Consequent to the announcement on May 27, 2009 regarding the likely start of crude oil production at Cairn India’s largest oil block in Rajasthan from June, there is greater visibility over the future prospects of the company. Additionally, global crude oil prices have risen by over 11 per cent since May 27 to $68-69 currently; it has nearly doubled since end-December 2008 levels.
Although a few key issues that pertain to the crude oil pricing and whether cess on the crude oil produced at the Rajasthan block is to be paid or not are unresolved, indications are that clarity should emerge soon. Meanwhile, the stock is up 18 per cent since the announcement, as compared to 7 per cent rise in the BSE Sensex. While most positives seem factored in the price, there could be further upsides in the long-run.
Volume boost
Currently, only two blocks of Cairn (where it has a minority stake) produce oil and gas. However, the share of Cairn works out to about 17,000 barrels of crude oil equivalent per day (bopd). But, with Cairn having completed a sizeable part of the capital expenditure at its key field, Mangala, in Rajasthan block, volumes are set to rise. The first phase (Train 1) is ready to start commercial production in June.
| ON AN UPWARD TRAJECTORY | |||
| Blocks | Cairn's stake (%) | Production capacity * | Start |
| Ravva | 22.5 | 52,539 | current |
| Cambay | 40.0 | 13,607 | current |
| Mangala (M) train1 | 70.0 | 30,000 | Jun-09 |
| train2 | 70.0 | 50,000 | Dec-09 |
| train3 | 70.0 | 50,000 | Jun-10 |
| train4 | 70.0 | 75,000 | 2011 |
| Total (M) | 205,000 | ||
| Bhagyam (B) | 70.0 | 40,000 | 2011 |
| Aishwariaya (A) | 70.0 | 20,000 | 2011 |
| Total (MBA) # | 265,000 | ||
| * average daily production capacity, including share of Cairn & others # Estimated plateau production of 185,000 barrels per day by 2011; Cairn's share = 129,500 barrels | |||
The output will initially be transported by road and sea to its destination as the pipeline to transport the same is not ready. Thus, in the interim, the cost of transportation will be higher at $7-10 per barrel. But, with the 600-km insulated and heated pipeline to be in place by December 2009 quarter, expect this cost to decline to just $1-1.5 per barrel. By that time, the second phase or Train 2 will be ready to go on stream. Thus, in six months, volumes should rise by 56,000 bopd considering that Cairn’s has a 70 per cent share in the Mangala field.
Thereafter, the development work on Train 3 and 4 of the Mangala field, which is on track to commence output by 2011, will boost the total production capacity (Cairn’s share pegged at 143,500 bopd). Likewise, the work at Bhagyam and Aishwariya (other Rajasthan-based fields) could see completion by 2011.
The company however, believes that it should be able to achieve a consistent production of 185,000 bopd from these fields for ten years (during 2011-2021), including with the help of EOR (enhanced oil recovery) techniques.
Unresolved issues
While the clarity regarding crude oil production has improved, the issue of pricing and applicability of cess still hang fire. Analysts say, since the crude oil produced at the Rajasthan block contains higher wax content, it is expected to be sold at a discount as compared to the price of its benchmark variety (Bonny Light). This has meant a discount of 10-16 per cent in their estimates for Cairn India’s financials. The company, however, is still negotiating the price with the buyers (Indian Oil, HPCL and MRPL) which should conclude soon.
Another issue that needs clarity is whether Cairn will have to pay a cess on crude oil produced from the Rajasthan fields. While Cairn believes that it is not liable to pay cess, analysts are divided on this with some having factored in a cess of Rs 925 per tonne (the rate applicable at the time of signing of production sharing contract) while others assuming Rs 2,575 per tonne (current rate). If Cairn has to pay cess, it would translate into $2.7 per barrel and $7.5 per barrel, respectively (assuming Rs 48 to the dollar).
Building long-term resources
The company’s 25 fields based in Rajasthan are estimated to have in-place crude oil reserves of 3.5 billion barrels. Of this, the three fields (Mangala, Bhagyam and Aishwariya) under the development phase account for 2 billion barrels, from which, Cairn hopes to produce at least 1 billion barrels (recovery rate of 50 per cent) over its lifespan (40 years). The company is also working on its Barmer (Rajasthan-based) field, which has in-place oil reserves of 400 million barrels. However, the recovery rate may be lower at up to 20 per cent as compared to the usual 45-50 per cent.
Cairn India also has interests (ranging 10-50 per cent) in several other blocks (total of 14) including in the high potential Krishna Godavari (KG) basin. These blocks are in different stages—including seismic data collection and analysis, and drilling of exploratory wells for testing purposes, which typically end with determining whether commercialisation makes sense or not.
| HIGH ON CRUDE | |||
| in Rs crore | FY09 * | FY10E | FY11E |
| Net sales | 1,433 | 3,120 | 9,695 |
| EBIDTA | 910 | 1,990 | 7,436 |
| Net profit | 803 | 1,213 | 5,298 |
| EPS (Rs) | 4.3 | 6.4 | 28.0 |
| PE (x) | 60.5 | 40.4 | 9.2 |
| * Non-annualised figures for 15 mths ended Mar' 2009 E: analyst estimates | |||
Last year, the company was also awarded a license by the Sri Lankan government to explore the Mannar basin. Cairn is likely to start initial studies and exploration activities in Mannar and KG basin by the end of 2009. While the outcome regarding these fields will be known in the medium-term, any meaningful discoveries should rub-off positively on the stock’s valuation.
Outlook
Crude oil prices have nearly doubled in the last five months to $68-69 a barrel currently. However, part of the gains for domestic oil producers like Cairn may get offset if rupee continues to gain (up nearly 10 per cent since May).
For Cairn India, with volumes set to rise from July 2009 onwards, its performance is seen improving substantially. By 2010-11, it could generate free cash-flows of about $1 billion (rising further to over $2 billion in 2011-12), which the company could use to develop new blocks or for retiring debt.
Going ahead, further triggers could come in the form of success from the company’s large exploration portfolio, which currently has potential reserves of 1.4 billion barrels or if crude oil prices rise further. For now, the stock offers limited upside of about 15 per cent from current levels of Rs 259. On the flip side, since the three Rajasthan fields account for a substantial part of the stocks’ value (almost 90 per cent) based on a sum-of-the-parts valuation, any unfavourable outcome regarding crude oil pricing or payment of cess (beyond market expectations) could impact the share price. Investors with some appetite for risk may consider the stock on dips with a long-term perspective.
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