Oil India OILI.NS OINL INbreport.myiris.com/NFASIPL/OIL_20150908.pdf · Lower oil/gas price assumptions and new subsidy formula has led to 20-26% earnings cuts for FY16-18F. After

Oil India OILI.NS OINL IN

EQUITY: OIL & GAS/CHEMICALS

Low oil prices for longer; down to Neutral

Correction limits downsides; but no reason to buy now if oil prices remain low for longer Action: Cut earnings by 20-25% and TP by 23% on lower oil price assumptions ; valuation inexpensive but triggers elusive

Global Markets Research 8 September 2015

Rating Down from Buy NeutralTarget price Reduced from 570 INR 440

Closing price 4 September 2015 INR 436

Potential upside +1%

Anchor themesLow oil for longer scenario is negative for upstream oil PSUs. We continue prefer downstream over upstream among oil PSUs.

Nomura vs consensusOur FY16/17F EPS are 20/24% below consensus. Our TP is 21% below consensus.

Research analysts

India Oil & Gas/Chemicals

Anil Sharma - NFASL [email protected] +91 22 4037 4338

Ravi Adukia, CFA - NFASL [email protected] +91 22 4037 4232

Nomura’s global oil/gas team has sharply cut Brent oil price assumption by up to 21-25%. Our new oil price assumptions are USD53/55/60/70/ bbl for FY16F/17F/18F/long term (vs USD60/70/80/bbl for FY16F/17F/LT), respectively. Lower oil/gas price assumptions and new subsidy formula has led to 20-26% earnings cuts for FY16-18F. After a period of underperformance (1-year OINL -24% vs Sensex -8%), valuations are inexpensive, in our view (trading at 1.1x FY17F P/B and 9.0x FY17F P/E), but we do not see many positive catalysts ahead. Neutral.

Outlook weak for oil and gas prices; operationally not much cheer Our global oil team thinks that while oil prices have bottomed at around

USD40/bbl, potential supply growth from OPEC countries such as Saudi Arabia, Iraq and Iran will keep a firm lid on oil price recovery.

The new FY16 subsidy formula (government support capped at INR12/L for kerosene, 18/kg for LPG) implies that upstream will bear the subsidy unless oil is< USD46/bbl. This is more negative than the earlier formula (no subsidy if oil < USD60/bbl), and will likely lead to flat realisations when oil is > USD65/bbl.

Domestic gas price will likely fall to USD4.2-4.3/mmbtu from 1-Oct, with further declines likely. Low prices will deter new investments, in our view.

Operationally, visibility remains low on any meaningful production increase.

The Assam’s government demand for royalty payments at pre-discounted prices remain an overhang.

TP cut to INR440 (from INR570); Prefer downstream oil PSUs Due to sharp 20-26% earnings cut, our P/B-based TP falls to INR440 (from INR570). We downgrade Oil India to Neutral. Among Indian oil PSUs, we prefer downstream names (IOCL>HPCL>BPCL) over upstream.

Year-end 31 Mar FY15

Key company data: See next page for company data and detailed price/index chart

FY16F FY17F FY18F

Currency (INR) Actual Old New Old New Old New

Revenue (bn) 95 119 105 125 107 115

Reported net profit (bn) 26 35 28 39 29 33

Normalised net profit (bn) 26 35 28 39 29 33

FD normalised EPS 43.39 58.76 46.56 65.07 48.25 55.13

FD norm. EPS growth (%) -11.3 35.4 7.3 10.7 3.6 14.3

FD normalised P/E (x) 10.0 N/A 9.4 N/A 9.0 N/A 7.9

EV/EBITDA (x) 7.5 N/A 6.2 N/A 6.1 N/A 5.2

Price/book (x) 1.2 N/A 1.1 N/A 1.1 N/A 1.0

Dividend yield (%) 4.6 N/A 4.3 N/A 4.4 N/A 5.1

ROE (%) 12.4 15.7 12.6 16.0 12.2 13.1

Net debt/equity (%) 0.2 net cash net cash net cash net cash net cash

Source: Company data, Nomura estimates

See Appendix A-1 for analyst certification, important disclosures and the status of non-US analysts.

Nomura | Oil India 8 September 2015

2

Key data on Oil India Relative performance chart

Source: Thomson Reuters, Nomura research

Notes:

Performance (%) 1M 3M 12MAbsolute (INR) -1.0 -7.4 -30.9 M cap (USDmn) 3,939.6Absolute (USD) -5.1 -10.7 -37.2 Free float (%) 12.7Rel to MSCI India 5.6 -5.3 -27.6 3-mth ADT (USDmn) 2.4 Income statement (INRbn) Year-end 31 Mar FY14 FY15 FY16F FY17F FY18FRevenue 92 95 105 107 115Cost of goods sold -56 -61 -66 -68 -70Gross profit 36 34 38 39 46SG&A -13 -11 -13 -15 -16Employee share expense 0 0 0 0 0Operating profit 23 23 25 24 29EBITDA 36 34 38 39 46Depreciation -13 -11 -13 -15 -16Amortisation

EBIT 23 23 25 24 29Net interest expense -1 -3 -4 -4 -4Associates & JCEs 0 1 1 1 1Other income 21 18 19 20 22Earnings before tax 44 38 41 42 48Income tax -14 -12 -13 -13 -15Net profit after tax 29 26 28 29 33Minority interests

Other items 0 0 0 0 0Preferred dividends

Normalised NPAT 29 26 28 29 33Extraordinary items

Reported NPAT 29 26 28 29 33Dividends -15 -14 -13 -14 -16Transfer to reserves 14 12 15 15 17Valuations and ratios

Reported P/E (x) 8.9 10.0 9.4 9.0 7.9Normalised P/E (x) 8.9 10.0 9.4 9.0 7.9FD normalised P/E (x) 8.9 10.0 9.4 9.0 7.9Dividend yield (%) 4.9 4.6 4.3 4.4 5.1Price/cashflow (x) 9.9 14.9 5.2 8.2 6.9Price/book (x) 1.3 1.2 1.1 1.1 1.0EV/EBITDA (x) 6.8 7.5 6.2 6.1 5.2EV/EBIT (x) 10.6 11.0 9.4 9.6 8.0Gross margin (%) 39.2 35.7 36.7 36.6 39.4EBITDA margin (%) 39.2 35.7 36.7 36.6 39.4EBIT margin (%) 25.3 23.9 23.8 22.8 25.3Net margin (%) 31.9 27.5 26.7 27.2 28.7Effective tax rate (%) 32.6 31.4 32.0 31.0 31.1Dividend payout (%) 51.4 55.4 48.1 48.1 48.1ROE (%) 14.8 12.4 12.6 12.2 13.1ROA (pretax %) 12.7 9.2 9.3 8.8 9.9Growth (%)

Revenue -3.3 2.7 10.4 1.9 8.2EBITDA -13.9 -6.7 13.5 1.7 16.6Normalised EPS -18.1 -11.3 7.3 3.6 14.3Normalised FDEPS -18.1 -11.3 7.3 3.6 14.3Source: Company data, Nomura estimates

Cashflow statement (INRbn) Year-end 31 Mar FY14 FY15 FY16F FY17F FY18FEBITDA 36 34 38 39 46Change in working capital -6 -2 19 1 4Other operating cashflow -3 -14 -7 -8 -11Cashflow from operations 26 18 51 32 38Capital expenditure -29 -30 -25 -25 -27Free cashflow -2 -12 26 7 11Reduction in investments -31 -4 -4 -4 -6Net acquisitions Dec in other LT assets -22 -13 -10 -9 -10Inc in other LT liabilities 4 4 0 0 0Adjustments -21 24 23 24 25CF after investing acts -72 -2 35 17 21Cash dividends -21 -9 -14 -13 -14Equity issue 0 0 0 0 0Debt issue 89 -13 0 0 0Convertible debt issue 0 0 0 0 0Others -1 -5 -4 -4 -4CF from financial acts 67 -27 -18 -17 -17Net cashflow -5 -28 17 0 3Beginning cash 121 117 88 106 106Ending cash 117 88 106 106 109Ending net debt -15 0 -17 -17 -20 Balance sheet (INRbn) As at 31 Mar FY14 FY15 FY16F FY17F FY18FCash & equivalents 117 88 106 106 109Marketable securities 14 14 18 22 28Accounts receivable 5 24 7 7 7Inventories 10 11 12 12 13Other current assets 27 27 27 27 27Total current assets 172 164 168 173 183LT investments 36 40 40 40 40Fixed assets 19 27 29 31 34Goodwill 53 56 56 56 56Other intangible assets 0 0 0 0 0Other LT assets 71 85 95 104 114Total assets 351 371 388 404 427Short-term debt 101 89 89 89 89Accounts payable 17 33 37 37 41Other current liabilities 8 9 8 9 11Total current liabilities 126 131 134 135 140Long-term debt Convertible debt 0 0 0 0 0Other LT liabilities 21 25 25 25 25Total liabilities 147 156 158 160 165Minority interest Preferred stock Common stock 6 6 6 6 6Retained earnings 175 185 200 215 232Proposed dividends Other equity and reserves 24 24 24 24 24Total shareholders' equity 205 215 230 245 262Total equity & liabilities 351 371 388 404 427

Liquidity (x)Current ratio 1.36 1.25 1.26 1.28 1.31Interest cover 33.0 6.5 6.5 6.3 7.6LeverageNet debt/EBITDA (x) net cash 0.01 net cash net cash net cashNet debt/equity (%) net cash 0.2 net cash net cash net cash

Per shareReported EPS (INR) 48.94 43.39 46.56 48.25 55.13Norm EPS (INR) 48.94 43.39 46.56 48.25 55.13FD norm EPS (INR) 48.94 43.39 46.56 48.25 55.13BVPS (INR) 340.72 357.90 382.07 407.13 435.76DPS (INR) 21.50 20.00 18.62 19.30 22.05Activity (days)Days receivable 27.5 55.3 53.4 22.8 22.1Days inventory 53.0 61.0 61.3 63.8 65.0Days payable 109.7 148.4 192.5 200.2 203.9Cash cycle -29.2 -32.2 -77.9 -113.6 -116.8Source: Company data, Nomura estimates


3

Oil prices to stay low for longer Nomura’s global oil/gas team is downgrading the average Brent oil price by 21% and 25% respectively for 2016 and 2017.

• Despite record-high global oil demand and surging China crude imports, potential supply growth from OPEC countries like Saudi Arabia, Iraq and Iran will keep a firm lid on oil price recovery.

• Potential US Fed rate hikes ahead also pose severe headwinds against any sustainable oil price rallies.

• US shale oil production has seen a steady decline since May and the current global oversupply of about 3m bopd could ease starting late 2016; thus we still forecast oil prices will rise mildly ahead, although we lower our long-term Brent price forecast from US$80 to US70/bbl from 2018F onwards.

• We believe global oil prices have bottomed at around US$40/bbl recently as pessimism peaked over widespread concerns of a slowdown in China amid global equity market routs.

Fig. 1: Average Brent oil price, historical and forecasts (new vs. old)

Source: Bloomberg, Nomura estimates

While many conventional oil projects such as those in the Middle East could still thrive at prevailing depressed oil prices, there are not enough of these low-cost projects around the world that could supply enough production growth to meet demand growth on a reliable basis. In our view, not only will abnormally low oil prices discourage the deployment of advanced technologies to mitigate mature field productivity declines, they may also trigger more project cancellations and existing field development delays, which ultimately could lead to a potential supply shortfall.

Fig. 2: Oil majors’ 1H15 capex vs. 1H14

Source: Company filings, Bloomberg

$55 $66

$73

$99

$63

$80

$111 $112 $109 $99

$53 $60

$55

$70 $60

$80 $70

$80

$-

$20

$40

$60

$80

$100

$120

-32%

-40%

-31%

-12%

-20% -19%

-13%

-45%

-40%

-35%

-30%

-25%

-20%

-15%

-10%

-5%

0%PetroChina Sinopec CNOOC Exxon-Mobil BP Shell Chevron

We believe the current oil price environment will trigger project delays and cancellations which will eventually cause a supply reduction.


4

Fig. 3: World petroleum supply and demand forecasts

Source: IEA

(For more details please refer to our oil and gas team’s detailed notes: “EU team’s oil price update” 08 Sep 2015 and “Asia oil & gas/chemicals: Oil prices to stay low for longer, 08 Sep 2015)

Fig. 4: Change in our India oil and gas price assumptions

FY16F FY17F FY18F LT

Brent (USD/bbl)

New 53 55 60 70

Old 60 70 80 80

Change -12% -21% -25% -13%

Domestic gas (USD/mmbtu)

New 4.7 4.0 4.0 4.0

Old 5.0 5.0 5.0 5.0

Change -6% -20% -20% -20%

Source: Nomura estimates

2006 2007 2008 2009 2010 2011 2012 2013 2014 1Q15 2Q15 3Q15 4Q15 2015 1Q16 2Q16 3Q16 4Q16 2016

Americas 25.7 25.8 24.5 23.7 24.1 24.0 23.6 24.0 24.1 24.2 24.1 24.5 24.7 24.4 24.5 24.2 24.6 24.9 24.5 Europe 15.7 15.6 15.5 14.7 14.7 14.3 13.8 13.6 13.4 13.6 13.4 13.8 13.5 13.6 13.3 13.5 13.8 13.5 13.5 Pacif ic 8.7 8.7 8.3 8.0 8.2 8.2 8.6 8.4 8.2 8.8 7.7 7.8 8.3 8.1 8.6 7.6 7.8 8.4 8.1

Total OECD 50.2 50.1 48.4 46.3 47.0 46.5 46.0 46.1 45.6 46.6 45.1 46.1 46.5 46.1 46.4 45.3 46.2 46.7 46.2

FSU 4.0 4.0 4.2 4.0 4.1 4.4 4.5 4.6 4.8 4.6 4.8 4.9 4.8 4.8 4.6 4.7 4.9 4.9 4.8 Europe 0.7 0.7 0.7 0.7 0.7 0.7 0.7 0.7 0.7 0.7 0.7 0.7 0.7 0.7 0.7 0.7 0.7 0.7 0.7 China 7.2 7.6 7.7 7.9 8.9 9.3 9.8 10.1 10.6 10.7 11.1 10.8 11.1 10.9 11.1 11.3 11.2 11.5 11.3 Other Asia 9.3 9.8 9.9 10.3 10.7 11.0 11.3 11.7 12.0 12.4 12.5 12.2 12.7 12.5 12.9 12.9 12.6 13.1 12.9 Latin America 5.2 5.3 5.6 5.7 6.1 6.2 6.4 6.6 6.8 6.7 6.9 7.0 7.0 6.9 6.8 7.0 7.1 7.2 7.0 Middle East 6.1 6.4 6.7 7.1 7.3 7.5 7.7 8.0 8.1 7.8 8.3 8.7 8.1 8.2 8.0 8.5 9.0 8.4 8.5 Af rica 2.9 3.3 3.3 3.4 3.5 3.5 3.7 3.7 4.0 4.1 4.1 4.0 4.2 4.1 4.3 4.3 4.2 4.3 4.3

Total Non-OECD 35.5 37.0 38.1 39.1 41.4 45.6 44.1 45.4 47.0 47.1 48.4 48.5 48.7 48.2 48.4 49.5 49.8 50.1 49.4 Total Demand 85.6 87.0 86.5 85.4 88.5 89.0 90.1 91.4 92.6 93.6 93.5 94.5 95.2 94.2 94.8 94.8 96.0 96.8 95.6

Americas 13.9 13.8 13.3 13.6 14.1 14.6 15.9 17.2 19.0 20.0 19.7 19.4 19.6 19.7 19.9 19.8 19.9 20.2 20.0 Europe 5.3 5.0 4.8 4.5 4.1 3.8 3.5 3.3 3.3 3.4 3.5 3.3 3.4 3.4 3.4 3.2 3.0 3.3 3.2 Pacif ic 0.6 0.6 0.6 0.6 0.7 0.6 0.6 0.5 0.5 0.4 0.4 0.5 0.5 0.5 0.5 0.5 0.5 0.5 0.5

Total OECD 19.8 19.4 18.7 18.8 18.9 19.0 19.9 21.0 22.8 23.8 23.7 23.2 23.5 23.5 23.8 23.5 23.5 24.0 23.7

FSU 12.3 12.8 12.8 13.3 13.5 13.5 13.6 13.9 13.9 14.0 14.0 13.8 13.8 13.9 13.8 13.7 13.6 13.6 13.7 Europe 0.1 0.2 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 China 3.7 3.7 3.8 3.8 4.1 4.1 4.2 4.2 4.2 4.3 4.4 4.3 4.3 4.3 4.2 4.2 4.2 4.2 4.2 Other Asia 3.8 3.7 3.7 3.6 3.7 3.6 3.6 3.6 3.5 3.6 3.6 3.6 3.7 3.6 3.6 3.6 3.5 3.5 3.6 Latin America 3.6 3.6 3.7 3.9 4.1 4.2 4.2 4.2 4.4 4.6 4.6 4.6 4.6 4.6 4.6 4.7 4.7 4.7 4.7 Middle East 1.7 1.7 1.7 1.7 1.7 1.7 1.5 1.3 1.3 1.3 1.2 1.2 1.2 1.2 1.2 1.1 1.1 1.1 1.1 Africa 2.5 2.6 2.6 2.6 2.6 2.6 2.3 2.4 2.3 2.3 2.3 2.2 2.2 2.3 2.2 2.2 2.2 2.2 2.2

Total Non-OECD 27.8 28.2 28.4 29.0 29.9 29.9 29.5 29.7 29.8 30.4 30.2 29.9 29.9 30.1 29.9 29.6 29.4 29.5 29.6 Processing Gains 2.0 2.0 2.0 2.0 2.1 2.1 2.1 2.2 2.2 2.2 2.2 2.2 2.2 2.2 2.3 2.3 2.4 2.3 2.3 Global Biofuels 0.8 1.1 1.4 1.6 1.8 1.9 1.9 2.0 2.2 1.8 2.4 2.6 2.3 2.3 1.8 2.3 2.6 2.3 2.3 Total Non-OPEC 50.4 50.7 50.6 51.4 52.6 52.8 53.4 54.9 57.0 58.2 58.4 57.9 57.9 58.1 57.8 57.7 57.9 58.1 57.9

Crude 30.9 30.7 31.6 29.1 29.2 29.9 31.3 30.5 30.3 30.5 31.5 NGLs 4.3 4.3 4.5 4.9 5.6 5.9 6.3 6.3 6.4 6.5 6.6 6.7 6.7 6.6 6.8 6.8 6.9 6.9 6.9

Total OPEC 35.2 35.0 36.1 34.0 34.7 35.8 37.6 36.8 36.6 37.0 38.1 Total Supply 85.5 85.7 86.7 85.4 87.4 88.7 90.9 91.6 93.7 95.3 96.5 STOCK CHANGES AND MISCELLANEOUSReported OECDIndustry 0.2 (0.3) 0.3 (0.1) 0.1 (0.2) 0.2 (0.2) 0.4 0.9 1.1 Government - 0.1 - 0.1 - (0.1) 0.0 0.0 - - - Total 0.3 (0.2) 0.3 - 0.1 (0.3) 0.2 (0.2) 0.4 0.9 1.1 Floating Storage/Oil in Transit (0.1) - - 0.3 (0.2) (0.1) (0.0) 0.1 - (0.1) 0.2 Miscellaneous to balance (0.3) (1.1) (0.1) (0.3) (1.0) - 0.7 0.3 0.6 0.8 1.7

Total Stock Ch. & Misc (0.1) (1.4) 0.3 - (1.1) (0.4) 0.9 0.2 1.0 1.6 3.0 Memo items:

Call on OPEC crude 29.1 30.3 30.3 30.4 30.3 29.3 28.8 28.5 30.0 30.6 29.5 30.3 30.2 31.1 31.8 30.8

OECD DEMAND

NON-OECD DEMAND

OECD SUPPLY

NON-OECD SUPPLY

OPEC

http://go.nomuranow.com/research/globalresearchportal/getpub.aspx?pid=761595&appname=Email&cid=UDRTSDdLZ2F2Nnc90





5

Downgrade to Neutral

Gross oil realisation to decline; Net oil realisation decline sharper as subsidies will now continue even at low oil

For upstream oil producers, the long-term low oil prices are a negative. For Indian public sector oil companies (oil PSUs), which did not benefit much from high oil prices (due to high subsidies), there was an expectation that the subsidy burden will not be there when oil prices are low.

Indeed, as per earlier proposed formula for 1Q (no subsidy below oil price <USD60/bbl, 85% subsidy for oil between USD60-100/bbl, 90% subsidy for oil >USD100/bbl), there would have been no subsidy paid by upstream at current oil prices.

However, the expectations were short lived, and this formula was not implemented even for 1QFY16. The Indian government (GoI) now has a new upstream subsidy formula for FY16. As per this formula, subsidy sharing would be as below:

• Kerosene: The GoI budgetary support at INR12/L and the remaining under-recovery will be borne by upstream companies.

• LPG: A fixed subsidy of INR18/kg under the direct benefit transfer of LPG (DBTL).

There will now be no upstream subsidy unless oil falls below USD46/bbl (vs USD60 previously) This formula, in our view, is negative for upstream companies, further increasing their problems, in the current environment of low oil prices.

• While for LPG, as the break-even price (including INR18/kg government support) is ~USD60/bbl, so there will likely be no subsidy sharing on LPG by upstream while oil prices are below USD60/bbl.

• However, the break-even price for kerosene (including INR12/L government support), is only ~USD46/bbl. Thus upstream subsidy burden due to kerosene will continue even if the oil price remains below USD60/bbl (as these currently are), and will vanish only when oil prices fall below USD46/bbl.

While overall under-recovery/subsidy size has declined sharply (from the peak of USD29-30bn in FY12-13 to likely USD5-7bn in FY16/17F), and GoI’s flexibility to compensate has increased (last year’s excise duty hikes on petrol/diesel led to incremental annual revenue of ~INR11-12b), we had previously expected the GoI to give relief to upstream companies from subsidy sharing when oil prices are below USD60/bbl. But, this is not the case now.

Fig. 5: Under-recoveries set to decline sharply FY12 FY13 FY14 FY15 FY16F FY17F FY18F

Brent price (US$/bbl) 114.5 110.6 107.7 85.6 53.0 55.0 60.0

Exchange rate (INR/US$) 47.9 54.4 60.4 61.1 65.0 65.0 65.0

Under-recoveries (per unit)

Diesel (INR/L) 10.4 11.3 8.4 2.7 - - -

PDS Kerosene (INR/L) 27 32 35 28 15 16 18

Domestic LPG (INR/cyl) 343 450 522 410 176 197 239

Domestic LPG (INR/kg) 24 32 37 29 12 14 17

Under-recoveries (INRbn)

Diesel 812 921 628 109 - - -

PDS Kerosene 274 294 306 248 132 140 155

Domestic LPG 300 396 465 366 - - -

Total under-recoveries 1,385 1,610 1,399 723 132 140 155

DBT on LPG - - - 40 191 222 283

Total Subsidies - INRbn 1,385 1,610 1,399 763 324 362 438

Total - USDbn 28.9 29.6 23.2 12.5 5.0 5.6 6.7

Source: Petroleum Planning & Analysis Cell (PPAC), Nomura estimates

We estimate fuel under-recoveries will decline to INR130-155bn for FY16-18F, less than 1/10th level from peak of INR1.6tn in FY13

Including DBT subsidy for LPG, the overall subsidy/under-recovery size is likely to decline to USD5-7bn in FY16/17F vs a peak of USD29-30bn


6

Upstream net realizations will likely remain flat when oil move over USD65/bbl Effectively under the newly adopted formula the upstream companies pay for all incremental subsidies for kerosene when oil prices are above USD46/bbl, and all incremental LPG subsidies when oil prices are above USD60/bbl.

As oil prices move up the subsidies on both LPG and kerosene are expected to rise sharply (unless retail prices are increased or the government takes some section of consumers out of subsidy sharing for LPG).

If upstream shares all incremental under-recoveries (over INR18/kg for LPG, over INR12/L for kerosene, as it currently is doing), we estimate that the effective net oil price realisation will likely remain flat for ONGC/OIL when oil prices move over USD65/bbl.

Fig. 6: Subsidy sharing : Net oil realisation for upstream will not increase much In low oil price environment, and capped govt subsidy, net realization for upstream will remain low FY12 FY13 FY14 FY15 FY16F FY17F FY18F

Total under-recoveries 1,385 1,610 1,399 763 324 362 438

Subsidy sharing (INRbn)

Government 835 1,000 708 313 298 327 386

- Kerosene 107 105 103

- DBTL 191 222 283

Upstream 550 600 670 428 25 35 52

- Kerosene 25 35 52

- DBTL - - -

OMCs 0 10 21 22 - - -

Subsidy sharing (%)

Government 60% 62% 51% 41% 92% 90% 88%

Upstream 40% 37% 48% 56% 8% 10% 12%

OMCs 0% 1% 1% 3% 0% 0% 0%

Upstream realisation (USD/bbl)

Brent 114.5 110.6 107.7 85.6 53.0 55.0 60.0

Upstream subsidy 56.0 56.0 59.3 37.7 2.1 2.8 4.0

Brent - Subsidy 58.5 54.6 48.4 47.9 50.9 52.2 56.0

Source: PPAC, Nomura estimates

Fig. 7: Upstream net-realisation scenario at different oil prices New subsidy share formula is inferior to earlier proposed formula. Upstream will need to pay subsidy till oil price fall below USD45-46/bbl, and upstream net-realisation will not move up when oil moves up over USD65/bbl Brent (USD/bbl) 45 50 55 60 65 70 80 90 100

Under-recoveries/subsidy (INRbn) 240 301 362 424 485 546 668 790 912

- Kerosene under-recovery 105 123 140 158 176 193 229 264 299

- DBT subsidy for LPG 135 179 222 266 309 352 439 526 613

New formula

Govt. support (INRbn) 240 284 327 371 393 393 393 393 393

Upstream share (INRbn) - 18 35 53 92 153 275 397 520

Upstream subsidy (USD/bbl) - 1.4 2.8 4.2 7.3 12.2 22.0 31.7 41.5

Net realisation (USD/bbl) 45.0 48.6 52.2 55.8 57.7 57.8 58.0 58.3 58.5

Earlier proposed formula

- Subsidy(USD/bbl) - - - - 4.3 8.5 17.0 25.5 34.0

- Net realisation (USD/bbl) 45.0 50.0 55.0 60.0 60.8 61.5 63.0 64.5 66.0

New vs earlier net realisation 0% -3% -5% -7% -5% -6% -8% -10% -11%


Despite much lower subsidy problem size, and much higher cushion with government to absorb fuel subsidies, upstream companies are bearing subsidies even when oil prices are below USD60/bbl.

Importantly, upstream companies net realisation will also not increase much even when oil prices move-up significantly under current formula.


7

Gas prices declining; low prices deter new investment

Domestic gas prices back to where it began, and will likely fall further Last year when government had adopted the new domestic gas pricing formula, we highlighted that ‘gas price hike was not so good or well thought out’. (See Good decision on diesel/LPG, not so for gas, 20 October 2014 and Gas formula gets more -ve for upstream, 21 October 2014.)

• The key reason for the industry seeking a higher gas price was to make current production more profitable and to encourage new investment. However, in our view, the basic intention (while modifying the Rangarajan formula) seemed to have been to limit price increases (to make the increase more palatable for consumers).

• To keep prices low, GoI removed expensive LNG components (both Japanese and Indian imports) and instead included Alberta gas reference price and Russian price, in addition to retaining Henry Hub and NBP prices. In our view, primarily using gas-surplus/export regions (eg, US, Canada and Russia) to determine prices in a gas-deficit country like India was not logical. Moreover, to further keep prices low, the GoI excluded transport and gas treatment charges under different hubs.

While the gas prices increased 34% in November 2014 (from USD4.2 to USD 5.6/mmbtu), these declined by 7% to USD5.2/mmbtu when prices were first reset on 1-Apr-15. As international prices have fallen further, we expect a much steeper decline of 17-18%, and domestic gas prices will likely decline to just USD4.2-4.3/mmbtu, prices would then be at a similar level as when new price formula was adopted. As regional hub prices remain low, we think prices will likely fall even further when prices reset next year.

No clarity yet on premium for new discoveries Also, while announcing the new gas price formula, government had talked of a premium over the price for higher cost development areas (such as deep water). The government later clarified that such premiums would be applicable only to new discoveries made after the 20 October 2014 gas price decision, thus ruling out such a premium for existing deep-water discoveries (like ONGC’s KG-98/2 ultra-deep water discovery).Nearly a year has elapsed, and the government is yet to announce the premium.

Gas production has been falling; and new investment seems unlikely soon The basic reason for adopting a new price formula was to increase domestic gas prices and to make these attractive for current production and also develop existing discoveries as well as encourage new investments. As the gas price increase was not large, and prices are on a declining trend, it is not encouraging investment to sustain current production, let alone development of existing discoveries. Similarly, as the government has not announced the premium for new discoveries (and expectations are not of very high premium, the likelihood of large scale investment remain low, in our view, in the short to medium term.

Fig. 8: Domestic gas prices

Gas prices (USD/mmbtu)

Nov - Mar 15 April - Sept 15 Oct - Mar 16

USA - Henry Hub 3.8 3.9 2.8

Canada (Alberta) 3.0 3.6 2.5

Europe (NBP) 9.2 7.7 6.9

Russia (domestic) 2.5 2.5 2.3

India (GCV) 5.1 4.7 3.9

India (NCV) 5.6 5.2 4.3

Decline -7% -17%

Source: Bloomberg, PPAC, Nomura estimates

Fig. 9: Gas price back to same level before the new formula

Source: PPAC, Nomura estimates

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The key rationale for adopting new price formula was to raise domestic gas prices to make current production attractive, and encourage new investment.

With prices declining so much, domestic production is not increasing, and new investment is not forthcoming.

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8

Operational headwinds remain • Oil India’s oil and gas production has been affected by the regular strike and worsening

law-and-order situation in the north east.

– Oil production has been on the decline after a peak in mid-2012. It has declined by 2-5%p.a. over FY13-15.

– Gas production has also not shown any meaningful increase. After remaining flat for FY13-14, it increased by a modest 4% in FY15. Gas production however is expected to increase with the commissioning of Brahmaputra gas cracker, in our view.

• Oil India’s overall production and other costs have significantly increased over the last few years.

• Despite a reserve replacement ratio of >1x over the last few years, Oil India’s 1P reserves have also remained largely stagnant.

• Oil India’s exploration efforts have not led to any significant success in recent years, in our view. Of the capex incurred on exploration (survey + drilling) over the last three years, it has written off c.80% of costs.

• Oil India has received a notice from the Assam government claiming INR 72.2bn for royalty on pre-discount oil price realisations for FY09-14. This issue will likely remain an overhang until the Supreme Court rules on the royalty dispute case between the Gujarat government and ONGC, in our view.

Fig. 10: Nominated blocks: Declining oil production

Source: Company data, Nomura research

Fig. 11: Nominated blocks: Largely flat gas production


Fig. 12: Oil India – operating and other costs trend

USD/boe FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 1QFY15 2QFY15 3QFY15 4QFY15 1QFY16

Brent 58.0 64.4 82.4 84.8 69.7 86.7 114.5 110.6 107.7 85.6 109.8 102.2 76.0 54.2 62.1

Operating costs 6.4 6.5 9.5 10.8 9.7 9.6 14.3 10.7 11.9 14.2 11.8 11.8 12.4 18.5 14.4

Statutory levies 11.7 13.8 16.7 13.6 13.3 14.5 12.3 14.2 12.6 12.1 13.1 11.5 11.2 12.9 13.3

DD&A 3.0 3.0 3.3 4.6 4.3 4.9 5.2 4.0 5.6 4.8 2.9 3.7 5.2 5.1 4.2

Total costs 21.0 23.3 29.4 28.9 27.3 28.9 31.8 28.9 30.1 31.1 27.8 27.0 28.8 36.4 31.8


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Fig. 13: 2P RRR of > 1 for last several years


Fig. 14: ...but 1P reserves have been on decline


Fig. 15: Capex on rising trend Spent over INR30bn in capex each of last three years


Fig. 16: Exploration capex and write-off trends Written off c.80% of exploration capex incurred over last 3 years


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Key modelling assumptions Fig. 17: Key assumptions and EPS estimates for OIL India

(USD/bbl) FY12 FY13 FY14 FY15 FY16F FY17F FY18F

Brent 114.5 110.6 107.7 85.6 53.0 55.0 60.0

Subsidy 56.0 56.0 59.3 37.7 2.1 2.8 4.0

Net realisation 58.5 54.6 48.4 47.9 50.9 52.2 56.0

Reported realisation

Gross 114.7 109.6 106.4 84.3 51.9 53.9 58.8

Subsidy 54.8 56.0 59.3 37.3 2.1 2.8 4.0

Net 59.8 53.6 47.1 46.9 49.9 51.1 54.8

Gas price (USD/mmbtu) 4.2 4.2 4.2 4.8 4.7 4.0 4.0

EPS (INR.sh) 57.7 59.8 48.9 43.4 46.6 48.3 55.1

EPS growth % 20% 4% -18% -11% 7% 4% 14%


Fig. 18: Production volume assumptions

FY10 FY11 FY12 FY13 FY14 FY15 FY16F FY17F FY18F

Oil production

- MMT 3.63 3.62 3.87 3.70 3.50 3.44 3.47 3.54 3.61

- kbpd 70.8 70.6 75.4 72.2 68.3 67.1 67.7 69.1 70.4

Y-Y% 3.9% -0.2% 6.7% -4% -5% -2% 1% 2% 2%

Gas production

- BCM 2.4 2.4 2.6 2.6 2.6 2.7 2.8 2.9 3.1

- mmscmd 6.6 6.4 7.2 7.2 7.2 7.5 7.7 8.1 8.4

Y-Y% 6% -3% 12% 0% 0% 4% 3% 5% 4%


Fig. 19: Sensitivity of Oil India’s EPS to key variables

FY16F FY17F

Base EPS(INR/share) 46.6 48.3

INR/share % INR/share %

Net reported oil realisation (USD/bbl) 49.9 51.1

- Increase by USD1/bbl 1.4 3% 1.4 3%

Gas price (USD/mmbtu) 4.7 4.0

- Increase by USD1/mmbtu 4.7 10% 5.0 10%

Exchange rate (INR/USD) 65.0 65.0

- INR1/USD appreciation 0.7 1% 0.7 1%


Nomura India 8 September 2015 | Oil

11

Maintain Buy with a new TP of INR440

We continue to use one-year forward P/B multiple to value Oil India. Based on our revised average ROE estimates for FY16-17F of 12.7% (previous 15.9%), cost of equity of 12.0% (unchanged), and growth rate of 2.0% (unchanged), we arrive at our target one-year forward P/B multiple of 1.0x (1.35x previously).

Our revised TP is INR440/share (down from INR570).

Fig. 20: We value Oil India at 1.00x FY17F P/BF multiple

New Old

Avg. ROE (FY16-17F) 12.7% 15.9%

Cost of equity 12.0% 12.0%

Growth rate 2.0% 2.0%

Target P/B multiple 1.00 1.35

FY17F book value per share 436 424

Implied Equity value per share 436 572

Target Price 440 570


Fig. 21: Oil India – 1-year forward P/E band

Source: Datastream, Nomura estimates

Fig. 22: Oil India – 1-year forward P/B band

Source: Datastream, Nomura estimates

Downside risks • Higher-than-expected upstream subsidy burden could negatively impact OINL’s

financials.

• Lower-than-expected production growth also poses downside risks to our estimates.

• An adverse Supreme Court decision on royalty issues could significantly impact OINL's earnings.

Upside risks • Higher oil price, lower subsidy burden, INR depreciation

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Appendix A-1

Analyst Certification

We, Anil Sharma and Ravikumar Adukia, hereby certify (1) that the views expressed in this Research report accurately reflect our personal views about any or all of the subject securities or issuers referred to in this Research report, (2) no part of our compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this Research report and (3) no part of our compensation is tied to any specific investment banking transactions performed by Nomura Securities International, Inc., Nomura International plc or any other Nomura Group company.

Issuer Specific Regulatory Disclosures The term "Nomura Group" used herein refers to Nomura Holdings, Inc. or any of its affiliates or subsidiaries, and may refer to one or more Nomura Group companies.

Materially mentioned issuers Issuer Ticker Price Price date Stock rating Sector rating Disclosures Bharat Petroleum Corporation BPCL IN INR 830 07-Sep-2015 Buy N/A Hindustan Petroleum Corporation HPCL IN INR 769 07-Sep-2015 Buy N/A Indian Oil Corporation IOCL IN INR 394 07-Sep-2015 Buy N/A Oil India OINL IN INR 433 07-Sep-2015 Neutral N/A

Oil India (OINL IN) INR 433 (07-Sep-2015) Rating and target price chart (three year history)

Neutral (Sector rating: N/A)

Date Rating Target price Closing price 02-Jul-15 570.00 454.15 15-Jan-15 650.00 532.15 18-Dec-14 710.00 561.80 22-May-14 Buy 618.90 22-May-14 690.00 618.90 23-Jul-13 Neutral 532.05 23-Jul-13 590.00 532.05 14-Dec-12 400.00 449.30 18-Sep-12 Reduce 476.30 18-Sep-12 405.00 476.30

For explanation of ratings refer to the stock rating keys located after chart(s)

Valuation Methodology We value Oil India based on P/B methodology. Based on average ROE (FY16-17F) of 12.7%, cost of equity of 12.0%, and a growth rate of 2%, we arrive at a target FY17F P/B of 1.0x. Applied to our FY17 book value per share forecast, we set our target price at INR440. The benchmark index for this stock is MSCI India. Risks that may impede the achievement of the target price Risks include higher-than-expected upstream subsidy burden, which could have a negative impact on OIL’s financials; lower-than-expected production growth, which poses downside risks to our estimates; and an adverse Supreme Court decision on the royalty issue, which could significantly affect OINL's earnings.


13

Bharat Petroleum Corporation (BPCL IN) INR 830 (07-Sep-2015) Rating and target price chart (three year history)

Buy (Sector rating: N/A)

Date Rating Target price Closing price 02-Jul-15 1,055.00 900.00 18-Dec-14 810.00 653.30 22-May-14 675.00 559.65 23-Apr-14 580.00 475.10 23-Jul-13 465.00 352.75 05-Feb-13 490.00 411.75 18-Sep-12 Buy 337.45 18-Sep-12 430.00 337.45


Valuation Methodology We value BPCL's core refining and marketing business(including Bina and NRL) at 2.0x FY17F P/B based on adjusted book value per share of INR403/share. We give a value of INR125/share to E&P. We value BPCL’s investments in listed entities like Petronet, Indraprastha Gas and Oil India at a 20% discount to the current market price. We value current treasury shares at market price. Our target price for BPCL is INR1,055.The benchmark index for this stock is MSCI India. Risks that may impede the achievement of the target price We do not assume any sharing by OMCs for FY16-17F. However, if OMCs were made to share any under-recoveries it would pose downside risks to our estimates. Lower-than-expected GRMs and higher inventory / forex losses could also be negative for BPCL.

Hindustan Petroleum Corporation (HPCL IN) INR 769 (07-Sep-2015) Rating and target price chart (three year history)


Date Rating Target price Closing price 02-Jul-15 935.00 780.65 18-Dec-14 675.00 575.95 22-May-14 495.00 431.65 23-Jul-13 330.00 230.70 05-Feb-13 410.00 331.40 18-Sep-12 Buy 286.25


Valuation Methodology We value HPCL's core refining and marketing business at 1.75x FY17F P/B, based on adjusted book value of INR497/share. We value HPCL’s investments in listed entities, such as MRPL and Oil India, at a 20% discount to their current market price. Our target price for HPCL is INR935. The benchmark index for this stock is MSCI India. Risks that may impede the achievement of the target price We do not assume under-recovery sharing by OMCs for FY16-17. If OMCs were made to share any under-recoveries, this would pose downside risks to our estimates. Moreover, lower-than-expected GRMs and higher inventory/forex losses could be negative for HPCL.


14

Indian Oil Corporation (IOCL IN) INR 394 (07-Sep-2015) Rating and target price chart (three year history)


Date Rating Target price Closing price 02-Jul-15 515.00 412.40 18-Dec-14 450.00 330.00 22-May-14 405.00 355.35 23-Jul-13 325.00 225.70 05-Feb-13 390.00 332.45 18-Sep-12 Buy 248.35 18-Sep-12 325.00 248.35


Valuation Methodology We value the core refining and marketing business at 1.3x FY17F P/B (adj. BVPS: INR302 ex E&P and investments). We value the listed investments at a 20% discount to market price. Our TP is INR515. The benchmark index for this stock is the MSCI India. Risks that may impede the achievement of the target price We do not assume any subsidy sharing by OMCs for FY16-17F. However, if OMCs were made to share any under-recoveries, it would pose downside risks to our estimates. Lower-than-expected GRMs and higher inventory/forex losses could also be negative for IOC.

Important Disclosures Online availability of research and conflict-of-interest disclosures Nomura research is available on www.nomuranow.com/research, Bloomberg, Capital IQ, Factset, MarkitHub, Reuters and ThomsonOne. Important disclosures may be read at http://go.nomuranow.com/research/globalresearchportal/pages/disclosures/disclosures.aspx or requested from Nomura Securities International, Inc., on 1-877-865-5752. If you have any difficulties with the website, please email [email protected] for help. The analysts responsible for preparing this report have received compensation based upon various factors including the firm's total revenues, a portion of which is generated by Investment Banking activities. Unless otherwise noted, the non-US analysts listed at the front of this report are not registered/qualified as research analysts under FINRA/NYSE rules, may not be associated persons of NSI, and may not be subject to FINRA Rule 2711 and NYSE Rule 472 restrictions on communications with covered companies, public appearances, and trading securities held by a research analyst account. Nomura Global Financial Products Inc. (“NGFP”) Nomura Derivative Products Inc. (“NDPI”) and Nomura International plc. (“NIplc”) are registered with the Commodities Futures Trading Commission and the National Futures Association (NFA) as swap dealers. NGFP, NDPI, and NIplc are generally engaged in the trading of swaps and other derivative products, any of which may be the subject of this report. Any authors named in this report are research analysts unless otherwise indicated. Industry Specialists identified in some Nomura International plc research reports are employees within the Firm who are responsible for the sales and trading effort in the sector for which they have coverage. Industry Specialists do not contribute in any manner to the content of research reports in which their names appear. Distribution of ratings (Global) The distribution of all ratings published by Nomura Global Equity Research is as follows: 47% have been assigned a Buy rating which, for purposes of mandatory disclosures, are classified as a Buy rating; 42% of companies with this rating are investment banking clients of the Nomura Group*. 42% have been assigned a Neutral rating which, for purposes of mandatory disclosures, is classified as a Hold rating; 55% of companies with this rating are investment banking clients of the Nomura Group*. 11% have been assigned a Reduce rating which, for purposes of mandatory disclosures, are classified as a Sell rating; 21% of companies with this rating are investment banking clients of the Nomura Group*. As at 30 June 2015. *The Nomura Group as defined in the Disclaimer section at the end of this report. Explanation of Nomura's equity research rating system in Europe, Middle East and Africa, US and Latin America, and Japan and Asia ex-Japan from 21 October 2013 The rating system is a relative system, indicating expected performance against a specific benchmark identified for each individual stock, subject to limited management discretion. An analyst’s target price is an assessment of the current intrinsic fair value of the stock based on an

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appropriate valuation methodology determined by the analyst. Valuation methodologies include, but are not limited to, discounted cash flow analysis, expected return on equity and multiple analysis. Analysts may also indicate expected absolute upside/downside relative to the stated target price, defined as (target price - current price)/current price. STOCKS A rating of 'Buy', indicates that the analyst expects the stock to outperform the Benchmark over the next 12 months. A rating of 'Neutral', indicates that the analyst expects the stock to perform in line with the Benchmark over the next 12 months. A rating of 'Reduce', indicates that the analyst expects the stock to underperform the Benchmark over the next 12 months. A rating of 'Suspended', indicates that the rating, target price and estimates have been suspended temporarily to comply with applicable regulations and/or firm policies. 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Nomura India 8 September 2015 | Oil

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