The government plans to divest 5% of its stake in ONGC through a public offer in March. Before that the company?s Rs 10 face-value shares will be split into two. That would afford more Indians an opportunity to pick up a stake in the Maharatna PSU.

ONGC, an upstream oil producer, may be entitled to international prices for its crude production but it is unlikely to fully benefit from the current high crude prices in the global market given the government?s subsidy sharing regime for the oil sector. Faced with runaway inflation, the government is unlikely to deregulate diesel price anytime soon. That means ONGC will continue to share under-recoveries of the public sector oil marketing companies (OMCs) on the retail sale of diesel.

While petrol prices have been deregulated, diesel prices are still being controlled by the government. That means public sector OMCs like Indian Oil, Bharat Petroleum and Hindustan Petroleum continue to suffer under-recoveries on the retail sale of diesel, and ONGC will be forced to share a portion of that.

?The biggest concern for ONGC is obviously the rising crude prices, which may increase the subsidy burden for the company. The deregulation of diesel prices along with other reforms also looks difficult now in the short term considering the high inflation and oil prices,? says Madhumita Ghosh, vice-president, PMS and research, Uncion Financial Intermediaries Pvt Ltd.

Globally, crude oil prices are taken as a proxy for an upstream oil company?s profitability. But since ONGC along with Oil India, another public sector upstream company, and Gail India is required to bear the OMCs? under-recoveries on diesel sale, its profitability may not reflect the international oil prices.

What makes the task of forecasting ONGC?s profits even more difficult is that the existing subsidy sharing mechanism lacks transparency. A final decision on subsidy sharing is taken by the government at the end of a fiscal.

Even when ONGC?s profits for three quarters are known, it is not possible for anyone to predict its profits for the whole financial year.

In the near term, ONGC?s stock performance may be constrained by adverse factors like mandatory sharing of under-recoveries. But there are significant upsides to the company?s valuation, which might get unlocked once there is more clarity on the policy front.

ONGC has benefitted from the government?s move to double the APM (administered price mechanism) gas price. ?The recent, more than two-fold hike in APM gas prices to $4.2 per mmbtu in order to bring it in line with K-G D6 gas is a positive for ONGC. It has also forayed into shale gas and will invest Rs 120 crore in a pilot project in West Bengal and Jharkhand. Schlumberger (US oilfield service provider) has executed the ONGC contract for drilling the country?s first shale gas well in Damodar Valley. We feel this can give potential upside to the stock,? Ghosh said.

According to DK Sarraf, ONGC?s director (finance), ?Our stock is grossly under-valued. One of the key reasons is that the full valuation of ONGC Videsh (OVL), a 100% subsidiary, is not fully factored in our market value. It is because we have not provided adequate data to investors and analysts on OVL. In the absence of that, they have valued the subsidiary on the basis of their perception.?

OVL accounts for some 24% of the ONGC group?s 1,619 million tonnes of oil equivalent reserves. Its share in the group?s production of oil and gas in 2010 was 14.5%. ?When more information is provided in due course of time, our true value will get unlocked,? Sarraf said.

ONGC is developing some mega projects in Dahej and Mangalore?ONGC Petro additions Ltd (OpaL ) and ONGC Mangalore Petrochemicals Ltd (OMPL)?under the joint venture route. These projects are lined up for commissioning between 2011 and 2013. ?Once these projects start production, ONGC turnover and profits would go up significantly,? he said. Besides, ONGC subsidiary, MRPL, is also expanding its refining capacity and setting up new projects.

The company has also made a few discoveries in the KG and Cambay basin. ONGC plans to invest over $10 billion to develop finds in the K-G basin. ?We expect oil production volumes to grow at a CAGR (compound annual growth rate) of 5% till FY13 which would drive the revenues,? Ghosh said.