MANGALORE CHEMICALS: New Owner, Use of Natural Gas Can Improve Show

The stock of Mangalore Chemicals and Fertilisers, or MCFL, which has more than doubled in the past three months, was locked at at 10% upper circuit on Wednesday at . 61.7 after the Karnataka-based company emerged as a target for a takeover. The prospect of a bidding war for MCFL increased when Pune-based Deepak Fertilisers took a 24.5% stake last week in the company that produces urea and phosphatic fertilisers, after Zuari Global acquired a 10 % stake. MCFL has long been a comparatively inefficient player in the fertiliser industry with low operating margins, says Sunil Jain, head of equity research at Nirmal Bang Securities. According to him, it will be a little while before the company converts to natural gas. It is also weighed down by huge outstanding subsidy claims. At the end of FY13, the company had a debt of close to . 1,200 crore on its books, almost 85% of which was towards working capital to fund . 1,070 crore of delayed subsidy receipts. However, MCFL’s key location and the projected shift to natural gas appear to have piqued Deepak Fertilisers’ interest in the company. The decision could have been influenced by MCFL plant’s proximity to the New Mangalore port, from where all the important inputs can be imported, says Rajen Shah, Chief Investment Officer, Angel Broking MCFL is working on a feedstock conversion project that will enable it to use natural gas in place of the costly naphtha. The project is scheduled for completion by early 2014. The company plans to source regassified LNG from Petronet LNG’s Kochi terminal and has entered into supply and transportation agreements with Indian Oil and Gail India. This will lower costs considerably, thereby reducing its subsidy burden and financing costs. In FY12, the company had spent . 775 crore, or 21% of its revenues, on naphtha, while interest costs accounted for over one-third of its operating profit. Investors may benefit if they stay on as the prospects are likely to improve for the company if there is a new owner on board. 

OIL INDIA: Going up Steadily

Being a smaller peer to industry biggies such as ONGC, state-run Oil India is hardly spoken about when there is any discussion on India’s petroleum exploration and production sector. However, it is doing well in certain key areas, which can help the company emerge as a better value creator for investors. 
Oil India is using its capital more efficiently, argues Barclays in a recent report. According to the report, Oil India’s ‘finding and development (F&D) costs — costs incurred when acquiring, exploring and developing properties to establish hydrocarbon reserves — is just 55% of ONGC’s. This has helped Oil India maintain its return on capital employed, or RoCE, consistently higher than ONGC’s over the last decade.
When it comes to production growth, Oil India does a better job. Its output grew at a cumulative annualised growth rate, or CAGR, of 3% over the last decade, while ONGC’s annual growth dropped at an average of 0.4%.
Oil India’s out-performance will continue even in future, according to Barclays, as it spends $2.4 billion to achieve 4.2% annualised growth in production over the next four years. ONGC is expected to spend $24.2 billion to achieve a 2% annualised growth in production in the next four years.

NATURAL GAS INDUSTRY: Growth Pains to Continue on Low Availability

Once a sunrise industry, it is a challenging phase for India’s natural gas industry. Over the past year alone, there has been a wealth erosion of close to 25% for companies in this sector. With flagging domestic availability of natural gas, the near-term outlook for the industry remains clouded. The failure of RIL’s KG field led to an annual average drop of 10.7% in India’s domestic natural gas production over the last three years, a trend which is likely to continue despite the announcement of an increase in prices. “We do not see domestic natural gas production to scale up till March 2015. In fact, domestic natural gas production is expected to fall till then,” says Niraj Mansingka, associate director, Edelweiss Financial Services. According to him, gas production is expected to scale up beyond March 2015, and add 30-50 mmscmd till March 2018 depending on approvals. The other factor which will weigh on the performance of the industry is the regulatory overhang from the Petroleum and Natural Gas Regulatory Board (PNGRB), which has imposed several sharp tariff cuts for various pipelines in the past. The major overhang of PNGRB is mostly over, other than in the case of IGL where the hearing is still pending in the Supreme Court, and pending tariff for GAIL’s Gujarat pipeline network, says Nitin Tiwari, oil & gas sector research analyst, Religare Institutional Research. These imply that companies are going to earn much less for every rupee invested as compared to past. Return on capital employed (RoCE) and capacity utilisation of the industry would continue to be negatively impacted due to low domestic natural gas production, says Edelweiss’ Mansingka. Imports by way of LNG made up for a part of the shortfall, but a further growth from here appears difficult with Petronet LNG’s Dahej terminal reporting full utilisation. In fact, the delayed commissioning and expected low utilisation levels at its Kochi terminal is expected to bring down profitability. The weak outlook for Kochi, which now makes up 61% of capital employed and has driven a 6-9% cut in FY14-15 consensus EPS in 2013 so far, may continue to be a headwind despite the shares’ 39% underper- formance since end-2011, says a recent report from Barclays. The industry’s under-performance of late has taken valuations to historical lows as well as below global peers. However, the near-term pain is likely to continue. Investors should consider buying into some of these stocks only if they have a three- to five-year horizon. 

‘Energy Poverty’s Best Prevented by Income Transfers, Not Subsidies’

The annual edition of BP’s Statistical Review of World Energy is eagerly awaited by the industry, academia and policymakers keen on long-term trends in energy markets. Christof Ruhl, chief economist of BP, the man in-charge of not only compiling the humungous data but also making the numbers tell the story, was in India to unveil the 2013 edition of BP’s Statistical Review of World Energy. He shared his views on the emerging trends in global energy markets with ET’sRamkrishna Kashelkar. Edited excerpts 

How do you see global oil prices panning out over the next few years? What will be the key drivers? 
As a matter of course, we don’t publish price forecasts. We do however, spend a lot of time researching and publishing data on the fundamentals driving oil prices, both in the annual BP Statistical Review of World Energy and in BP’s annual Energy Outlook. There are at least two clearly discernible trends — on the supply side, the surprising growth of tight oil and the relentless shift towards emerging market economies on the demand side. We do think that OECD demand is likely to have peaked in 2005 and is in structural decline since. This indicates a relatively strong supply growth outside OPEC and moderate demand growth for the rest of this decade. Consequently, we believe that global oil markets will come under pressure, with OPEC being forced to cut its own production to stabilise the system. 

How do you view the advent of shale oil and gas and growth therein? Which are the countries likely to lead the unconventional hydrocarbons revolution? The resource is widespread globally, but its production is still in its infancy outside North America. I think it is very important to understand why this ‘revolution’ took place in the US and Canada, and not elsewhere. The reasons are not merely the availability of resources below ground. The reasons have much to do with what our industry likes to call ‘above ground’ factors — free access, competition and stable and conducive investment rules. Who is next in bringing these resources to market will thus not be a function of resource availability alone but of political decisions, mostly in two spheres — allowing for free access and competition among private investors to attract the necessary capital and technology and the constraints a society puts in place to prevent damage to our natural environment. In our outlook, we have China in the matter of shale gas and Russia in the matter of tight oil as the two next big producers for the period to 2030. But there are many smaller places in between which have large potential to realise. 

What will be the impact of a boom in shale oil or gas on OPEC in the medium term? How do you think OPEC will react? The growth of unconventional liquids is already changing global oil balances. We estimate increments of unconventional non-OPEC supply will account for all of the net growth in global oil production over this decade, and of 70% of the growth from 2020-30. There are large uncertainties, but our estimates at the lower end of a wide range of such estimates. In a normal market, this will bring down prices. But in oil markets, the impact seamlessly translates into the question how OPEC will respond. We assume that OPEC members are willing and able to curtail crude oil production in response to the new supplies over the current decade to balance oil markets. Even under our conservative scenario, this will translate into OPEC spare capacity climbing to the highest levels since the late 1980s and OPEC’s market share falling for years. The ability of OPEC to enforce these cuts is one key uncertainty here. The other is the future production level of tight oil. 

How do you view the influence of speculators and investors on crude oil price movements? Will that continue to go up in future? From time to time, and mostly when prices rise — rarely when they fall — people speculate about speculators or financial investors. Usually, without even as much as a clear definition of what the term “speculator” is supposed to mean and despite the fact that the fundamental forces of demand and supply appear to explain price movements well. Many studies — from academia, think-tanks, the industry, financial sector regulators and government agencies alike — have investigated the evidence and tried to establish a causal relationship between financial investment and oil prices. To the best of my knowledge, none has found a smoking gun. 

How do you view India’s current status with regard to high import dependency? What specific measures should India should adopt to ensure long-term energy security? Generally speaking, the key for energy security lies in liberalisation and global integration. A fast-growing emerging market economy such as India, with the ambition of combining rising population with rising income levels for a while longer, is obviously well advised to tap into all available resources, domestic and abroad. In both cases, this means to recognise that energy markets may well be big and complicated and slow moving, with their huge project sizes and long-gestation periods. But at the end of the day, they are only markets and so they follow the same principles as any other market. In the case of domestic production, this means to recognise the importance of market prices and competition in attracting the investment India needs. Producers will not produce if they can’t make a profit; and to prevent monopolies from exploiting the country’s needs is best done through competition. Similarly, consumers will always consume more if energy prices are cheap and subsidised than at international market prices; while energy poverty is best prevented by income transfers, not blanket subsidies. But I think the government knows all this and is on its way to graduallychange the landscape accordingly. 

What is the future of unconventional energy sources such as solar, wind or tidal? Will they continue to remain marginal in the foreseeable future?The basic problem for renewables is that as a sector they are still dependent on financial and policy support. Some renewable sources can compete, for example onshore wind in the best locations or solar power in Southern Italy, where there is plenty of sunshine and conventional electricity is expensive. But generally, it is a subsidised sector. If any subsidised fuel expands faster than its costs come down, subsidy payments have to increase to sustain the expansion. Such a process has its limits. 

CRUDE OIL: Rupee Plays Spoilsport

Stocks of state-owned oil companies were battered on Wednesday as oil prices rose in the global markets while the rupee once again fell below 60 against the dollar. The marginal increases in the price of diesel every month are inadequate and the industry’s under-recoveries are once again seen as rising.
“There has been a significant rally in crude oil prices in the last few days as they hit a 14-month high at NYMEX and a 5-year high in domestic bourses amidst tensions in the Middle East, which raised concerns about supply disruptions, and with market expectations of a sharp drop in crude inventories in the United States, the world’s top oil consumer,” says Sugandha Sachdeva, AVP, Energy Research, Religare Securities.
The petroleum ministry announced recently that under-recoveries on diesel have crossed 8 per litre and the industry’s daily losses have shot up to 358 crore — its highest level this fiscal. The three oil marketing companies together are expected to post under-recoveries of close to 28,000 crore for the April-June ’13 quarter, which may go up if the rupee and crude oil continue their northward course.

Reliance Inds may be on Course to Emerge as a Value Creator

Over the past six years, the stock of Reliance Industries, controlled by India's richest man Mukesh Ambani, has languished especially after the fall in the company’s gas output from its offshore field.
The government’s decision last week to increase the price of natural gas from $4.2 per British thermal unit to $8.4 from April next year could well be the trigger for the stock’s breakout. What should also help is the rising output and revenues from its investment in shale oil and gas in North America and expansion of its retail business and 4G services in telecom. Revenues from its retail business have already topped . 10,000 crore and the company now wants to raise its share of revenues from these two relatively new businesses to diversify.
The new natural gas pricing formula based on the recommendations of a committee headed by C Rangarajan, who heads the PM’s Economic Advisory Council, will come into force from April 1. That will mean the benefits will start accruing from FY15. The consensus estimate on RIL’s FY15 earnings is close to . 80 per share — an annualised growth of over 11% over . 64.5 for FY13.
Apart from higher prices for the natural gas produced by the company from its Krishna Godavari D6 block, RIL should also start deriving benefits from its investments in the refining and petrochemicals businesses. At the company's recent shareholders meeting, Mukesh Ambani had said that the conglomerate would pour in $27 billion over three years across all its businesses. This should lead to doubling of operating profits within five years.
RIL will also be a major beneficiary of the government's decision to raise customs duty on polymers in May 2013 and the introduction of a 15% investment deduction allowance in Budget 2013-14.
But what will keep RIL’s potential gains under check is stagnating production in its offshore field. Production from the KG basin has fallen below 15 MMSCMD and any significant improvement in output will take time. Barclays Capital reckons that there could be a rebound in FY15 although material increases will come only in 2016-17, it says.
A Kotak Securities report also echoes this view saying that EPS accretion could be meaningful at higher levels of gas production. The brokerage expects higher output from FY17E onwards led by commissioning of satellite fields. Going by the recent decision of the government, the price of natural gas will be revised on a quarterly basis based on a formula. The pricing formula is linked to India’s imported gas prices. This will mean that gas prices should move up in the medium-term since India’s longterm contract with RasGas will see annual revisions and higher-priced LNG imports from Gorgon in Australia will kick off in 2014-15.
The increase in gas price eliminates a key regulatory overhang. The change in tide for one of India’s top companies by revenues and profitability is reflected in the movement of its stock share, which has gained nearly 17% in the past year outperforming the gain of 11% gain in the benchmark Nifty. This is at odds with its under-performance since 2008 and is perhaps an indicator that RIL may be on course to emerge as a value creator for long-term investors.

Long-term PPAs to Save Utilities from Big Shock

HIKE IN NATURAL GAS PRICES: GROWTH TRIGGER FOR SOME, WHILE OTHERS FACE A HIT 

The revision in gas prices, which comes into force from April 2014, will have a marginal impact on power utilities such as NTPC, Reliance Power, GMR and GVK Power, thanks to the long-term power purchase agreement (PPA) with distribution companies. After the new gas price, the power bill of state discoms is likely to rise by just 3.5%, which in absolute numbers works out to $1.2 billion (. 7,000 crore). This may well be absorbed but given their poor financial health, distribution companies may need an additional subsidy from the government. 
Power producers, which sell power on longterm contracts, are likely to see a marginal impact on their earnings as in most contracts the fuel cost is a pass-through. What the government will need to ensure is that the state electricity boards are able to purchase power at higher costs. For most of them, gas-based plants form only 10-15% of their total power producing portfolios. But as power becomes more expensive, these companies may have to reckon with lower volumes though there is a comfort in that discoms will have to ensure at least a RoE of at least 15.5%.
Among gas-based power producers, stateowned NTPC will be the least less impacted as it has the entire capacity tied for longterm contracts with a fuel cost passthrough. However, GMR Infra and GVK Power, which plan to sell 20-25% power in the open market, will see a slightly higher impact. For these companies, gas-based capacities are higher than that of NTPC. NTPC’s gas-based capacity is only 12% of its total portfolio, while for GMR Infra and GVK Power it is over 25%. Reliance Power also has a 2,400 MW gas-based plant, which
    is still not operational. 
Another key consumer of domestic natural gas is the urea industry. The governmentmandated market price of urea is way below the cost of production, thus making it necessary to provide subsidies to producers, too.
For the industry, the feedstock cost is a pass-through. So, the rise in domestic gas prices will have no impact on the operating profit of fertiliser players. However, the industry’s working capital position could be stretched as the government typically delays subsidy payments, which leads to higher interest costs. Credit rating agency Crisil estimates that a rise in interest cost will lead to a 30-40 bps decline in net profit margins of urea manufacturers, assuming other things remaining constant. The government has already indicated that it will continue to subsidise these industries. If that happens, it will benefit all gas-based plants which are operating below 20% due to the fall in domestic availability of gas.