ONGC, Oil India Stare At Steep Earnings Cut As Crude Price Crashes

Domestic oil majors- ONGC and Oil India- maybe trading 15-20 per cent higher, compared to their 52-week lows seen last month, but the challenges regarding their earnings persist and investors need to be cautious. With crude oil prices crashing, the profitability of the two companies is expected to be severely hit.

Being a play on crude oil prices and with Brent crude trading below $30 a barrel, ONGC and Oil India may not be in a position to recover their cost of production. Nilesh Ghughe, analyst at HDFC Securities, estimates including expenses for maintaining the production level (capex), ONGC’s cost of production will be close to $31 a barrel; for Oil India, it will be $25-26 a barrel. Thus, if oil prices remain at the current levels, the companies may even end up posting a loss at the pre-tax level. Brent crude prices, which had dipped below $25 a barrel, have seen some rebound after the stimulus package by the US lifted sentiment on demand. However, they are still trading around $27, less than half the 52-week high levels of $70.

Moving forward, too, Moody's expects oil prices to average $40-45 per barrel in 2020, and in a downside scenario, where economic weakness persists longer, to average $30-35 in 2020 and $35-40 in 2021. This is not good news for upstream oil producers, and both ONGC and Oil India may see pressure on net realisations. Cairn India, which is now a part of Vedanta, will also be impacted.

Analysts had already been cutting their earnings estimates. Even estimating Brent prices at $42 in FY21, analyst at Edelweiss had expected a 59 per cent year-on-year decline in ONGC's FY21 earnings. This translates into a 70 per cent cut in ONGC's FY21 earnings estimates. It is unlikely that Oil India's earnings decline could be significantly different.

Given the increasingly uncertain oil price environment, ONGC's depleted cash reserves, and government guidelines which constrain state-owned enterprises' ability to lower dividends, the company’s ratings have been downgraded by Moody’s. “ONGC's credit metrics will weaken beyond the tolerance level for its ratings, if oil prices remain low for a prolonged period," says Vikas Halan, Moody's lead analyst for ONGC.

The requirement by government-owned companies to pay a minimum annual dividend equal to 5 per cent of their net worth is seen as a negative for credit profile at a time when profits are under stress and companies need to meet debt repayment obligations, too. ONGC's cash and cash equivalents declined to Rs 6,700 crore on September 30, 2019, from Rs 24,700 crore at the end of 2016, while its net borrowings increased to about Rs 1 trillion from Rs 21,500 crore during the period.