ONGC’s nod for Vedanta Group’s acquisition of Cairn India marks the end of the year-long saga of anxiety and uncertainty surrounding Cairn’s fate. Although Cairn had to finally accede to a few unfavourable covenants, those are already discounted in its share price. The share price should now reconnect with international crude oil prices — a correlation that had gone awry for the past one year.
Prior to the announcement of Vedanta’s acquisition, Cairn India had become a proxy for the equity investors to benefit from rising oil prices. Till August 2010, when the deal was announced, Cairn’s share was enjoying a nearly 90% correlation to the global oil prices. However, when oil prices started going up from December 2010 and gained over 21% within 12 weeks to cross $100 per barrel mark in February 2011, it became clear that the link had broken. Cairn’s share stayed range-bound between . 320 and . 340.
Now that the deal overhang is behind the company, there is a strong case for it to resume its old relationship with crude oil. There is no doubt that the compromise the company accepted — paying royalty on its 70% share of crude oil and paying cess without protest — will impact its profitability. However, the 15% fall in its share price since July this year has already captured the negative news.
A Nomura research report on August 26, when Cairn was trading at . 252 mentioned, “By our estimates its current stock price factors in a long-term oil price of only $60 per barrel.” Extending this logic its Wednesday’s closing price will factor oil price of around $67 per barrel.
Brent crude oil at $105 per barrel on Wednesday trades nearly 40% higher since August ’10, while the scrip trades 15% below. This makes a case for it to play a catch-up in the near future and make up for the lost ground. The regulatory approvals and ONGC’s support will also enable the company to stick to its development plans for the Rajasthan fields necessary to increase production.
A recent report by Goldman forecast a growth of Cairn’s production volumes by 2x between FY11 and FY14E and estimated Rajasthan gross oil volumes to reach 175,000 bpd by March ’12.
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