The global oil and gas sectors
Oil and gas sector value chain consists of several activities like exploration and development , production and refining and finally storage, transportation and marketing. Industry volume which s an indicator of consumption of oil and gas and is measured in BOE – (millions of barrels equivalent).
The division of Global market is as follows :
North America
Canada, Mexico, and the United States.
South America
Argentina, Brazil, Chile, Colombia, and Venezuela
Western Europe
Belgium, Denmark, France, Germany, Italy, the Netherlands, Norway, Spain,
Sweden, and the United Kingdom
Eastern Europe
Czech Republic, Hungary, Poland, Romania, Russia, and Ukraine
Asia-Pacific
Australia, China, India, Japan, Singapore, South Korea, and Taiwan
In 2009 the industry had revenues of close to $ 2220 Bn which was an annual growth of 5% from a period of 2005-2009. In 2009 it shrank in size by close to 30 % . If we have a look at the volumes, they reduced by close to 1.5% and reached a volume total of close to 37 Bn. The forecasted growth rate for the industry is 9% for the five year period from 2009-2014.
The following table summarizes the growth pattern in the last 5 years.
Year
$ Billion
Euro Billion
% Growth
2005
1753.2
1260.2
2006
2027.8
1458.3
15.6
2007
2261.8
1626.6
11.5
2008
3053.6
2196.0
35
2009
2119.3
1524.1
(30.6)
CAGR
5%
America is one of the largest consumer in the segment and has 37% market share. The industry is organized such that economies of scales matter with large fully integrated players deriving benefit from it. Buyers include individual and wholesale buyers and the most important suppliers are equipment providers.
Pre- 2009 the industry went through a period of rapid growth and declined given global recessionary conditions. The Asia – Pacific and Euro markets had an annual growth rate of 7.9% and 6%. 64% of the market value was occupied by crude oil and had revenues of $ 1400 Bn. The natural gas segment had revenues of $ 760 Bn in 2009 which was 35% of the market’s revenues.
The following graph shows the market share by geography.
FIVE FORCES ANALYSIS for Global Industry
The presence of large integrated player increases the strength of rivalry in the industry. The industry is highly vertically integrated and they have presence as buyers and suppliers across the value chain. These highly integrated players create high barriers to entry and there is huge investment and capital expenditure required to start operations. Hence all in all the barriers to entry are high. Recently the trend has shifted towards increased demand for specialized equipment and services. This was because the commodity prices were quite high and thus the companies went for exploring commodities that were thought to be costly but which have proved to be revenue boosters. But in 2009 the commodity prices saw a fall and the scope of prices variation is unknown.
Substitutes in the oil and gas market are the renewable sources of energy which are gaining momentum even though they have a high cost of production and the companies would incur high switching costs.
Moreover high capex and high sunk cost which increases exit barriers , the competition level has intensified in the market.
Buyer Power :
As mentioned previously the oil and gas market consists of large entities which are well diversified and highly vertically integrated. Due to the complex nature of the industry there are a large number of buyers which results in weak buying power. However buyers which are large institutions cam make large purchases and thus are important buyers. Hence loss of such customers would have an impact on the business so these buyers have high bargaining power.
Crude oil and natural gas are highly commoditized and hence their prices are obtained according to demand and supply conditions and declared on the exchanges of New York and London and thus buying power is quite low. Typically customer loyalty is a very important factor in buyer power but since the concept of loyalty is not very strong in this sector , buying power is strong. Hence costs associated with switching for individuals could be higher than institutional buyer. In totality the overall buying power is weak
Supplier Power
Suppliers include equipment provider and major players are Schlumberger Halliburton and Baker Hughes. The industry players are diversified and large and they have a huge portfolio of products. Certain players provide niche services and thus have high supplier power. Many larger companies have integrated across the value chain and alternatively use third party services. Since the oil and gas industry provides the suppliers with huge revenue the supplier bargaining power is quite low. Some supplier like the government and land owners may have higher bargaining power due to scarcity of the land and the resources it houses. In totality the power of the supplier is moderate in nature.
Threat of new entrants
As mentioned before since the companies are present in different parts of the value chain, analysis of the market is complicated. The costs of large established players are very low dues to economies of scale. These players have invested a lot in equipment and R & D. Hence to compete with such players , similar investment is required. Hence this acts as a substantial barrier to entry. Moreover the oil and gas industry has significant amount of regulations which again increases the barriers to entry. Exploration and extraction requires permission from the government which in turn is a long procedure. Also given the changing environmental scenario , the impact of the oil and industry on the environment is a concern which again results in barriers.
On the other hand when the oil prices were at an oil time high the revenues surpassed the costs and hence it was an attractive sector for new players. Hence a bullish trend in oil prices always encourages capacity addition. In totality the threat of “new entrants” is moderate.
Substitutes
Substitutes can be alternative sources of energy. They have a positive impact on the environment but the cost of switching is substantial. It would primarily require huge investment in R& D and production facilities. Moreover as the reserves reach a peak , the importance of the alternative sources of energy would increase. In totality the threat of substitutes is not strong in the medium term
Rivalry
As mentioned before the industry largely consists of integrated players , hence they have lower costs due to the huge economies. Moreover the operations are such that they heavily labor intensive and require huge investments . Hence the barriers to exit are high. Most big players are not only vertically integrated but also geographically diversified. The next spurt of demand is expected to come from emerging economies and hence the huge demand there might reduce the intensity of rivalry. Also it is expected that there would be a gradual shift to renewable sources. In totality the rivalry is significantly strong.
Some of the leading companies in the sector are
BP
Exxon Mobil
Royal Dutch Shell
Sinpoec Shanghai Petrochemical Company
Indian Market
The Indian economy is heavily dependant on imports in energy sector. The oil and gas industry is a key sector and has strong linkages with various other sectors and has had a significant role in the growth of the Indian economy. The petroleum sector contributes 15% to GDP and consists of the following activities
Transportation
Refining
Marketing of Petroleum and Gas
The sector also adds to the revenue of the govt (64% ) in the form of taxes and duties. Petroluem Products are also a key source of foreign exchange, having a share of 18%. Moreover Asian refining margins have moved higher to USD 2.5-3 Bn.
India is a key market for petroleum products and crude oil and is expected to be a large consumer in the future. Moreover India has invested a huge amount in oil fields across the world in countries like Sudan , Egypt.
Conventionally it is believed that higher consumption of fuel is a strong indicator of a booming economy. However this has increasingly put pressure on the bottom line of oil marketing companies. Apart from the high economic growth , the subsidised rates is one of the reasons behind high consumption. Consumers have no incentive to save as the prices are too high. Once prices are deregulated in the short term it might hurt the retail customers but it would make India more competitive. Moreover the OMC can improve their situation of under- recoveries by charging higher prices , however the govt would take action in case price rise in international market is too high.
The government has taken many progressive steps to create a favourable policy and regulatory environment for attracting investments.
It is believed that the net sales position would increase to Rs 2390 Bn that is an increase of 34% in the next fiscal. The operating profit is expected to increase 22% to 311 Bn.
The Indian oil and gas market has revenues of around $ 80 bn in 2009 which is a CAGR of 10.3% for the 5 year period from 2005-2009.
Year
$ Billion
INR Billion
Euro Billion
% Growth
2005
51.6
2522.1
37.1
2006
62.4
3046.9
44.9
20.8
2007
76.5
3732.3
55
22.6
2008
111.2
5432.0
80.0
45.4
2009
76.3
3728.2
54.9
(31.4)
CAGR
10.3
In terms of volume , the consumption increased by 4% and reached 1.4 Bn ( BOE ) in 2009.
The growth pattern for the industry in the past 5 years is as follows:
Year
Million BOE
% Growth
2005
1162
2006
1185.5
2
2007
1263.3
6.6
2008
1330
5.3
2009
1361
2.3
CAGR
4
The forecasts for the growth of the industry ( in terms of value ) are as follows :
Year
$ Billion
INR Billion
Euro Billion
% Growth
2009
76.3
3728.2
54.9
(31.4)
2010
96.1
4692.5
69.1
25.9
2011
99.7
4869.2
71.7
3.8
2012
114.9
5615.0
82.7
15.3
2013
127.8
6244.4
91.9
11.2
2014
136.9
6688.5
98.5
7.1
CAGR
12.4
The forecast for the sector in terms of volume is as follows
Year
$ Billion
INR Billion
Euro Billion
% Growth
2009
76.3
3728.2
54.9
(31.4)
2010
96.1
4692.5
69.1
25.9
2011
99.7
4869.2
71.7
3.8
2012
114.9
5615.0
82.7
15.3
2013
127.8
6244.4
91.9
11.2
2014
136.9
6688.5
98.5
7.1
CAGR
12.4
Year
Million BOE
% Growth
2009
1361.3
2.3
2010
1425.3
4.7
2011
1492.8
4.7
2012
1565.9
4.9
2013
1642.9
4.9
2014
1714.3
4.3
CAGR
4.7
The oil and gas sector in India has a strong growth period followed by a decline in 2009.
The segment break up was follows “
Crude Oil – $ 63.5 Bn- 83.2 %
Natural Gas – $ 12.8 Bn- 16.8 %
The break up of the market share of India in the Asia Pacific region is as follows :
The major Indian companies are Indian Oil Corporation Limited, Oil and Natural Gas Corporation Limited, Reliance Industries Limited.
Industry Analysis
There are primarily 2 stages in the energy value chain
Upstream (exploration and production)
Downstream (refining and marketing)
Once crude oil extracted from the reserves, it is further processed. In the end we obtain various petroleum products, which are further marketed.
In India’s Case ONGC and Oil India have a high market share in the upstream segment of close to 85%. Major players in the downstream segment are IOC, HPCL, BPCL , Reliance. There are 19 refineries in India ( 17 in public sector and 2 in private sector)with a refining capacity close to 180 MMTPA.IOC has 32%market share in terms of refining capacity. ONGC dominates the natural gas sector and controls 60% production. GAIL dominates the transmission and distribution of natural gas and has 80% market share. KG basin discoveries would provide relief in terms of increased supply but demand would still be largely unmet.
The sector is still influenced by political decisions and there is high amount of political intervention.
FIVE FORCE ANALYSIS
Supply :
Supply from the internal market satisfies 30% of the demand for crude. Mostly the supply of the crude is achieved through import. For the downstream segment, refining has had high capacity addition . Lack of infrastructure support can harm the large-scale export potential of the products.
Demand :
It is a fairly well know fact that the availability of petroleum drives economic growth in the country
Barriers to Entry :
Government permission is required In the upstream segment. The sector requires huge capex and exploration and development is a high investment activity posing high entry barriers. On the other hand in the retail segment , the new players need to pump in atleast Rs 20 bn in the sector as eligibility criteria.
Bargaining power of suppliers
Since the demand supply gap is huge the bargaining power of suppliers is high. For eg. OPEC has high bargaining power. For petroleum based products, the bargaining power of the players is low as India has surplus capacity.
Bargaining power of customers
The govt . through its NELP program provides crude oil in the upstream segment. In downstream segment the subsidy is shared by the refineries. Traditionally the govt has been a strong advocate of controlling the prices for customer welfare, resulting in huge losses for OMC. However with deregulation being implemented in the market, things could improve for the OMC’s. With increase in refining capacity , the industrial segment could face high competition.
Competitive Rivalry :
NELP has introduced competition in the market in the upstream segment and in downstream segment setting of pipeline would increase competition.
Future Prospects :
The govt has laid increased emphasis on oil exploration outside , and is aggressively buying assets abroad. OVL produced close to 9. MMT of oil and gas in FY 09 from its acquired assets. India has also invested in capacities outside the country for the petrochemicals sector to increase supply in the sector.
Valuation of a Oil and Gas Stock
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Profitability is revenues – expenses. Revenues is dependant on volumes and realisations.
Volume for oil sector is related to economic growth. Economic growth is linked to the performance of the major sectors of the economy that is agriculture, industrial and services sector. When growth increases or economy si on upswing the requirement for petroleum products increases. This is because it is a source of energy which is the driver of any economy. A similar analysis can be applied to customer demand i.e demand for fuel for cars and CV’s
The industrial side
It has been observed that the demand for petroleum products is usually inelastic to change in prices. The key user segments are as follows :
Fertilizer (naphtha or natural gas)
Utilities (naphtha or natural gas)
Aviation (ATF)
Improvement in economic activity albeit growth in the power sector or energy needs, growth in foreign tourism will have a good impact on the demand for petrol and thus improve revenues of oil and gas companies. Thus to analyse a oil stock overall economic activity and sectoral performances are important.
The retail side
In the retail segment , the income levels is a driver of demand. Higher income would lead to a higher demand for vehicles ( two- wheeler and 4- wheeler ) and this in turn would increase demand for fuel.
According to estimates, diesel consumption is close to 40%-45% of total and Kerosene and petrol 8% and 13% respectively.
Realisation
A very important parameter in this segment is the realisation. Before deregulation in 2002, the government had taken the onus of fixing prices of petroleum products. Moreover prices were cross-subsidised.
Petrol prices were usually higher in comparison to their actual cost and kerosene , diesel. LPG were sold at lower rates. However with the dismantling of Administered Price mechanism, the scenario has changed. The prices are now directly related to the international crude prices. Hence when prices go up, Indian petrol and diesel prices would go up too. Hence awareness of international crude prices is essential.
Expenses
As mentioned before it is important to know international crude prices. Usually crude prices are very volatile, Moreover exchange rate fluctuation would also have an impact on cost.
Important Factors to remember when valuing an oil and gas company are :
Lastly , management past record is essential. PSU’s are abound in this sector but still the management’s initiative in terms of branding activities and capacity expansion are essential.
Company Analysis
Cairn India (CIL) is a listed subsidiary of London based Cairn Energy plc. Cairn Energy in turn was formed after the acquisition of privately-held Cairn Energy Management by Caledonian Offshore. The combined entity was renamed Cairn Energy. Changing market conditions meant that emerging markets became very attractive and Cairn decided to focus on South Asia. The assets of Cairn are as follows :
Ravva in Eastern India which was the first offshore oil & gas field
Lakshmi gas field in Western India, discovered in 2000 and began production in 2002
The Mangala oilfield discovered in Rajasthan, ( biggest oil discovery in the country since 1985)
Bhagyam and Aishwariya fields
Cairn India Assets
Cairn bought a stake in Barmer Basin from Shell as it wasn’t able to find oil and gas in the area. IN turn , Cairn was able to discover oil in this area. Mangala has been the largest oil – field discovered in India post 1985 and there is huge potential hidden in this area.
The following graphs highlights the fact that the company’s Exploration Resource Base is displaying an uptrend. Cairn has reserves of close to 690 mm BOE in the Mangala , Bhagyam and Aishwariya belt. Additional recovery that is expected from this block is close to 290 mm BOE ( from EOR / IOR)
Moreover Cairn has discovered additional resource base on the Barmer Hill, hence higher recovery is expected from this belt.
Growth Predictions
Production is believed to be close to 50 % CAGR. Moreover as crude will become stronger , so would returns and realizations as shown in the following graph.
As mentioned before , there is a uptrend in the production and reserve base and hence earnings can improve gradually. The Rajasthan asset base is set to rise by 2.5 bn BOE.
Crude Prices
The global economy is set for recovery and hence crude oil prices would show an uptrend. IMF has predicted that world GDP would be at 4.6% for 2010 and at 4.3% for 2011 which is sharp rise in comparison to last year de growth of 0.6% in world GDP.
Hence crude oil demand and thus prices are set to increase in 2011. Emerging markets would be the main source of this demand. IEA oil market report as also predicted demand to be 87 mbpd which is rise of 2%
The following graphs show the estimates of World GDP and also how oil demand would grow with growth in GDP.
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Acreage
In totality Cairn has a huge exploration acreage under its control in India which is close to 40, 000 sq km which is the 4th largest asset base in the country. The company’s most productive asset base is in Rajasthan in the MBA belt. It also has asset base in the KG Basin. Moreover it has now expanded to Sri Lanka and acquired a 3000 sq km block.
The following graph shows the acreage break up in the country.
The company has already closed its sales contracts which are about 143 kb / d. Given that the crude from the MBA fields is waxy in nature , the closed sales agreements have laid to rest the concerns regarding the saleability of the crude.
High Operational Efficiency
Cairn has a rich experience in exploring and developing hydrocarbon resources in India. For eg. In Laksmi Basin In Cambay , Cairn started production within 30 months. At Ravva field which is located in the KG Basin production was enhanced to 50 , 000 b /d .
Another core competency of Cairn is the low cost with which it operates. The expencditure for Ravva filed , Lakshmi and Gauri fields is close to US$3/ bbl.
Result Update ( Q4FY10)
The revenues showed a rise of 281.2% to Rs 692.8 crore as against Rs 181.8 crore in the previous quarter. PAT also showed a rise to Rs 245.2 crore. This was due to increased production from the Mangala field. Costs were higher at 120 cr hence profitability took a hit. Train 3 would be ready by June end , according to management. The Mangala production is expected to move up to 125000 boepd.
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