Meaningful recovery in oil realizations key for ONGC’s earnings growth
There may be a ray of hope for ONGC as a rise in oil prices may support its net oil realization and, in turn, the oil producing company’s earnings. Volatility in crude prices during 2020, owing to pandemic-led disruptions had a significant impact on ONGC’s earnings prospects. Crude prices now are close to an 11-month high, which is improving the outlook for ONGC. However, sustaining these price levels remains crucial. Brent crude oil future prices, which ranged $37-40/barrel at the start of the December quarter, though volatile, moved to around $52/barrel towards the end of the quarter. The start of January has seen a further tightening of supplies by oil-producing nations. Thus, crude prices remain firm and Brent crude oil futures are now trading around $56 a barrel. This has improved realisations outlook for upstream oil producing companies such as ONGC further. This has been reflected in stock prices as ONGC has gained about 60% since October lows. ONGC is expected to report net realisations of $44 a barrel in the December 2020 quarter, an improvement from $41 a barrel in the September quarter. However, the expected net realisation is still 26% lower than that seen during the quarter ending December a year ago. For net realisations to improve further, crude needs to sustain the higher levels. Production discipline by oil-producing nations and continued improvement in global oil demand will thereby be watched for. An uptick in oil realisations is also necessary since the production is likely to maintain a flat trajectory. Though some promises are offered by fresh oil and gas discoveries, analysts at Motilal Oswal Financial Services model in flattish oil production for the next two years. Meanwhile, gas sales and prices also remain under pressure for ONGC. Natural gas sales volumes are to decline 3% year-on-year (YoY) to 4.7 billion cubic meters (bcm) during the December quarter (as per Kotak Institutional Equities estimates) reflecting lower production in the recent months. The earlier expectations of rising gas production boosting earnings growth have been dashed, with delay in demand and production ramp-up due to the pandemic. Meanwhile, gas prices are also under pressure. Domestic gas prices had been cut by 25% for the second half of FY21 looking at weak international prices. The same will only be reviewed at the end of March despite some uptick in spot gas prices being seen currently. Hence, gas segment contributions in the near-term may not provide a meaningful upside to earnings. So, while valuations remain attractive (about 3.2x FY22 estimated EV/Ebitda) and there is some improvement in prospects for the company being led by rising crude prices, more may be needed.
Natural gas price headed towards $3/MMBTU in a month
Natural gas is a commodity that has been heavily volatile in 2020. NYMEX natural gas prices made a low of $1.43/MMBTU in late June 2020, a high of $3.39/MMBTU in November 2020, and finally ended the year at $2.53/MMBTU, marking an annual gain of 16 per cent. Since MCX’s natural gas prices are a mirror reflection of NYMEX rates, the volatility was similar on the domestic bourse. MCX natural gas prices were up 17 per cent in 2020, settling at Rs.182.1 per MMBTU on December 31. Electricity generation via natural gas increased in the US in 2020. The use of natural gas, which is one of the main sources of generating electricity in the US, has been substantial in the past five years. Annual electricity generation from natural gas power plants in the US increased 31 per cent in the northeastern region, 20 per cent in the central region, and 17 per cent in the southern region between 2015 and 2019. In the western region of the continental United States, electric power generation from natural gas power plants remained relatively flat during the same period. Through November 2020, the central, southern and northeastern regions have generated similar amounts of electricity from natural gas power plants. While the electricity generation efforts via gas was commendable, the increase in LNG exports from the US also played a significant role for the rise in natural gas prices, while the world grappled with the pandemic in 2020. In November, estimated LNG exports surpassed the previous record set in January 2020. In December 2020, the US Energy Information Administration (EIA) estimated that November US LNG exports reached 9.4 billion cubic feet per day (Bcf/d), which was 93 per cent of peak LNG export capacity utilization. Several factors contributed to the increase in the US LNG exports in recent months. International natural gas and LNG prices increased in Asia and Europe with an increase in global natural gas demand after easing of COVID-19 restrictions and a fall in global supply due to unplanned outages at export facilities in Australia, Malaysia, Qatar, Norway, Nigeria, and Trinidad and Tobago. New US LNG export capacity of 2.7 Bcf/d was added in 2020, whereas several US LNG terminals, affected by hurricanes and annual maintenance, also resumed LNG shipments, according to the EIA. On the other side, working gas in storage was 3,460 Bcf as of December 25, 2020, according to EIA estimates. Stocks were 251 Bcf higher than last year at this time, and 206 Bcf above the five-year average of 3,254 Bcf. At 3,460 Bcf, total working gas is within the five-year historical range, which clearly indicates that the inventory is in a comfortable situation. Hedge funds positioning in natural gas Speculative positioning in natural gas increased in the second half of 2020, with hedge funds increasing their bets from net shorts to net longs. As of April 14, 2020, hedge funds were net shorts in natural gas at 86,154 contracts. As of, December 29, 2020, they were net longs at 7,744 contracts, indicating a rise in interest in the commodity. The tale of winter: Where is natural gas headed? While the winter in the US is a time when the demand for gas increases, this time around, the winter (2020-21) is warmer than normal. This US Winter Outlook 2020-2021 map shows above-average temperatures are likely in the south and below-average temperatures in parts of the north. Natural gas price headed towards $3/MMBTU in a month Winter in the US (October-March) does not offer a feasible demand-side situation for natural gas prices to rise. Moreover, with a comfortable inventory situation and more coronavirus-related restrictions, a warm winter is not favourable for gas prices from here on. We expect NYMEX natural gas prices to move higher towards $3/MMBTU in a month, while MCX gas prices have the possibility to move higher towards Rs 230/ MMBTU.
Goldman forecasts ‘perfect storm’ for global gas markets
Goldman Sachs raised its forecasts for key natural gas price benchmarks on Wednesday, saying falling supplies and colder weather in Asia and Europe made for a “perfect bullish storm”. It sees European balances even tighter on colder weather revisions in North-Western Europe and a deeper-than-expected drop in NW European Liquefied Natural Gas (LNG) deliveries. Goldman lifted its Dutch Title Transfer Facility (TTF) gas price forecasts for the rest of the winter, and calendar years 2021 and 2022, to $8.30 per one million British thermal units (mmBtu), $6.72/mmBtu and $6.48/mmBtu from $6.65, $5.63 and $6.03 previously. The European benchmark Dutch month-ahead gas contract retreated slightly on Wednesday from an over two-year peak scaled in the previous session. While Goldman expects tightness in coal markets to moderate from the summer, it sees a slower-than-expected return of Colombian coal supplies, implying higher TTF gas prices later. “We also raise our 2021/22 winter, 2022 summer and 2022/23 winter TTF forecasts to $6.60/mmBtu, $6.30/mmBtu and $6.90/mmBtu from $5.95, $5.85 and $6.75 previously,” the bank said. Supply disruptions, shipping delays and strong LNG demand, supported by heavy nuclear maintenance in Japan and a cold start to 2021 in North-Eastern Asia, have significantly tightened the market, Goldman analysts said in a note. The bank also raised its Japan Korea Marker (JKM) forecasts for balance of winter for 2020/21, and calendar years 2021 and 2022, to $14.30/mmBtu, $8.73/mmBtu and $7.85/mmBtu from $12.65, $7.56 and $7.37 previously. Goldman reiterated its expectation for a significant upside to NYMEX gas prices this summer to help correct what it sees as a 2.5 billion cubic feet per day market imbalance through October 2021, and maintained its $3.25/mmBtu 2021 summer U.S. gas price forecast.