With oil at a low and the discount for Barmer crude having widened, the explorer is hard-pressed to maintain output
It’s been a double whammy for Cairn India, operator of the biggest on-land oil block in India which contributes nearly 25% to the country’s output. On the one hand, it has seen Brent crude oil price plummeting to a six-year low. On the other, the explorer is selling crude oil from the Barmer block in Rajasthan at a discount of 14.3% to Brent.
Thus, Cairn India has been forced to produce more hydrocarbon from its block—though at ‘optimal cost.’ This is a challenge at a time it saw its crude oil production dip to 159,000 barrels per day (bpd) in September, as against 167,000 bpd in July and 170,000 bpd in August. The company has had to employ the expensive ‘polymer-injection’ technique to pump out more, resulting in its blended operating cost going up by 11% q-o-q to $6.4/barrels of oil equivalent (boe).
Much below street expectations, the Vedanta Group company saw its net profit during the July-September quarter of FY16 nosedive 70.45% to a meagre R673 crore, as against R2,278 crore in the previous year. This was primarily because of the discount to Brent for Rajasthan crude widening to 14.3% from 9.9% on a sequential basis. The average Brent prices fell 18% quarter on quarter to $50.5/ barrel, driving Cairn India’s average oil realisation down by 22%
q-o-q to $43.7/barrel.
Investors are worried, no doubt. Goldman Sachs reckons Cairn India’s long-term production profile a concern given its single-asset dependence, and says its proposed merger with parent Vedanta may increase near-term uncertainty.
Shares of Cairn India have lost nearly 36% in 2015 so far, as against a drop of 1.45% in the benchmark Sensex. Cairn India reported a cash equivalents position of Rs 17,943 crore as on September 30.
There are two major overhangs on the company—outcome of the Production Sharing Contract (PSC) extension efforts and the proposed merger with Vedanta. Sources in the petroleum ministry told FE a decision on extending the contract for Barmer beyond May 2020 (by another 10 years or till the economic life of the field) would be taken in the next six months. As for the merger, Vedanta’s chief executive officer Tom Albanese recently said it might happen sometime next year.
Cairn India has made several attempts to earn a better price for the waxy crude drilled from Barmer. First, it urged the then United Progressive Alliance government to allow it to export the crude oil and earn for itself a better price . This was later turned down by the National Democratic government.
Second, Cairn sought a review of the crude oil pricing formula. This too didn’t work, as the petroleum ministry felt it had ‘no direct role to play’ on the pricing of crude oil and asked Cairn India to negotiate with the buyers directly. Ironically, IOC which buys about 25% of the Barmer crude, is not willing to negotiate the pricing mechanism unless directed by the government.
So, what is the explorer doing? It claims it is trying to weather the prevailing weak price environment by optimising the overall capital and operating expenditure. It has brought down the cost of procurement of services by 13% through negotiations with the vendors. A nearly 15% cut on well costs for new contracts across assets has been achieved by tweaking well completion designs and an improvement in the cycle time. Further, the water-flood operating costs remain low at $5.5/boe driven by a decrease in the crude processing and facility maintenance costs.
Cairn India has committed to maintaining its Rajasthan production in the current year at FY15 levels, at the minimum. Presently undertaking a planned capital investment of $500 million, it retains the flexibility to invest another $1.4 bn as oil prices improve and costs bottom out.