The oil and gas stocks, especially upstream oil companies, are in focus. CLSA has a bullish stance on Oil And Natural Gas Corporation (ONGC). The brokerage has an “Outperform’ recommendation on the stock on the back of the upstream royalty cut, contrary to fears of a windfall tax.
CLSA has set a target of Rs 405 per share. This implies an upside of over 44% from current levels.
Gas pricing reforms
Higher price caps for domestic gas have the potential to significantly boost margins. In a surprise announcement, the government announced an effective cut in the rate of royalty charged on the production of oil & gas in India.
For onshore production, the effective royalty rate dropped significantly by 6.7 percentage points (from 16.66% to 10%), and for offshore, it dropped by 1.09 percentage points.
“These have been changed by making the deduction to a standard ad-valorem 20% and then applying a rate of 12.5% for onshore blocks and 10% to offshore blocks. This implies an effective cut in royalty rate on onshore production from 16.66% to 10% and from offshore blocks to 9.09% to 8%,” said CLSA.
Applying the flat deduction of 20% also means the royalty on natural gas declines to 8% from 10% earlier.
Windfall tax stability
More predictable government taxes on crude oil production are the key factor that is being seen as a positive by market participants. CLSA believes that by choosing to cut royalties instead of increasing taxes during a period of rising crude prices, the government has signalled it will not impose a 2022-like windfall tax. This move addresses a major concern that previously made these companies some of the worst-performing upstream stocks globally.
“Importantly, this action should remove fear of an increase in upstream taxation through a 2022-like windfall tax, which has made ONGC & Oil India some of the worst-performing global upstream stocks. At $80/bbl, we see an over- 50% total return for ONGC as it is pricing in $65/bbl Brent,” said CLSA.
Attractive valuations
Both ONGC & Oil India trade at a discount compared to global peers despite strong cash flows. These changes provide a direct boost to valuations. CLSA estimates these reforms add a fair value boost equal to 7–9% of the current market price for ONGC and 9–11% for Oil India.
CLSA noted that ONGC is currently pricing crude oil at only $65/bbl, while the current price is around $80/bbl. At the $80/bbl level, they see an over 50% total return for ONGC and a potential 43% upside for Oil India.
ONGC: CLSA Outperform Rating & Key Metrics
| Crude priced in by market | $65/bbl |
| Current crude price | ~$80/bbl |
| Total return at $80/bbl (ONGC) | 50%+ |
| Potential upside (Oil India) | 43% |
ONGC share price performance
The share price of ONGC has risen 1.3% in the last five trading sessions. The stock has surged 1.5% in the past one month and 15% in the last six months. ONGC’s stock price has given a return of 20% over the previous one year.