We cut our FY2018-19 EPS estimates of ONGC and OIL by 10-20% factoring in lower crude prices at $52.5-57.5/bbl. However, we retain ADD on ONGC stock with a revised TP of Rs 190 (Rs 210 previously) given our expectations of crude price recovery from current low levels, rising comfort on gas production and possibility of policy incentives for EOR/IOR production. OIL remains at ‘sell’ with a lower TP of Rs 285 (Rs 315 previously) given continued concerns on reserves/production. The recent weakness in crude prices despite extension of production cuts by OPEC and select non-OPEC countries reflect quicker-than-expected recovery in crude production from Libya and Nigeria and the US shale. Libya and Nigeria, exempt from OPEC cuts, have increased production to ~2.5 mn b/d currently from 1.9 mn b/d in March-April 2017, amid resolution of internal disruptions.
On the other hand, the US shale oil production has recovered rather quickly to 5.3 mn b/d currently from 4.8 mn b/d six months ago led by continued increase in rig count and monetisation of drilled but uncompleted wells (DUC). We continue to expect a sharp drawdown in global crude inventories by ~1.2 mn b/d during H2CY17, which can support crude price recovery to more reasonable $50-55/bbl; sustained production cuts and reasonable 1.5 million b/d growth in demand will more than offset a robust ~1 million b/d y-o-y average recovery in the US shale production and higher supply from Libya and Nigeria.
We also see the possibility of slowdown in the US shale drilling activity amid current weakness in crude prices, which can reduce optimism on the pace of incremental supply. We reduce our FY2018-19E EPS estimates for ONGC to Rs 15.3 (-20%) and Rs 19.8 (-10%) and for OIL to Rs 24.3, -18%, and Rs 29.8, -11%, factoring in lower dated Brent crude price of $52.5-57.5/bbl versus $60-62.5/bbl earlier and other minor changes. A $1/bbl decline in crude price will impact FY2019E EPS of ONGC by nearly Rs 0.6 and OIL by Re 1. We retain our positive view on ONGC, expecting it to benefit from our assumption of a recovery in crude prices, rising comfort on gas production volumes and possibility of policy incentives for EOR/IOR production.
We see ONGC as a pure play on recovery in global crude prices given continued exemption from fuel subsidies, which have become a lot more manageable. ONGC will also benefit from an expected recovery in domestic gas price to $3.3/mn BTU in H2FY18 and $3.6/mn BTU in 1HFY19 from current $2.8/mn BTU; domestic gas price formula is linked to global gas (in effect, crude) prices with a lag.