The declining international prices of crude oil and gas [since last year] has brought huge relief to critical sectors like fertilizers, power, transport, households etc besides helping the government in reining in subsidies [fertilizers] in turn, helping fiscal consolidation and reducing losses of state electricity boards [SEBs].
However, international rating agencies [Moody & Standards and Poor] as well as domestic rating agencies viz., CRISIL feel that this will have deleterious impact on Oil and Natural Gas Corporation [ONGC] and Oil India Limited [OIL] – both central public sector undertakings [PSUs] which supply indigenous crude to oil refineries. This would be an overly simplistic way of looking at an otherwise complex situation on the ground.
They argue that price paid to ONGC/OIL for crude they supply is linked to its international price and since the latter has dropped steeply [from over US$ 100 per barrel in mid-2014 to US$ 45 per barrel now], this will inevitably affect their top lines and bottom lines. However, what they are ignoring is that even earlier, these PSUs were not realizing the international price in full.
This is because since 2003, till last year, they were ordered to give discount to downstream oil PSUs viz., Indian Oil Corporation Limited [IOCL], Bharat Petroleum Corporation Limited [BPCL] and Hindustan Petroleum Corporation Limited [HPCL] to cover a portion of latter’s under-recoveries [URs] on sale of diesel, petrol, LPG and kerosene.
The discount varied from year-to-year even as the formula used for arriving at it was shrouded in secrecy. For 2013, then UPA government fixed this at US$ 56 per barrel which ONGC/OIL must give irrespective of prevailing international price. This meant that even at say, US$ 100 per barrel, these PSUs would have a net-back of only US$ 44 per barrel [100-56].
The above dispensation continued till December 31, 2014. During January – March, 2015, Modi – government did not ask ONGC/OIL to contribute any amount towards URs; in other words, discount was ‘nil’. Therefore, even with international price dropping to US$ 50 per barrel [during this period], the latter got more than what they were getting earlier.
For 2015-16, it has mooted a fair and transparent policy in regard to sharing of URs. Thus, for price of crude oil up to US$ 60 per barrel, ONGC/OIL do not have to give any discount. For price in US$ 60-100 per barrel range, the discount will be @85% of incremental price and for above US$ 100 per barrel, it will be @90% of incremental price.
Clearly, these PSUs are not worse off than what they were earlier. In addition, they get certainty of the policy environment [unlike past when they won’t know – many a times even till finalization of their balance sheets – how much they would get]. And, the most promising part is that for price up to US$ 60 per barrel, they get the full amount.
Reportedly, ONGC has come out with some numbers to show that its production cost has increased to around US$ 60 per barrel and therefore, it would suffer a loss at prevailing crude price of around US$ 45 per barrel. The numbers dished out by it now have to be taken with a pinch of salt as earlier this year, it had reported its cost to be around US$ 40 per barrel!
Even so, the market for services viz., drilling wells, rigs etc is in a recessionary phase [in tandem with declining crude price]. This has led to their supply at much lower price. That should warrant a reduction in production cost [that ONGC has promised to lower the cost by at least US$ 10 per barrel – under pressure from oil ministry – confirms that there is big scope here].
As in oil, in regard to gas also, rating agencies see bleak prospects on account of the reduction in price of domestic gas. During the current fiscal, the price was reduced twice [first from April 1 and now from October 1] leading to a cumulative decline of US$ 1.37 per mBtu [million British thermal unit]. The current price is US$ 4.24 per mBtu.
ONGC has claimed that for its discovery viz., KG-DWN-98/2 in Krishna-Godavri basin off the Andhra coast [the field was discovered more than a decade ago and is being developed now] to be commercially viable, it needs a price of at least US$ 6-7 per mBtu. It argues that being a deep water field, investment in development and commercialization will be much higher which cannot be serviced at current price of US$ 4.24 per mBtu.
This requires closer scrutiny especially in the backdrop of an all pervading perception [including amongst multinationals and private companies in India] that the current price is a serious dis-incentive to companies undertaking investment in exploration and production [E&P] from new fields or even commercializing fields already discovered.
Let us look at some basic numbers. 1 metric standard cubic metre of gas contains 10,000 kilo calories [kcl]. 1 million metric standard cubic metre per day [mmscmd] = 10,000 million kcl. @ US$ 1 per mBtu or US$ 4 per mkcl [1 mkcl = 4 mBtu], the value of 1mmscmd is US$ 40,000.
Taking production at around 17 mmscmd [as per ONGC estimate for KG-DWN-98/2], the value generation will be US$ 0.68 million [40,000×17] per day. Annualized, this will be US$ 250 million [0.68×365]. While, this corresponds to US$ 1 per mBtu, at current price of US$ 4.24 per mBtu, the revenue will be US$ 1060 million [250×4.24] per annum.
Additionally, the field will produce 77,000 barrels a day of oil. @ US$ 50 per barrel, the value of this would be US$ 3.85 million [77,000×50]. Annualized, the revenue from this would be US$ 1405 million [3.85×365]. Put together, total revenue from gas and oil would be US$ 2465 million [1405+1060] per annum.
ONGC estimates the cost of developing and commercializing the field to be about US$ 6 billion or 6000 million. One wonders whether the impact of current glut in the market for E&P related services has been captured [this should drastically reduce the estimate]. Even taking figure at its face value, the investment will be recovered in less than 30 months [6000/2465].
Therefore, the most critical factor is production. If, project proponents can maintain production at the committed level, then even the current price can help ONGC recover cost pretty fast and there after handsome profits year-after-year. And in case, it falls short [as happened with KG-DWN-98/3 or KG-D6 – as it is commonly known – operated by Reliance Industries Limited] then any price howsoever high, cannot salvage the investment.
In case of both crude oil and gas therefore, E&P companies including ONGC/OIL need to focus on optimizing production [besides reducing cost] instead of harping on higher price ‘ad infinitum’. Under Modi – government, even as the price of gas is formula based providing a certain and predictable policy environment, in case of oil too, it has allowed price allowed to domestic producers to converge to international price. Under a fair play, this is the best any investor could have looked for.