Thursday, March 25, 2010


Crude price upgrade. Macquarie’s oil economist, Jan Stuart, has upgraded the WTI crude oil forecast by 13-18% for 20010E–13E and long-term forecast from US$75/bbl to US$85/bbl.

Upstream companies’ gain. We sharply upgrade our target price for Cairn India by ~15% as it is India’s only crude oil pure-play. We also upgrade ONGC, OIL & RIL by 2-4%. We re-affirm our switch recommendation from ONGC and Cairn India to RIL and OIL.

Stronger fundamentals. Fundamental data have turned and finally show tightening oil supply and demand balances. Inventories are still high. But it now appears that they did fall late last year and that inventories should normalize quite quickly over the course of this year. The driving force toward leaner balances is demand growth in emerging economies. That will become
especially obvious once OECD oil consumption stops falling next quarter.

We also raise our Long Run oil price. We use $85/b WTI as a proxy for long-term cost of incremental supply, after taking a fresh, in-depth look at cost-structures and margins of Canadian oil sands projects.

GRM estimates remain unchanged: Our refining margins estimates remain unaffected by the increase in crude assumptions, since GRMs follow their own demand-supply dynamics, which we believe is improving.

Cairn India to gain the most as it is an oil pure play: We upgrade our target price by ~15%. Our near-term earnings upgrade is slightly less steep though (+13% FY11E & + 10% FY12E) given a slow production ramp-up.

ONGC, OIL positive impact partially offset by subsidy: Although, there is no clear subsidy-sharing mechanism as yet, the government does tend to increase ONGC & OIL’s subsidy burden as oil prices rise. This takes away a bulk of the upside. Hence we believe gains to these companies would be diluted, and hence upgrade ONGC and OIL’s target prices only mildly by 2.5% and 2.0%, respectively.

RIL is not significantly leveraged to crude with only 4% of its turnover coming from crude oil. Nevertheless it is not burdened by subsidies and it is an operationally leveraged business. We upgrade RIL’s target price by 4%.

GAIL and Reliance Industries remain our top sector pick. We believe both are poised to witness a volume and margin expansion. RIL’s upstream KGD6 gas ramp-up is poised to nearly double GAIL’s gas transmission volumes. While GAIL’s petrochemical margins are poised to improve, we believe RIL’s recently doubled refining capacity is well-timed to capitalise on a rebound in gross refining margins.

To read the full report: OIL & GAS