The Hindu Business Line : Hindustan Oil Exploration: Invest

Shareholders of Hindustan Oil Exploration Company (HOEC) can subscribe to the rights offer from their company in the ratio of one share for every three held at Rs 76 per share. Such investment, however, will be subject to high risk and capital appreciation will depend on further reserve accretion by the company.

HOEC's revenue and earnings growth ride on two variables — increased oil and gas output through addition to existing reserves and/or high crude oil prices. The latter was a critical factor in revenue buoyancy in the last couple of years.

The degree of rise in the crude oil price has been such that it has even compensated for a decline in HOEC's output in 2005-06. However, from hereon, crude price rise may not contribute to revenue buoyancy in the same measure as in the recent past. At least, it may not be high enough to compensate for declining production.

And that brings us to the second variable, which is addition to existing reserves. The company is raising funds now to part-finance further exploration and development of its fields in the Cauvery, Cambay and Assam-Arakan basins.

Though a couple of these blocks are development ones, which means that reserves are proven and only need to be tapped, the reserve sizes are relatively small. There are three other blocks where exploration activity will be financed from funds raised through this offer. Therefore, significant reserve addition, if at all it happens, may be only in the medium-long/term.

Risks

About 95 per cent of HOEC's revenues accrue from the PY-3 field in the Cauvery Basin where it holds a 21 per cent participating interest. Production of oil from this field showed a natural decline of 10 per cent in 2005-06 compared to 2004-05 and yield can be increased only by further development of the field. With the government's share of profit in oil increasing to 25 per cent from last year, HOEC's entitlement will be lower than in the past and can be compensated in absolute terms only by increase in output.

HOEC realisations shot up from around $29 per barrel in 2003-04 to $41 per barrel in 2004-05 and further to $58 a barrel in 2005-06. Though crude prices touched a high of $78 a barrel briefly this fiscal, they have subsequently retraced their steps and are now trading at around $60 per barrel. HOEC's realisation has risenby 41 per cent every year since 2003-04 and a similar rise this year would require an average Brent price of around $82 per barrel for the whole of 2006-07. This appears an unlikely prospect at this point in time.

The company will be investing in exploration in some of its fields, which implies significant risks to the financials. A failure to strike oil or gas will mean large write-offs. In 2005-06, for instance, the company had to write-off Rs 42 crore from unsuccessful exploration efforts, which caused a decline in profits by more than half to Rs 17 crore.

The Positives

Typical of oil exploration activity, a single strike of oil or gas reserves would mean a major transformation in the company's fundamentals. HOEC has the advantage of being familiar with all the three basins where it is now working and it fully owns a couple of the exploratory blocks. It is also developing the PY-1 field with proven gas reserves and once it drills its production wells and installs the required pipelines by the next one year, it can begin to sell gas from there. The company is in the process of signing the deal with a power producer in the region.

The company has applied for five on-shore blocks in the NELP-VI round that closed last week as a consortium with other big players. Sentiment in the stock could get a leg up if it manages to prove even partially successful in its bid.

Re-development is set to being soon in the main PY-3 asset to increase output. This could help keep revenues and earnings on the growth path.

HOEC has a tight cost-structure, which is a major advantage in this business. The first quarter performance where it almost doubled its profit to Rs 13 crore lends confidence to the near-term earnings picture.

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