Our analysis of ONGC’s FY17 capital allocation (from the annual report) highlights the company’s renewed focus on development drilling (as opposed to exploration). Capex allocation to development drilling has increased from 25% (of total) over FY14-16 to 35% currently. Coupled with efficiency gains, ONGC was able to drill 50% more wells in the past year. Higher well completions have driven an increase in ONGC’s output, with oil/gas production run-rates now up 3/13%, compared to 1HFY17. While the exploratory activity remains similar to the FY14-16 levels, this has been achieved at a 40% lower cost. Despite this lower spending, we note the desired outcome (i.e., 2P reserve accretion > 1) has been achieved.
Good for volume growth, but KG concentration risk: Given the strong focus on development activity, we raise our oil and gas volume expectations for FY18/19 by 1-3%. It is positive that the six development projects approved in FY17 are relatively low-cost and oil-heavy, adding to output by 2HFY20. An analysis of projects under execution suggests the KG-DWN-98/2 block accounts for one-third of the reserves being monetised and 55% of project capex over the next four years. Given this large concentration, any delays in execution or cost over-runs can hurt the stock.
OVL reserves see 4% cut: Excluding acquisitions, ONGC’s overseas assets saw a 4% cut in 2P reserves, largely from fields in Brazil/Sudan, as well as Imperial in Russia.
Update model, stay positive: We update our model for the AR, and FY18/19 EPS increases 4/3% on higher volumes and lower write-offs. We reiterate our positive stance, with multiple catalysts ahead: (1) robust volume momentum, (2) continued subsidy reduction and (3) 30% gas price increase.
Sharp improvements in drilling efficiencies
We analysed data on (domestic) project selection and execution from annual report, to draw conclusions on cost savings, efficiency of capital deployment, future production profile and whether ONGC has been able to achieve its objectives in terms of replenishing reserves. Our conclusions are that while cash costs have increased y-o-y, the company has seen strong gains on execution metrics. The cost per well drilled has halved over a three-year period. Metrics such as commercial speed and non-productive-time have seen large improvements. Capex has fallen 7% y-o-y, but the number of wells drilled has increased nearly 45%, helped by efficiency gains. ONGC’s allocation of capex has also seen a step-change, with a substantial increase in focus on development drilling. This has driven strong volume momentum, with oil/gas up 3/13% vs 1HFY17 levels.