Top Reasons Why Investors Should Buy ONGC at current Levels

4 min read
Top Reasons Why Investors Should Buy ONGC at current Levels

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India has cut the domestic natural gas prices for the third consecutive time to $1.79 per million British thermal units (mBtu) which raised the questions about the earnings of producers like ONGC & IOC causing share plunge in revenues and incurring huge losses on gas production.

It is also the first time that the price has gone below $2 per mBtu.

ONGC, which is the biggest crude oil and natural gas producer India, contributing around 75% to Indian domestic production was not able to recover the total cost of production at the current level of gas prices, making the gas business not profitable for the company. The average cost of production for ONGC is close to $3.7 per million British thermal unit. Low domestic gas price in the domestic market is one of the major risk factors, to the profitability of the gas business.

ONGC and Oil India produce and sell close to 80% of India’s total gas, while the remaining comes from private players like Reliance Industries Ltd., Vedanta Ltd., Hindustan Oil Exploration Ltd., and others

Domestically, the extremely low gas prices are a cause of anxiety for gas producers. At the current price point, most gas projects are running cash negative. Without the necessary policy support and fiscal incentives, the prospect of a gas-based economy looks difficult.

Crude Price: One more shock for ONGC

The cut in gas prices is a two way shock for the producer that has seen crude prices near the lower-end of its ‘acceptable’ levels.

For ONGC, the total cost of production for every barrel of crude is around $35-40, while crude prices are currently trading at $40-42 a barrel. For ONGC, every $1 a barrel change in prices of crude oil, natural gas, and other products has an impact of close to ₹ 6,000 crore on its revenue. For a company like ONGC where the bulk of the production comes from legacy fields and production costs rise for every incremental barrel, lower prices are a significant disincentive for any major capital programme. (Read more)

Stock Price Slump:

Low crude and gas prices, weak demand and production caused ONGC stock price to plunge over 55% in just one year. Fiscal challenges may force more aggressive stake sales by the government which will be another major overhang on ONGC.

Good News for others:

This is a good news for consumers of piped natural gas (PNG) and compressed natural gas (CNG) as companies like Indraprastha Gas Ltd (IGL) and Mahanagar Gas Ltd (MGL) would be passing on the benefits of the price cut. A cut in the natural gas price will result in a lower cost of manufacturing of urea and petrochemicals where natural gas is used as a feedstock. A decrease in the price of Natural gas could also positively impact the margins of the power sector and sponge iron industry where it used for the generation of energy.

New hope for ONGC

India is considering a floor price for natural gas produced from local fields. The proposal being considered by the oil ministry pegs the price to the popular benchmark Japan-Korea Marker that is used for LNG tariff in North Asia with a discount. The implementation of a floor price could lead to an increase in the price, even after factoring in a discount of $1/mmBtu to the Japan-Korea Marker price. The current Japan-Korea Marker price is close to $5 per mmBtu. India will phase out price controls in natural gas and make it market-linked.

If implemented, this will also make almost all key petroleum products in India close to global benchmarks and reduce government’s intervention to a very minimal level.

If the above policy is implemented, it would raise consolidated FY22 earnings 20-22%, and improve annual cash flows by $0.5-0.6 billion - Morgan Stanley

..and so the stock price.

A sharp jump in crude prices, deregulation of gas prices, and cut in government taxes related to oil are the only factors that could lead to an upside in the share prices of ONGC.

For a stock like ONGC whose Dividend Yield is 7.22 % and Free cash flow 151,179 Cr. of last 5 years, a sharp bounce back is expected which may benefit investors for short and long term.

"For wealth creation, Buy Fundamentally strong stock when they are in deep pain"

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Akshay Seth
Research Analyst (SEBI Regd.)
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