India’s quest for energy security has seen state-owned oil companies sign preliminary agreements with Rosneft for stakes in two Siberian assets (we expect total consideration at ~$5.5 bn).
We estimate the Rosneft acquisitions are likely fairly valued, and imply $70/bbl LT oil (in line with CS oil price deck). Any Exxon buy into Mozambique LNG (link) can push back development timelines, but is positive given the company’s expertise in LNG projects– and can aid a re-rating of BPCL’s E&P holdings.
HPCL has low E&P exposure, and in a low oil price environment ($40/bbl hereon), is the best pure play OMC. At our oil price deck ($70/bbl LT oil), E&P can be ~17% of BPCL’s EV; even considering higher upstream capex, BPCL RoCE retains its premium over HPCL on more efficient operations and BPCL is our top pick. The risk in our view, is if BPCL materially expands E&P investments, above and beyond the current quantum.
India’s quest for energy security drives acquisitions
The Indian government’s focus on energy security has translated into (i) more supportive policy for future developments, (ii) attempts to create larger strategic reserves and (iii) encouraging public-sector oil companies to acquire E&P assets abroad—to increase ‘equity oil’. India oil companies recently signed preliminary agreements with Rosneft for a stake in two projects: (i) Vankor –26% stake to ONGC, and 8% stake each for Oil India, IOCL and BPCL—we estimate for a total consideration of $4.2 bn (ii) Taas-Yuryakh–10% stake each to Oil India, IOCL and BPCL for an estimated $1.3 bn. Of this total $5.5 bn in acquisition spend, we estimate BPCL’s share at $1.1 bn. While a bulk of the capex has been spent at the assets, we estimate $80m in annual capex for BPCL over the next five years. Adding existing projects, 30-35% of BPCL capex over next five years could be on E&P; this compares to HPCL, which may allocate just ~5% to E&P.
ENI Area-4 divestment may lead to BPCL E&P re-rating
CS LNG analysts highlight Exxon’s likely interest in buying a stake in Area-4 Mozambique and ENI management’s intent to sell at least a part of its 50% stake. Our view has been that the key ingredient missing in the Mozambique development project is a Super Major operator. A stake sale to Exxon can solve this problem—although given Exxon management’s view on the LNG market (oversupplied to 2023), we would expect FID by 2018/19 and operations to start by 2023/24. With Exxon’s experience in LNG development, we would see a stake sale as a positive (despite the delay in timelines). This can help re-rating of BPCL’s E&P holdings.
Fundamental earnings drivers in place
We expect oil product demand in the Asia + Middle East regions to outpace refining supply additions over 2015-20 and refining margins to stay strong. Marketing margins have been strong post deregulation; combined with accelerating oil demand, we expect marketing Ebitda to stay robust as well. In addition to sustained strength in earnings, as deregulation continues to hold, we expect OMC multiples to expand.
Prefer BPCL—higher return ratios, modest E&P investment
HPCL has low E&P exposure, and in an environment where oil prices stay benign (such as, say US$40/bbl hereon), we would see HPCL as the best pure play oil marketing company. At our oil price deck ($70/bbl LT oil), we estimate E&P can be ~17% of BPCL’s EV—and the market would ascribe this full value to the stock, if operatorship of the Mozambique development passed to a Super Major. BPCL generates superior returns compared to peers helped by more efficient refining and marketing businesses and stronger working capital management. Even considering higher upstream capex, BPCL RoCE retains its ~8 pp premium over HPCL and is our top pick.