Budget Analysis

1st February 2018Outlook on Oil & Gas Sector

23rd August 2018

Sumit PokharnaSector Analyst

Upstream Sector - Oil and Gas Exploration

“In some countries the government runs the oil companies and in many others the oil companies runs the

government”

What is Crude Oil?

Let’s start from the start…

Crude oil is a naturally-occurring substance found in certain rock formations in the earth.

Crude oil is classified as a hydrocarbon - compound containing carbon and hydrogen. It’s sister hydrocarbon is natural gas which is also extracted from earth.

The demand for crude oil is derived from the demand for petroleum products such as gasoline, diesel etc.

Oil is measured in barrels and Gas in mmscm/cubic feet

What’s in a Barrel of Crude Oil?

What differentiates Brent, WTI, Dubai crude?

Source: EIA/IEA

Analysis of higher margins & Competitive positioning

Why RIL GRMs is better than OMCs?

NCI--14

US$/bbl Product slate Cracks Product Cracks

Diesel (10 ppm sulfur or Euro IV) 44% 15.75 6.9

Gasoline 30% 10.7 3.2

Jet/Kerosene 4% 14.25 0.5

Alkylates 8% 12.84 1.1

LPG 0% -4.1 0.0

Naphtha 0% 0.5 0.0

Propylene 3% 22.2 0.7

Reformate 0% 17.4 0.0

Petroleum Coke 9% -45.8 -4.0

Sulfur 2% -45.8 -1.0

Wighted average product prices 100.00% 7.4

Crude Spread 7.6

RPL's theortical refining margins 15.0

Theortical refining margins based on product and crud Prices

NCI--11.4

US$/bbl Product slate Cracks Product Cracks

Diesel (50 ppm sulfur or Euro III) 40% 14.5 5.8

Gasoline 11% 10.7 1.2

Jet/Kerosene 8% 14.3 1.2

LPG 13% -4.1 -0.5

Naphtha 3% 0.5 0.0

Propylene 8% 22.2 1.7

Reformate 9% 17.4 1.5

Petroleum Coke 9% -45.8 -4.1

Wighted average product prices 100% 6.6

Crude Spread 5.7

Theortical refining margins 12.3

Theortical refining margins based on product and crud Prices

Around $2/bbl better margins due to crude spread

Source: Kotak Securities - Private Client Research.

Our view on Brent crude oil price

We remain bullish on international crude oil prices

“Never Say Never Again” (BRENT: US$ 147 / 28 / 73 bbl)

Brent crude oil price remains in a bullish phase and could spike to US$80-90/bbl due to

Geopolitical concerns

Supply shocks

Tight demand-supply balance amid declining production and

Sustained production cuts despite targeted moderation of OECD inventories

Socio-economic crises in Venezuela led to sharp decline in oil production

Sharp decline in oil production

1.0

1.2

1.4

1.6

1.8

2.0

2.2

2.4

2.6

Feb

-11

Jun

-11

Oct-

11

Feb

-12

Jun

-12

Oct-

12

Feb

-13

Jun

-13

Oct-

13

Feb

-14

Jun

-14

Oct

-14

Feb

-15

Jun

-15

Oct-

15

Feb

-16

Jun

-16

Oct-

16

Feb

-17

Jun

-17

Oct-

17

Feb

-18

Jun

-18

Venezuela oil production mn b/d

Source: Bloomberg

Geo-political Risk: USA sanctions on Iran will impact supply from Iran

3.0

3.2

3.4

3.6

3.8

4.0

4.2

4.4

4.6

4.8

Au

g-1

1

Dec-

11

Ap

r-12

Au

g-1

2

Dec-

12

Ap

r-13

Au

g-1

3

Dec-

13

Ap

r-14

Au

g-1

4

Dec-

14

Ap

r-15

Au

g-1

5

Dec-

15

Ap

r-16

Au

g-1

6

Dec-

16

Ap

r-17

Au

g-1

7

Dec-

17

Ap

r-18

Source: Bloomberg

Incremental global oil demand expectations of the key agencies (2018)

Incremental global oil demand expectations (mn b/d)

Source: Bloomberg

1.5

1.8

1.6

1.0

1.1

1.2

1.3

1.4

1.5

1.6

1.7

1.8

1.9

IEA EIA OPEC

International Energy Agency Crude Oil Demand World TotalWorld oil demand growth YoY (mopd) 1.22 0.95 1.84 1.53 1.57

mopd

Description 2013 2014 2015 2016 2017

Total Demand 91.92 92.87 94.71 96.24 97.81

OECD Demand 46.02 45.72 46.17 46.90 47.35

Americas 24.07 24.14 24.36 24.74 24.86

Europe 13.62 13.46 13.71 14.04 14.33

Pacific 8.34 8.13 8.10 8.12 8.16

Non-OECD Demand 45.90 47.15 48.54 49.34 50.46

FSU 4.72 4.92 4.87 4.71 4.80

Europe 0.66 0.67 0.70 0.71 0.74

China 10.26 10.64 11.31 11.85 12.45

Other Asia 11.80 12.10 12.60 12.90 13.30

Latin America 6.67 6.82 6.78 6.56 6.57

Middle East 7.91 8.04 8.18 8.27 8.25

Africa 3.89 3.98 4.11 4.29 4.32

Total Supply 91.40 93.70 96.40 97.00 97.40

OECD Supply 21.00 22.90 23.90 23.40 24.10

Americas 17.20 19.10 19.90 19.50 20.20

Europe 3.30 3.30 3.50 3.50 3.50

Pacific 0.50 0.50 0.50 0.40 0.40

Non-OECD Supply 28.60 28.90 29.30 29.30 29.30

FSU 13.90 13.90 14.00 14.20 14.40

Europe 0.10 0.10 0.10 0.10 0.10

China 4.20 4.20 4.30 4.00 3.90

Other Asia 2.70 2.60 2.70 3.60 3.50

Latin America 4.20 4.40 4.60 4.50 4.50

Middle East 1.40 1.30 1.30 1.30 1.20

Africa 2.20 2.30 2.30 1.70 1.70

Processing Gains 2.20 2.20 2.20 2.30 2.30

Global Biofuels 2.00 2.20 2.30 2.30 2.40

Total Non-OPEC 53.80 56.30 57.70 57.40 58.20

OPEC

Total OPEC 37.50 37.50 38.70 39.60 39.20

Source: Bloomberg

Global demand was higher than global supply in 2017

Demand-Supply dynamics

91.00

92.00

93.00

94.00

95.00

96.00

97.00

98.00

99.00

2013 2014 2015 2016 2017

mb

op

dGlobal Crude oil demand Global Crude oil Supply

Source: Bloomberg

U.S. crude oil inventory levels

Despite meaningful jump in US oil production, inventory levels still remains lower

Source: Bloomberg

8.20

8.70

9.20

9.70

10.20

10.70

11.20

395

415

435

455

475

495

515

535

555

13-J

an

-17

3-F

eb

-17

24-F

eb

-17

17-M

ar-

17

7-A

pr-

17

28-A

pr-

17

19-M

ay-1

7

9-J

un

-17

30-J

un

-17

21-J

ul-

17

11-A

ug

-17

1-S

ep

-17

22-S

ep

-17

13-O

ct-1

7

3-N

ov-1

7

24-N

ov-1

7

15-D

ec-

17

5-J

an

-18

26-J

an

-18

16-F

eb

-18

9-M

ar-

18

30-M

ar-

18

20-A

pr-

18

11-M

ay-1

8

1-J

un

-18

22-J

un

-18

13-J

ul-

18

3-A

ug

-18

mb

op

d

Mn

bb

ls U.S. crude inventories (LH) U.S. crude production (RH)

Relationship between Dollar Index vs Brent Crude

Inverse relationship

Source: Bloomberg

85

95

105

115

125

30

50

70

90

110

130

150

Dec-

14

Jan

-15

Mar-

15

Mar-

15

Ap

r-15

May-1

5Ju

n-1

5Ju

l-15

Au

g-1

5Sep

-15

Oct

-15

No

v-1

5D

ec-

15

Jan

-16

Feb

-16

Mar-

16

Ap

r-16

May-1

6Ju

n-1

6Ju

l-16

Au

g-1

6Sep

-16

Oct

-16

No

v-1

6D

ec-

16

Jan

-17

Feb

-17

Mar-

17

Ap

r-17

May-1

7Ju

n-1

7Ju

l-17

Au

g-1

7Sep

-17

Oct

-17

No

v-1

7D

ec-

17

Jan

-18

Feb

-18

Mar-

18

Ap

r-18

May-1

8Ju

n-1

8Ju

l-18

Au

g-1

8

Brent Dollar Index

Higher bond yields (%)

Keep a close watch–Negative for equities and other asset classes

Source: Bloomberg

1.3

1.5

1.7

1.9

2.1

2.3

2.5

2.7

2.9

3.1

3.3N

ov-1

5

No

v-1

5

Dec-1

5

Jan

-16

Feb

-16

Mar-

16

Ap

r-16

May-1

6

Jun

-16

Jun

-16

Jul-

16

Au

g-1

6

Sep

-16

Oct

-16

No

v-1

6

Dec-1

6

Jan

-17

Jan

-17

Feb

-17

Mar-

17

Ap

r-17

May-1

7

Jun

-17

Jul-

17

Au

g-1

7

Au

g-1

7

Sep

-17

Oct

-17

No

v-1

7

Dec-1

7

Jan

-18

Feb

-18

Mar-

18

Mar-

18

Ap

r-18

May-1

8

Jun

-18

Jul-

18

Au

g-1

8

US Treasury 10-year Yield (R)

Impact of rising crude oil prices on India

Fiscal

deficitTwin deficit riskCAD

Inflation

-

CPI and

WPI

Impact of

higher crude oil

prices on India

Bond

yields

Subsidy SELL OMCs

Currency

Depreciati

on

Source: Kotak Securities - Private Client Research.

Sensitivity Analysis – Crude oil and India’s GDP

Oil can hurt India’s GDP

Particulars Units

India's annual net Imports MMTPA 154.0

Assuming crude price rise $/bbl 10.0

Import bill rise $ bn 11.3

Nominal GDP at market prices $ Tn 2.8

Forex INR/USD 68.0

Sensitivity for every US$10/bbl move in oil to GDP (%) bps 41

India is a net importer of ~3 mn barrels/ day of crude oil.

India’s oil import dependence to oil consumption is 81%-83%. This makes us highly sensitive to crude oil price movement.

This implies a sensitivity of ~US$11bn i.e 41 bp of GDP for every US$10/bbl move in oil

Source: Kotak Securities - Private Client Research.

India’s rising crude oil import bill

Rising bill

143.0

112.7

64.0 70.2

87.6

105.0

-

20.0

40.0

60.0

80.0

100.0

120.0

140.0

160.0

FY14 FY15 FY16 FY17 FY18 FY19E

US$ BnIndia’s Crude oil import bill

Source: PPAC

Impact on Indian currency

Double whammy – Can INR go to 75?

INR/USD depreciated by 6.7% since April’18 due to trade war issues, Fed rate hike and rising fiscal deficit

Fiscal slippage likely ahead of the general election due to be held in April-May 2019

63.0

64.0

65.0

66.0

67.0

68.0

69.0

70.0

71.0

2-J

an

-18

8-J

an

-18

12-J

an

-18

18-J

an

-18

24-J

an

-18

31-J

an

-18

6-F

eb

-18

12-F

eb

-18

20-F

eb

-18

26-F

eb

-18

5-M

ar-

18

9-M

ar-

18

15-M

ar-

18

21-M

ar-

18

27-M

ar-

18

5-A

pr-

18

11-A

pr-

18

17-A

pr-

18

23-A

pr-

18

27-A

pr-

18

7-M

ay-1

8

11-M

ay-1

8

17-M

ay-1

8

23-M

ay-1

8

29-M

ay-1

8

4-J

un

-18

8-J

un

-18

14-J

un

-18

20-J

un

-18

26-J

un

-18

2-J

ul-

18

6-J

ul-

18

12-J

ul-

18

18-J

ul-

18

24-J

ul-

18

30-J

ul-

18

3-A

ug

-18

9-A

ug

-18

16-A

ug

-18

Source: Bloomberg

If the government takes the entire hit from hereon then it will impact fiscal deficit by 23 bp of GDP

What if government cuts Excise duty on petrol and Diesel

Impact of Rs.3/ltr cut in excise duty on Petrol/Diesel

Impact of Excise duty Units Petrol Diesel

Consumption pa FY19E Mn Ton 27.7 86

Consumption pa Mn Lts 39,149 103,985

Assuming excise duty cut Rs./ltrs 3 3

Excise revenue loss to Govt Rs. Mn 117,448 311,954

Total revenue loss on Petrol and Diesel Rs. Mn 429,401

Nominal GDP at market prices Rs. Bn 187223

Forex INR/USD 68

Sensitivity for Rs.3/ltr cut in excise duty on Petrol

and Diesel bps 23 Source: Kotak Securities - Private Client Research.

A crucial analysis of crude price movement and its impact on the bottom-line of various

players in O&G sector in India

Rising crude price Good or Bad?

Crude Price & Earnings SensitivityCrude Oil

Prices

Below $50/bbl At $50-60/bbl Above $60/bbl

OMCs uncertain,

ONGC benefits

Upstream realizations

are under pressure,

No under recoveries

for OMCs

Party time for Pvt.

Companies,

PSUs cries.

Upstream:

Lower realization.

Negative for ONGC, Vedanta

PSU OMCs:

Uncertain on earnings

as subsidy sharing

is unknown

Pvt: Realiz. boom,

refining margins Inc.

Risk: windfall tax.

OMCs: Higher marketing

Margins to offset pressure

on refining margins.Govt.

may cut prices

GAS: Spot LNG markets will be

hit. Negative for Petronet LNG

ONGC:Rising realization

offsets higher U/R.

Pvt Co’s:

Stable earnings

PSU: Significant rise

in under recoveries,

ltd. possibilities of

auto fuels price hikes.

Positive for: IOC, BPCL

HPCL, RIL, MRPL, CPCL

Negative for

ONGC, OIL India, Vedanat

Positive for: RIL, ONGC,

Negative for:

IOC, BPCL and HPCL.

Positive for: Vedanta

Selan, HOEC, PLNG

Negative for: IOC, BPCL,

and HPCL.

Source: Kotak Securities - Private Client Research.

Due to election heavy year, if the government caps retailfuel price hike and partly passes on some subsidy burdento OMCs then earnings will get impacted.

Traditionally, upstream oil co’s had to share the subsidywhich is sentimental negative for ONGC/OIL. However, webelieve CMP of ONGC already discounts US$45/bbl of netcrude realizations at current levels of global crude prices.

Also, higher domestic gas prices and weaker rupee will bepositive.

Higher bond yields may impact NIM compression for NBFCs.

Rising oil is also a negative for users of oil-based chemicals industry including consumer staples and paints.

Weak INR is positive for exporters.

Impact on companies

Brent crude oil price and Singapore Jet Kerosene (USD/bbl)

Jet prices increase is impacting margins of Airline companies. Weaker rupee against dollar will further add to woes. Higher Jet Kerosene prices will led to higher working capital, interest cost and higher operating cost.

35

45

55

65

75

85

95

Jan

-17

Feb

-17

Mar-

17

Ap

r-17

May-1

7

Jun

-17

Jul-

17

Au

g-1

7

Sep

-17

Oct

-17

No

v-1

7

Dec-1

7

Jan

-18

Feb

-18

Mar-

18

Ap

r-18

May-1

8

Jun

-18

Jul-

18

Au

g-1

8

Crude Oil (Brent) Singapore Jet Kerosene USD/Barrel

Source: Bloomberg

Kotak Securities - Private Client Group - Path: Login to www.kotaksecurities.com > Research > Equity Reports > Stock Recommendation Snapshot

Kotak Securities - Institutional Equities - Path: Login to www.kotaksecurities.com > Research > Equity Reports > India Daily Institutional Equities Research Report

Stock views

Price Latest Upside/

Name of the Company Latest as on price (Down

Reco ^ 20-Aug-18 target^ side) FY19E FY20E FY19E FY20E FY19E FY20E FY19E FY20E

(Rs) (Rs) (%)

BPCL 376 375 (0.3) 37.6 38.7 10.0 9.7 20.5 19.1 7.3 6.9

Castrol India Ltd * * BUY 159 195 22.7 7.3 7.8 21.8 20.4 52.1 51.6 13.5 12.5

Chennai Petroleum Corporation BUY 305 373 22.4 64.2 67.7 4.7 4.5 22.2 20.4 3.5 3.2

GAIL (India) BUY 379 440 16.1 26.1 28.7 14.5 13.2 14.0 14.1 9.1 8.3

HPCL REDUCE 270 285 5.6 32.4 31.7 8.3 8.5 19.6 17.4 7.3 7.7

IOCL REDUCE 159 150 (5.5) 18.2 17.5 8.7 9.1 15.1 13.4 5.0 4.9

ONGC ADD 169 200 18.6 20.3 20.4 8.3 8.3 11.2 10.6 4.0 3.8

Reliance Industries SELL 1,235 985 (20.2) 69.5 78.0 17.8 15.8 12.2 12.1 12.0 10.2

Gujarat State Petronet Ltd (GSPL) SELL 191 182 (4.8) 11.2 11.0 17.1 17.4 11.7 10.5 6.6 6.7

Indraprastha Gas (IGL) SELL 284 257 (9.5) 12.1 14.1 23.5 20.1 20.8 20.6 13.5 11.1

Mahanagar Gas Ltd ACCUMULATE 923 1,030 11.6 56.7 59.9 16.3 15.4 24.9 23.1 8.9 8.3

MRPL BUY 81 106 30.3 11.3 12.3 7.2 6.6 17.8 16.9 5.0 4.6

Oil India Ltd BUY 206 245 19.0 27.1 28.0 7.6 7.4 9.7 9.7 6.0 6.0

Petronet LNG BUY 226 267 18.3 16.1 18.6 14.0 12.1 22.0 22.0 7.4 6.3

EPS (Rs) PE (x) RoE (%) EV/EBITDA (x)

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Report: No.

Kotak Securities Limited has actual/beneficial ownership of 1% or more securities of the subject company(ies) at the end of the month immediately preceding the date of publication of Research Report: No

Subject company(ies) may have been client during twelve months preceding the date of distribution of the research report.

"A graph of daily closing prices of securities is available at https://www.nseindia.com/ChartApp/install/charts/mainpage.jsp and http://economictimes.indiatimes.com/markets/stocks/stock-quotes. (Choose a

company from the list on the browser and select the "three years" icon in the price chart).“

Kotak Securities Limited. Registered Office: 27 BKC, C 27, G Block, Bandra Kurla Complex, Bandra (E), Mumbai 400051. CIN: U99999MH1994PLC134051, Telephone No.: +22 43360000, Fax No.: +22 67132430. Website:

www.kotak.com/www.kotaksecurities.com. Correspondence Address: Infinity IT Park, Bldg. No 21, Opp. Film City Road, A K Vaidya Marg, Malad (East), Mumbai 400097. Telephone No: 42856825. SEBI Registration No:

NSE INB/INF/INE 230808130, BSE INB 010808153/INF 011133230, MSE INE 260808130/INB 260808135/INF 260808135, AMFI ARN 0164, PMS INP000000258 and Research Analyst INH000000586. NSDL/CDSL: IN-

DP-NSDL-23-97. Our research should not be considered as an advertisement or advice, professional or otherwise. The investor is requested to take into consideration all the risk factors including their financial

condition, suitability to risk return profile and the like and take professional advice before investing. Investments in securities market are subject to market risks, read all the related documents carefully before

investing. Derivatives are a sophisticated investment device. The investor is requested to take into consideration all the risk factors before actually trading in derivative contracts. Compliance Officer Details: Mr.

Manoj Agarwal. Call: 022 - 4285 8484, or Email: ks.compliance@kotak.com.

Level 1: For Trading related queries, contact our customer service at 'service.securities@kotak.com' and for demat account related queries contact us at ks.demat@kotak.com or call us on: Toll free numbers

18002099191 / 1800222299, Offline Customers - 18002099292

Level 2: If you do not receive a satisfactory response at Level 1 within 3 working days, you may write to us at ks.escalation@kotak.com or call us on 022-42858445 and if you feel you are still unheard, write to our

customer service HOD at ks.servicehead@kotak.com or call us on 022-42858208.

Level 3: If you still have not received a satisfactory response at Level 2 within 3 working days, you may contact our Compliance Officer (Mr. Manoj Agarwal ) at ks.compliance@kotak.com or call on 91- (022) 4285

8484.

Level 4: If you have not received a satisfactory response at Level 3 within 7 working days, you may also approach CEO (Mr. Kamlesh Rao) at ceo.ks@kotak.com or call on 91- (022) 4285 8301.