1x and a band of 1.5 3x. Emkay Research July 3, 212 2

21 Exhibit 46: Historical P/E Exhibit 47: 1 year forward P/E Apr-3 Jan-4 Oct-4 Jul-5 Apr-6 Jan-7 Oct-7 Jul-8 Apr-9 Jan-1 Oct-1 Jul-11 Apr-3 Jan-4 Oct-4 Jul-5 Apr-6 Jan-7 Oct-7 Jul-8 Apr-9 Jan-1 Oct-1 Jul-11 Exhibit 48: P/E Band x 1x 8x 6x 1 Apr-3 Jan-4 Oct-4 Jul-5 Apr-6 Jan-7 Oct-7 Jul-8 Apr-9 Jan-1 Oct-1 Jul-11 Exhibit 49: Historic P/B 4 Exhibit 5: 1year forward P/B Apr-3 Jan-4 Oct-4 Jul-5 Apr-6 Jan-7 Oct-7 Jul-8 Apr-9 Jan-1 Oct-1 Jul-11 Apr-3 Jan-4 Oct-4 Jul-5 Apr-6 Jan-7 Oct-7 Jul-8 Apr-9 Jan-1 Oct-1 Jul-11 Exhibit 51: P/B band x 2.5x 2x 1.5x 1 Apr-3 Jan-4 Oct-4 Jul-5 Apr-6 Jan-7 Oct-7 Jul-8 Apr-9 Jan-1 Oct-1 Jul-11 Emkay Research July 3,

22 Exhibit 52: Historic EV/EBITDA 12 Exhibit 53: 1 year forward EV/EBITDA Apr-3 Jan-4 Oct-4 Jul-5 Apr-6 Jan-7 Oct-7 Jul-8 Apr-9 Jan-1 Oct-1 Jul-11 Apr-3 Jan-4 Oct-4 Jul-5 Apr-6 Jan-7 Oct-7 Jul-8 Apr-9 Jan-1 Oct-1 Jul-11 Exhibit 54: EV/EBITDA band x 5x 4x 3x 1 Apr-3 Jan-4 Oct-4 Jul-5 Apr-6 Jan-7 Oct-7 Jul-8 Apr-9 Jan-1 Oct-1 Jul-11 Exhibit 55: Peer EV/BOE (On 1P Reserves) ONGC OIL Exxon Petrobras Royal Dutch Chevron Concophilips ENI SPA HESS CORP. Exhibit 56: Peer EV/EBITDA ONGC OIL Exxon Petrobras Royal Dutch Chevron Conocophilips ENI SPA HESS CORP. Petrochina CNOOC Sinopec Emkay Research July 3,

23 Exhibit 57: Peer P/E ONGC OIL Exxon Petrobras Royal Dutch Chevron Conocophilips ENI SPA HESS CORP. Petrochina CNOOC Sinopec Exhibit 58: Peer P/B ONGC OIL Exxon Petrobras Royal Dutch Chevron Conocophilips ENI SPA HESS CORP. Petrochina CNOOC Sinopec Emkay Research July 3,

24 Key Financials (Standalone) Income Statement Y/E Mar (Rsmn) FY11A FY12A FY13E FY14E Net Sales 1,176,151 1,463,76 1,581,27 1,633,93 Growth (%) Expenditure 691, ,4 1,5,924 1,1,229 Raw Materials 312, ,23 537,721 58,134 Employee Cost 17,155 16,958 18,653 2,519 Other Exp 54, ,55 481,577 EBITDA 484, ,72 575,12 623,673 Growth (%) EBITDA margin (%) Depreciation 112, ,116 26,464 22,68 EBIT 278,42 343, ,73 379,612 EBIT margin (%) Other Income 69,247 57,62 73,518 76,545 Interest expenses 4,486 4,349 1,319 11,119 PBT 343, ,629 41,91 445,38 Tax 114, , , ,855 Effective tax rate (%) Adjusted PAT 228,25 252, ,362 29,183 Growth (%) Net Margin (%) (Profit)/loss from JVs/Ass/MI 3,69 2,832 4,61 4,661 Adj. PAT After JVs/Ass/MI 224,559 25,52 265,31 285,522 E/O items 31,46 Reported PAT 224, , ,31 285,522 PAT after MI 224,559 25,52 265,31 285,522 Growth (%) Cash Flow Y/E Mar (Rsmn) FY11A FY12A FY13E FY14E PBT (Ex-Other income) 339, ,798 46,84 44,376 Depreciation 112, ,116 26, ,61 Interest Provided 4,374 4,349 1,319 11,119 Other Non-Cash items -69,247-57,62-73,518-76,545 Chg in working cap 68,656-14,212 5,142-3,815 Tax paid -114, , , ,855 Operating Cashflow 34, ,92 413,78 46,342 Capital expenditure -311,881-34,537-39, ,426 Free Cash Flow 28,678 2,555 14, ,916 Other income 69,247 57,62 73,518 76,545 Investments 18,32 Investing Cashflow -224,61-282, ,65-258,882 Equity Capital Raised 3,346 Loans Taken / (Repaid) 24,156-34,22-2, -3, Interest Paid -4,374-4,349-1,319-11,119 Dividend paid (incl tax) -87, ,848-19, ,521 Income from investments Others 14, ,37 4,661 Financing Cashflow -52, ,37-119, ,979 Net chg in cash 63,4-94,862 58,625 74,481 Opening cash position 223, , ,2 25,646 Closing cash position 286, ,2 25, ,127 Balance Sheet Y/E Mar (Rsmn) FY11A FY12A FY13E FY14E Equity share capital 42,778 42,778 42,778 42,778 Reserves & surplus 1,11,495 1,276,14 1,435,554 1,63,555 Net worth 1,153,272 1,318,882 1,478,331 1,646,332 Minority Interest 2,19 21,567 25,628 3,29 Secured Loans 7,6 7,6 7,6 7,6 Unsecured Loans 254,41 22,19 218,19 215,19 Loan Funds 261, , , ,196 Net deferred tax liability 111, , , ,526 Total Liabilities 1,546,234 1,679,172 1,84,682 2,1,344 Gross Block 2,28,125 2,64,894 2,774,894 2,944,894 Less: Depreciation 1,349,649 1,48,83 1,62,84 1,741,438 Net block 93,476 1,124,64 1,172,91 1,23,456 Capital work in progress 376, , , ,165 Investment 33,561 33,561 33,561 33,561 Current Assets 589, , , ,844 Inventories 85, ,37 137, ,388 Sundry debtors 97,724 12,35 129, ,293 Cash & bank balance 286, ,2 25, ,128 Loans & advances 19,96 19,96 19,96 19,96 Other current assets 9,13 9,13 9,13 9,13 Current lia & Prov 391, ,31 466, ,643 Current liabilities 34, ,43 415, ,763 Provisions 5,88 5,88 5,88 5,88 Net current assets 198,71 117,421 17,94 249,21 Misc. exp 7,961 7,961 7,961 7,961 Total Assets 1,546,234 1,679,172 1,84,682 2,1,344 Key Ratios Y/E Mar FY11A FY12A FY13E FY14E Profitability (%) EBITDA Margin Net Margin ROCE ROE RoIC Per Share Data (Rs) EPS CEPS BVPS DPS Valuations (x) PER P/CEPS P/BV EV / Sales EV / EBITDA Dividend Yield (%) Gearing Ratio (x) Net Debt/ Equity Net Debt/EBIDTA Working Cap Cycle (days) Emkay Research July 3,

25 Annexure A Exhibit 59: Status of OVL s exploration projects Sl. No. Name of the Project PI / Partners / Operator Current Status 1 Farsi Offshore OVL 4% (Operator); Commerciality for Farzard-B gas accepted by NIOC. Development plan submitted for finalisation. DSC is under negotiation. With geopolitical tensions surrounding Iran in the wake of sanctions imposed by the UN, OVL has sought government's advice on the way ahead. Iran IOC 4%; OIL 2% 2 Block 24 OVL 6%; Discovery in Abu Khasab and Rashid structures. 2 exploratory wells are under drilling and 2 wells are under testing. Infrastructure facilities for Rashid field development is in progress. Syria IPR 4% (operator) 3 Block 8, Iraq OVL 1% (operator) Service contract offered to OVL. Block holds 645 million barrels of reserves, of which,54 million are recoverable.ovl has committed to investing $ 86 million in two phases of exploration and $ 1.45 billion in development of the reserves. According to the service contract,ovl will be paid about 18% rate of return on the investment it makes in finding and producing oil from Block 8 4 Block 43, Libya OVL 1% (operator) Force Majeure since 26th Feb 211,G&G data under interpretation 5 Block 34 & 35, Cuba 6 Block 128, Vietnam 7 Block RC8, Colombia 8 Block RC1, Colombia 9 Block ES 42, Brazil 1 Block BMS 73, Brazil 11 Block CPO-5, Colombia OVL 1% (operator) OVL 1% (operator); Petro Vietnam upto 2% optional on commercial discovery) OVL 4% (operator); Ecopetrol 4%; Petrobras 2% OVL 5% (operator); Ecopetrol 5% OVL 1% (operator) OVL-43.5% (Operator), Petrobras-43.5%, Ecopetrol-13% OVL-7% (Operator), Petrodorado-3% 12 Block 279, Nigeria OMEL 45.5% (operator); Total 14.5%; EMO 4% 13 Block 285, Nigeria OMEL 64.33% (operator); Total 25.67%; EMO 1% 14 Blocks 25 to 29,36,35A - OVL 3%; Cuba Repsol 4% (operator); StatOil 3% OVL board accorded in principle decision to farm-out upto 5% to bring in credible partners having technical and financial capabilities for sharing the risks OVL board accorded in principle decision to farm-out upto 49% to bring in credible partners having technical and financial capabilities for sharing the risks. Recent reports suggest ONGC Videsh Ltd has decided to abandon this block off the Vietnam coast in the South China Sea due to logistic constraints Acquisition and processing of 3D data is in progress Acquisition and processing of 3D data is in progress OVL board accorded in principle decision to farm-out upto 5% to bring in credible partners having technical and financial capabilities for sharing the risks OVL board accorded in principle decision to farm-out upto 2% to bring in credible partners having technical and financial capabilities for sharing the risks. Drilling to begin early 212 One exploratory well drilled. This resulted in oil and gas discovery. 3D seismic acquisition of 534 Sq km carried. Newly acquired 3D seismic data is under processing 1 st exploratory well drilled. 3D seismic acquisition of 525 Sq Km carried and is under processing. PSTM completed. PSDM under processing Addendum to Contract for extension up to 19 th September, 212 will be signed with two wells commitment. 15 SSJN-7, OVL 5%, 2D seismic data acquisition was scheduled to begin in Sep'211 Columbia Pacific Stratus Energy Columbia Ltd (PSE) - operator 5% 16 Block RC-9, OVL 5%; Entered into 2 nd phase of exploration. Location for drilling 1 well identified. Columbia 17 Block BM-BAR-1, OVL 25%; Brazil 18 Block BM-SEAL-4, OVL 25%; Brazil Ecopetrol 5% (operator) Petrobras 75% (operator) Petrobras 75% (operator) 19 Block BM-S-74, OVL 43.5%, Based on G&G interpretation, decided to enter into phase-ii of exploration. Brazil Petrobas 43.5%, Ecopetrol 13% Emkay Research July 3,

26 Exhibit 6: Status of OVL s exploration projects Sl. No. Name of the Project PI / Partners / Operator Current Status 2 Satpayev, OVL 25%; Acquired in April'211. OVL estimates a peak output of 287, bpd from the Satpayev and Satpayev Vostochni (East) structures. Kazakhstan Kazmunasgas (Operator) 75%, OVL paid $13 million as a signing amount to Kazakhstan. In addition, it will pay $8 million as a one-time assignment fee to KazMunaiGas. On top of this, OVL has committed a minimum exploration investment of $165 million and an additional optional expenditure of $235 million to the project.ovl has an option to raise its stake by a further 1 % in case of a commercial discovery. Emkay Research July 3,