>OIL & NATURAL GAS: Strong domestic reserve replacement; production decline continues (GOLDMAN SACHS)

What's changed
ONGC announced its annual operational metrics for FY10, which indicate strong 1P reserve replacement (1.33x) in domestic fields but declining oil production. Notably, oil production has declined in ONGC’s overseas subsidiary, OVL (ONGC Videsh) as well. Natural gas production grew marginally by about 1% yoy, keeping the overall production volume flat yoy. The numbers were below our volume forecasts for ONGC.

Implications
Overall, ONGC’s production profile remains challenged by natural decline in its key blocks in India and overseas. The oil production decline would have been steeper had it not been for ONGC’s share in Cairn India’s oil production from Rajasthan. While ONGC continues its redevelopment efforts in Mumbai High offshore fields in order to arrest the decline, we note that share in Rajasthan oil production likely represents the most significant new avenue of volume growth for ONGC in the medium term.

Valuation
We maintain our Neutral rating on ONGC with a new 12-m TP of Rs1,010 (earlier Rs1,110), based on EV/GCI vs. CROCI/WACC framework, implying downside of 1%. Our valuation now assumes ONGC’s net oil realization at US$55/bbl in FY10E and US$50/bbl in FY11E vs. US$ 58/bbl and US$53/bbl previously. We have cut FY10E-12E consolidated earnings by 3%-13%,
reflecting our new production forecasts and oil realization estimates.

However, given continued uncertainty in the subsidy-sharing mechanism for loss-making state-owned oil marketing companies, we believe ONGC will likely end up paying a higher subsidy and hence see further potential downside risk to our earnings estimates.

Key risks
1) Higher subsidy burden, 2) lower production volume from legacy fields, and 3) fuel price reforms leading to higher net realization for ONGC.

To read the full report: OIL & NATURAL GAS