Hopes of pricing reforms by the Modi government fired up many public sector oil stocks last year. The government did deliver. It made good use of the sharp fall in crude oil price since last June and decontrolled diesel pricing.

The direct transfer mechanism for LPG subsidy has been rolled out. Natural gas price is now being reset every six months, though gas producers are glum about the pricing formula.

Expectation that lower subsidies would improve realisations saw the stock of oil and gas producer Oil India rise nearly 40 per cent from May to September.

But since then, the stock has ceded all these gains — from ₹661 last September, it has come down with a thud to ₹458.

Two factors, playing out in conjunction, are to blame — the rout of crude oil and the government not reducing the fuel subsidy burden (on controlled fuels LPG and kerosene) to be borne by the upstream companies ONGC and Oil India, and GAIL. This took a heavy toll on the performance of Oil India which bears about 13-14 per cent of the upstream burden. In the December 2014 quarter, Oil India’s net realisation was just about $37 a barrel, down from about $52 in the year-ago period.

For the nine months ended December 2014, the company’s net realisation was $45 a barrel from $50 a year ago. It did not help that output growth was flat.

The stock’s fall though presents a good buying opportunity. At its current price, the stock discounts the trailing 12-month earnings by 11 times, a tad higher than the average 10 times it traded at in the past.

But the higher valuation is due to the company’s weak earnings in September and December quarters. Adjust for this, and the valuation would be less than the past average.

Lower subsidy burden

Importantly, Oil India’s realisations and earnings should recoup in the March quarter and the coming periods.

With diesel decontrolled, there is no subsidy on the fuel any more.

Also, the government, better late than never, has exempted the upstream companies from subsidy-sharing in the March quarter. Besides, it has exempted the upstream companies from sharing LPG subsidy in 2015-16.

Between LPG and kerosene, the former accounted for more than 60 per cent of the subsidy burden in the nine months ended December 2014; so, being kept off the net will bode well for Oil India.

There is no clarity yet on the subsidy sharing on kerosene. But the burden on upstream companies in 2015-16 should be lower than in 2014-15, given that overall kerosene subsidy has fallen sharply.

It is now about ₹16 a litre, half of what it was in September 2014. Without hazarding a guess on the price of crude oil, Oil India’s realisations should improve.

The price of gas (about 15 per cent of revenue) is weak, but is still better than last year.

Healthy outlook

Besides, there is scope for raising output. In the last few years, local protests in the North-East (Oil India’s main area of operations) have impacted production.

But the company should be able to tide over this and raise output in the coming years. It has targeted oil production of 3.63 mmt in 2014-15, up from 3.5 mmt in 2013-14.

Natural gas production is expected to improve to 2,840 mmscm in 2014-15 from 2,626 mmscm in 2013-14. This should further improve in 2015-16 with the commencement of the BCPL gas cracker project in which Oil India has 10 per cent stake.

Oil India’s reserve replacement ratio was healthy at 1.29 times in 2013-14. International forays, especially the stakes in the giant Rovuma offshore gas block in Mozambique and Carabobo Basin asset in Venezuela, should also add to output in the coming years. Oil India has a healthy balance sheet with negligible debt. Its current dividend yield is attractive at about 4.5 per cent.

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