>ESSAR OIL (JP MORGAN)

■ Initiating coverage with Neutral rating and Mar-11 PT of Rs160: Essar Oil Ltd (ESOIL) is emerging as an integrated player across the energy chain with value-creation options in refining and upstream. While the competitive position in refining could be advantageous in the current environment, further value-unlocking through low-cost refinery expansion and the development of Ratna fields are likely to be contingent on funding and government approvals.

■ Positive drivers: ESOIL is upgrading its 10.5mmtpa refinery to 16mmtpa, adding significant secondary processing capacities. The expansion would give ESOIL significant advantages in: (1) complexity—allowing ESOIL to process a tougher crude diet (API 24.8), enabling better GRMs; and (2) competitive cost structure—an opex of c.US$2/bbl vs. US$4-5/bbl for western peers. By 1HCY10 ESOIL will begin to monetize its CBM asset at Raniganj—this will deliver significant revenue (Rs8.3B over FY11-12E) and value (US$662MM based on a 17-year plateau of 3.5 mmscmd) to ESOIL.

An emerging integrated play

■ Key challenges: We expect global new refining capacity of 1.5MM- 2MM bopd/annum over 2009-11, in a weak demand environment, which will put pressure on refining utilization/margins. OPEC production cuts have resulted in narrower light-heavy crude differentials, which hurt complex refiners. ESOIL’s ability to accrete value through low-capex cost (US$875/complexity bbl) refinery expansion is contingent on funding. The development of the newly discovered Ratna field (US$810MM value for Essar) awaits government approval.

■ Valuation, PT and risks: Our PT of Rs160 is based on 7x EV/ EBTIDA for 16mmtpa refinery, NPV for Raniganj, and the value of tax incentives. We assume option values for refinery expansion (50% value accretion) and Ratna field (50%). Downside risks to our PT are project delays and a prolonged refining downturn. Upside risks are availability of funding for expansion, and approval for Ratna development.

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