ONGC CFO DK Sarraf feels the co’s biggest challenge is the uncertainty & opacity surrounding huge oil subsidy
Being the finance director of the biggest oil producer in the country, can you elaborate on the immediate challenges ONGC is facing?
We are currently passing through a unique phase in our history. On the one hand, crude prices are going up, raising investors’ expectations regarding topline and bottomline growth, in line with the returns generated by other domestic or global oil producers. On the other hand, the company is burdened with subsidies, even as domestic production is stagnating partly. In fact, even maintaining the production from our old fields requires heavy investments.
Competition in the exploration business is growing, while the assets carrying out exploration work have become scarce. Scarcity of talent has also emerged as a key issue with substantial increase in exploration activity globally. Liaisoning with the government for various issues such as subsidies is another challenge.
You have been in talks with the government over the issue of subsidies for a long time. When can we expect a solution for this issue?
Yes, subsidy-sharing remains a bone of contention between the government and ONGC. However, disagreement is more on the method, rather than its validity. With crude oil prices soaring, we are generating additional profits.
Hence, we do not mind sharing a part of that with the government. However, what we seek is a transparent mechanism. Today, we get to know our share of subsidy some time after the quarter ends, which we want to change.
We have proposed that the government should decide a level of crude oil prices for which no subsidy will be required. And whatever be the incremental realisation, let the government retain a large portion of that as subsidy.
This way, we will have sufficient revenues to take care of increasing costs and bring in visibility on our future earnings and profits. Visibility on future earnings is important for investors as lack of it increases risk. This clarity will attract better valuations for ONGC. The government is paying attention to our problem and it has set up the Chaturvedi committee to look into the matter. Mr Chaturvedi was earlier the petroleum secretary and is well aware of the industry’s problems. We have already sent our recommendations to the committee with supporting data. We are hopeful of a solution soon.
Crude prices have nearly doubled over the past one year and continue to increase by the day. What is your view on the current crude price rally? Is it sustainable in the long run?
It is difficult to hazard a guess on crude oil prices. While demand-supply forces are affecting oil prices, speculation is certainly adding fuel to the fire. However, I think that crude oil prices will remain firm, as we don’t see any big increase in supply in the near future. Ultimately, crude prices will fall for sure, because when they increase beyond a point, the burden will be shifted to consumers. Once that happens, consumers will shift towards conservation — either improving efficiencies or cutting down on consumption altogether — and this will bring down prices, though it is difficult to guess to what extent.
Despite being out of the subsidy-sharing burden, why didn’t ONGC Videsh (OVL) gain much from rising crude oil prices in FY08?
Higher crude oil prices did benefit OVL. Its profit after tax (PAT) for FY08 rose 44% to Rs 2,397 crore. And this was despite paying Rs 725-crore interest to ONGC, which was not paid in the previous year. Further, OVL wrote off Rs 627 crore of depreciation on pipelines due to a change in accounting policy last year. Also, some provisions were created for its exploration projects, mainly in line with our conservative accounting policy. These provisions can be written back in future, based on the exploratory successes. If you consider these factors, you will notice a big jump in OVL’s profit.
Are high crude oil prices affecting OVL’s investment plans in oil fields?
High oil prices are creating many complications in valuation of assets. The sellers are asking for higher valuations, while as a buyer, we have to be more prudent. In that respect, it has become more difficult to strike a deal as a buyer. However, the deals are still being struck, though it is becoming more and more difficult to convince sellers of the valuations. Again, convincing ourselves of the new reality is also difficult.
What is your outlook on OVL’s production?
OVL’s production has been growing at a fast pace over the past few years. In FY03, it didn’t produce anything, but today, OVL’s production has crossed 8.8 million tonnes of oil equivalent (mtoe). During FY08, OVL’s crude oil production grew by around 18% to 6.81 mtoe and total production was up 11% to nearly 8.8 mtoe.
It’s A Balancing Act
HOWEVER, PRODUCTION may stagnate in FY09, as the existing fields have reached a plateau and no new fields are scheduled to commence production. That is, of course, provided we don’t make any acquisition. In the first half of FY10, OVL’s Brazil block is likely to start production. Similarly, our blocks in Egypt and Myanmar will commence production over the next couple of years. Besides, there are a number of exploration blocks in various stages of development and the option of acquisitions is always open.
OVL has been acquiring oil fields in the past. What is your financial strength for similar acquisitions in future?
ONGC’s balance sheet is quite strong with net worth of Rs 75,000 crore. It is a debt-free company with high cash reserves. This gives us a strong leverage of over Rs 1 lakh crore to finance our growth plans as well as acquisitions.
ONGC’s production has remained stagnant for the past few years. How do you expect your crude oil production to increase in India?
All of ONGC’s producing fields are old, wherein the production is naturally declining. Hence, a lot of investment is needed just to maintain the production. The costs of production, repair and maintenance are also high. Despite this, ONGC is wonderfully maintaining its production. Due to our exploration efforts, we have achieved a reserve replacement (RR) ratio of over 1. Higher reserve accretion than our production means that we won’t run out of oil soon. Going forward, we have three long-term strategies to improve our production.
Firstly, we want to add 20 billion tonnes of oil equivalent reserves by ’20. Secondly, we will take the oil recovery factor to 40% from 28%. So, we will produce more oil from each of our current fields.
Thirdly, we are looking at overseas assets for production growth. Our stated goal is to produce 20 million tonnes overseas by ’20, but we may even achieve this goal earlier. For the short term, redevelopment of older fields, marginal fields and Rajasthan fields, wherein we hold 30% stake, will lead to production growth for ONGC.
What is your dividend policy? Considering that ONGC is a cash-rich company, will it continue to declare hefty dividends as in the past?
As per government guidelines, we need to pay 30% of our profits as dividend. However, our dividend payout ratio is close to 50%. We are the largest dividend-paying company in India and since we have surplus money, we follow a liberal dividend policy. Going forward, we intend to maintain our dividend payout ratio.
Considering that the government has imposed restrictions on the company’s profitability, what is your message to ONGC’s retail investors?
If we compare ONGC with global oil majors, most of them do not have a high RR ratio. Our RR ratio has stayed above 1 in the past four years, which indicates that we are adding more to our reserves than our annual production. This ensures long-term future production growth.
While global oil companies are witnessing a fall in production, ONGC’s total production is increasing. The only problem is ad-hoc subsidies, which we are trying to do away with.
However, if we club together the profits of ONGC, OVL and Mangalore Refinery and Petrochemicals (MRPL), we see our consolidated profits growing steadily in future. Besides, we also have a consistent dividend policy. Hence, I believe retail investors should not be concerned with the short-term fluctuations in ONGC’s share price.
Being the finance director of the biggest oil producer in the country, can you elaborate on the immediate challenges ONGC is facing?
We are currently passing through a unique phase in our history. On the one hand, crude prices are going up, raising investors’ expectations regarding topline and bottomline growth, in line with the returns generated by other domestic or global oil producers. On the other hand, the company is burdened with subsidies, even as domestic production is stagnating partly. In fact, even maintaining the production from our old fields requires heavy investments.
Competition in the exploration business is growing, while the assets carrying out exploration work have become scarce. Scarcity of talent has also emerged as a key issue with substantial increase in exploration activity globally. Liaisoning with the government for various issues such as subsidies is another challenge.
You have been in talks with the government over the issue of subsidies for a long time. When can we expect a solution for this issue?
Yes, subsidy-sharing remains a bone of contention between the government and ONGC. However, disagreement is more on the method, rather than its validity. With crude oil prices soaring, we are generating additional profits.
Hence, we do not mind sharing a part of that with the government. However, what we seek is a transparent mechanism. Today, we get to know our share of subsidy some time after the quarter ends, which we want to change.
We have proposed that the government should decide a level of crude oil prices for which no subsidy will be required. And whatever be the incremental realisation, let the government retain a large portion of that as subsidy.
This way, we will have sufficient revenues to take care of increasing costs and bring in visibility on our future earnings and profits. Visibility on future earnings is important for investors as lack of it increases risk. This clarity will attract better valuations for ONGC. The government is paying attention to our problem and it has set up the Chaturvedi committee to look into the matter. Mr Chaturvedi was earlier the petroleum secretary and is well aware of the industry’s problems. We have already sent our recommendations to the committee with supporting data. We are hopeful of a solution soon.
Crude prices have nearly doubled over the past one year and continue to increase by the day. What is your view on the current crude price rally? Is it sustainable in the long run?
It is difficult to hazard a guess on crude oil prices. While demand-supply forces are affecting oil prices, speculation is certainly adding fuel to the fire. However, I think that crude oil prices will remain firm, as we don’t see any big increase in supply in the near future. Ultimately, crude prices will fall for sure, because when they increase beyond a point, the burden will be shifted to consumers. Once that happens, consumers will shift towards conservation — either improving efficiencies or cutting down on consumption altogether — and this will bring down prices, though it is difficult to guess to what extent.
Despite being out of the subsidy-sharing burden, why didn’t ONGC Videsh (OVL) gain much from rising crude oil prices in FY08?
Higher crude oil prices did benefit OVL. Its profit after tax (PAT) for FY08 rose 44% to Rs 2,397 crore. And this was despite paying Rs 725-crore interest to ONGC, which was not paid in the previous year. Further, OVL wrote off Rs 627 crore of depreciation on pipelines due to a change in accounting policy last year. Also, some provisions were created for its exploration projects, mainly in line with our conservative accounting policy. These provisions can be written back in future, based on the exploratory successes. If you consider these factors, you will notice a big jump in OVL’s profit.
Are high crude oil prices affecting OVL’s investment plans in oil fields?
High oil prices are creating many complications in valuation of assets. The sellers are asking for higher valuations, while as a buyer, we have to be more prudent. In that respect, it has become more difficult to strike a deal as a buyer. However, the deals are still being struck, though it is becoming more and more difficult to convince sellers of the valuations. Again, convincing ourselves of the new reality is also difficult.
What is your outlook on OVL’s production?
OVL’s production has been growing at a fast pace over the past few years. In FY03, it didn’t produce anything, but today, OVL’s production has crossed 8.8 million tonnes of oil equivalent (mtoe). During FY08, OVL’s crude oil production grew by around 18% to 6.81 mtoe and total production was up 11% to nearly 8.8 mtoe.
It’s A Balancing Act
HOWEVER, PRODUCTION may stagnate in FY09, as the existing fields have reached a plateau and no new fields are scheduled to commence production. That is, of course, provided we don’t make any acquisition. In the first half of FY10, OVL’s Brazil block is likely to start production. Similarly, our blocks in Egypt and Myanmar will commence production over the next couple of years. Besides, there are a number of exploration blocks in various stages of development and the option of acquisitions is always open.
OVL has been acquiring oil fields in the past. What is your financial strength for similar acquisitions in future?
ONGC’s balance sheet is quite strong with net worth of Rs 75,000 crore. It is a debt-free company with high cash reserves. This gives us a strong leverage of over Rs 1 lakh crore to finance our growth plans as well as acquisitions.
ONGC’s production has remained stagnant for the past few years. How do you expect your crude oil production to increase in India?
All of ONGC’s producing fields are old, wherein the production is naturally declining. Hence, a lot of investment is needed just to maintain the production. The costs of production, repair and maintenance are also high. Despite this, ONGC is wonderfully maintaining its production. Due to our exploration efforts, we have achieved a reserve replacement (RR) ratio of over 1. Higher reserve accretion than our production means that we won’t run out of oil soon. Going forward, we have three long-term strategies to improve our production.
Firstly, we want to add 20 billion tonnes of oil equivalent reserves by ’20. Secondly, we will take the oil recovery factor to 40% from 28%. So, we will produce more oil from each of our current fields.
Thirdly, we are looking at overseas assets for production growth. Our stated goal is to produce 20 million tonnes overseas by ’20, but we may even achieve this goal earlier. For the short term, redevelopment of older fields, marginal fields and Rajasthan fields, wherein we hold 30% stake, will lead to production growth for ONGC.
What is your dividend policy? Considering that ONGC is a cash-rich company, will it continue to declare hefty dividends as in the past?
As per government guidelines, we need to pay 30% of our profits as dividend. However, our dividend payout ratio is close to 50%. We are the largest dividend-paying company in India and since we have surplus money, we follow a liberal dividend policy. Going forward, we intend to maintain our dividend payout ratio.
Considering that the government has imposed restrictions on the company’s profitability, what is your message to ONGC’s retail investors?
If we compare ONGC with global oil majors, most of them do not have a high RR ratio. Our RR ratio has stayed above 1 in the past four years, which indicates that we are adding more to our reserves than our annual production. This ensures long-term future production growth.
While global oil companies are witnessing a fall in production, ONGC’s total production is increasing. The only problem is ad-hoc subsidies, which we are trying to do away with.
However, if we club together the profits of ONGC, OVL and Mangalore Refinery and Petrochemicals (MRPL), we see our consolidated profits growing steadily in future. Besides, we also have a consistent dividend policy. Hence, I believe retail investors should not be concerned with the short-term fluctuations in ONGC’s share price.
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