A fantastic webinar conducted by sector specialist at Care Ratings on Oil Industry.
Please find our key notes from above webinar
Exploration and Production (E&P) companies engage primarily in the exploration, development, production and sale of crude oil and natural gas.
The presentation covers the following topics:
a) Demand and Supply of Crude Oil
b) Trend in Oil Prices
c) Impact in Inflation of Crude Oil Volatility
d) Government Balances to support Crude Buying (in case of imports)
e) Key Financial and Operating parameters to analyse E&P oil companies
Before getting ahead with the presentation; speaker explains how the exploration of Hydro-fluoro-carbons (HFCs) happens in India.
Central Government agencies like ONGC and Oil India carry out exploration through a nomination regime and private companies were allowed to enter into exploration through a joint venture with NOCs, this was applicable with the pre-NELP regime. Subsequently 100% foreign participation was allowed in exploration in the new exploration and licensing policy.
Currently, beginning with the year 2016, the government of India started awarding oil and gas blocks under the hydrocarbon exploration and licensing policy which is being monitored by the directorate general of hydrocarbon. HELP is a new fiscal model based on revenue sharing contract; this is an upgraded version as compared to the NELP production sharing contracts.
Under the HELP regime the government will not be concerned with the costs incurred and will receive a share of the gross revenue from the share of sale of oil and gas.
Since NELP was introduced in the late 1990s, 314 blocks have been offered under various auction grounds of which 254 have been awarded and out of that 60 are operational today by players such as ONGC, Reliance Industries and Oil India.
From 2017, all the contracts are being offered under the HELP regime. Most of the producing blocks in the country at present are those that have been offered before the NELP or after the NELP.
ONGC is the largest oil explorer in the country and contributes to around 60% of the total domestic production. Oil India contributes to around 9 to 10% of the domestic production and the remaining 30% is contributed by the private companies.
The crude oil production over the years has declined considerably. The primary reason for that is because of the loss of output due to the maturing of oil fields and the inability to further dig deeper to explore more oil.
The same trend has continued in the current financial year as well. Production has dropped by around 6% during the April and January period.
India imports more than 80% of its crude oil requirements and in the current financial year we have imported almost 4.5 million barrels per day. Imports have grown at a compounded annual growth rate of 4.6% during financial year 15 to 19.
But in the current financial year in the April January period, Imports have declined marginally by 0.9 percent. The compliance of US sanctions on Iran May 2019 onwards has led to the decline of our import levels. Iran used to be India’s third largest crude oil supplier up until April 2019.
In the current financial year India has tried to make up for the loss of Iranian crude by importing additional crude oil from the US and the Kazakistan and by also signing a new pact with Russia.
Refineries in the country use crude oil as a raw material or input to manufacture petroleum products in India. It consumes around 5.09 million barrels per day in the current financial year that is 2019-20.
Domestic consumption of Crude Oil has increased at a CAGR of 3.6 percent during financial year 15 to 19, indicating growing requirements of the country which is a growing economy.
In the current financial year the Crude oil processed by the Indian Refiners has fallen by 1.2 percent due to the weak fuel demand which has led to the inventory build up of refined petro-products thus leading to trimming of the crude processing activities.
Indian refineries are capable of processing sweet crude and sour crude effectively and are able to produce LPG, NAFTA, Motor Spirit, Air turbine Fuel, Superior Kerosene Oil, High Speed Diesel like Diesel oil and looms, low sulphur heavy stock and bitumen.
Transportation fuels such as diesel and petrol account was 57% of the total refinery products followed by NAFTA and LPG. NAFTA is used as a feedstock in fertilizer and petrochemical firms whereas LPG is used as a cooking fuel.
Trend in Oil prices is a very important aspect to consider while analysing the oil and gas industry. Brent oil is one of the main benchmarks which serve as a reference price for buyers and sellers. Having a benchmark for crude oil makes it easier for buyers and sellers to determine the prices of multitudes of crude oil varieties and blends as there are nearly 200 varieties of crude oil.
India uses the Indian Basket of crude as benchmark crude, it is also used as an indicator as the price of crude oil imports in the country and the government of India watch the index while examining the domestic price issues. The composition of Indian Basket of crude represents average of Oman and Dubai.
Due to its large stature in the crude oil market, Brent crude market is influenced by a number of factors, these factors influence the price of just about any crude oil blend. However, because it’s a benchmark it tends to be more sensitive to these factors other than other crude oil blends.
So oil prices are the function of global supply and demand. The prices of crude oil are also influenced by the political and economic conditions prevailing in major oil-producing and refining countries as well.
Tension in the middle-east also tends to influence oil prices. Environmental hazards too have an effect on oil prices as it has a potential to stall oil production.
When it comes to macroeconomic policies and its influence on oil prices it is expected that a strong economy is likely to increase the demand for crude oil and on the other hand an economic crisis will lead to a decline in oil prices.
If the supply is less than there are chances of prices of crude oil projecting upwards. Hence OPEC decisions are important in the oil market because OPEC owns about two-thirds of the global oil market.
If OPEC decides to cut down on production, the supply will reduce leading to an increase in the crude oil prices. But, in the past few years USA has been emerging as one of the key players in the global oil and gas markets and has been able to exercise considerable influence on global benchmark oil prices given the surplus production of oil.
Oil prices increased during the current year because the US government did not grant an additional extension to India, Japan, Italy, Greece, Turkey, Taiwan, South Korea and china on the Iran Sanction waiver. The anticipation of the loss of supply of Iranian crude thus led to a rally in oil prices but shortly the oil prices started falling due to the bearish sentiments in the economy due to the tensions between US and China coupled with the over increasing US production.
In the new-year despite the production cuts undertaken by OPEC and its allies, the prices of crude oil have fallen further and have entered the bear markets due to the outbreak of Novel Corona-virus, which has led to dent in global oil demand.
The Indian Basket of crude is approximately US dollars 0.3 to 0.6 barrels less than the Brent oil on a monthly basis.
Increase or decrease in the crude oil prices has a significant impact on inflation as it will be driving the monetary policy decisions in future.
Crude oil and its products have weight of 10.4% in the WPI (Wholesale Price Index) in which Crude petroleum and natural gas have a weight of around of 2.41% and Mineral oils comprise of 7.95% of the total. Except of LPG every resource is market driven which means that any increase or decrease in crude prices would significantly impact WPI. The weight of crude oil in CPI (Used in vehicles which account for only 2.4%) is fairly less as compared to WPI that’s why the crude prices will have more impact on WPI rather than CPI.
The government is impacted by crude oil prices in two ways: Both state governments and central government earn substantial revenues through oil and petroleum products through taxation as they have been kept out of the GST purview states are also able to levy variable taxes as a result of which prices across states vary. The state governments also earn income in the form of dividends from oil companies in which it has a promoter stake in. Secondly, Government is also able to provide subsidy for certain fuel products, which is LPG and Kerosene in order to buffer against surprises.
The total contribution of the Petroleum Sector towards exchequer during 2018-19 was around 5.27 lakh crores out of which excise duty and VAT constitute around 70% of the total contribution. Taxes levied by the center are a fixed amount whereas the state governments don’t only follow a different tax regime but also levied taxes on AD valorem basis.
As of 16th February, 2020, the government (centre plus states) is collecting around 107% taxes (Excise duty and VAT) on the base price of petrol and 69% in the case of diesel.
The fuel subsidy used to be as high as around Rs. 97000 Crore during FY13; efforts have been made to lower this amount by restricting the amount of products which need to be subsidized as well as to target them more effectively.
The revised estimate for FY20 is around Rs. 38569 crore and the fuel subsidy has been budgeted at Rs. 40915 crore (The government has increased the fuel subsidy by 6.1 percent).
Within the subsidy the government has increased the subsidy allocated to LPG by 9% and Kerosene subsidy has come down by 18.4%.
Upstream Oil Companies- Analytical Paramters
Exploration and Production (E&P) companies engage primarily in the exploration, development, production and sale of crude oil and natural gas.
Assessment of the E&P companies is influenced by the fact that these companies assets are finite depleting resources subject to unpredictable commodity prices. Further, these companies need reinvest substantial amounts replace depleting reserves.
The reserve replacement and financial position of these companies can be affected by volatility in commodity prices and by geopolitical surprises during exploration and production.
Overtime, the credit quality of such companies is determined by operating returns on invested capital and the money spent in acquiring, finding, and developing acreage and reserves.
The different stages of the E&P value chain are geological & geophysical activity, exploratory drilling, developmental drilling and finally production.
Major Risk Drivers
Business risk drivers
a) Scale of operations in terms of production volume
b) Geographical diversification across basins, geologies, geographies and countries
c) Re-investment risk to sustain cash flows and service the debt in future years
d) Operating and Capital efficiency
e) Evacuation risk
f) Regulatory risk
Financial Risk drivers
a) Operating Profitability and Return on Capital Employed
b) Gearing (Debt/Equity Ratio)
c) Foreign Currency-related risks (in terms of principal repayments effects due to currency depreciation)
Key Credit Rating Factors
a) Strong Parentage
b) Strategic importance of the sector for Govt. of India
c) Flexibility with regards to raising funds at competitive terms
d) Strong operational profile driven by dominant market position
Key Takeaways
The domestic Up-stream industry is dominated by large public sector undertakings (PSUs), who contribute around three-fourths to India’s oil and gas output by volume.
Lack of robust data, delays in decision making and regulatory clearances are some of the reasons that have led to subdued interest from the private sector.
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