Ballooning Natural Gas Supply-Demand Deficit to Fuel LNG Imports

India‟s natural gas supply has been adversely impacted in 2011-12 due to fall in KG D6 production to 46.6 MMSCMD in H1 2011-12 from 55.9 MMSCMD in 2010-11. KG D6 production is likely to remain at subdued levels over the next couple of years, especially in comparison to the earlier anticipated production of 60-80 MMSCMD. Overall, ICRA expects domestic natural gas supplies to increase to around 153 MMSCMD by 2014-15 from 143 MMSCMD in 2010-11. The current estimate is about 22% lower than our previous estimates of 195 MMSCMD primarily due to lower KG-D6 production and delays anticipated in commissioning of KG satellite fields. 


On the demand front, despite the significantly high potential across several sectors, the realisable demand for natural gas will be a function of gas supplies in the market at reasonable price, the price competitiveness of gas as compared to alternative fuels, timely commissioning of the proposed transmission pipeline infrastructure, and regulatory initiatives in the power sector. 


ICRA believes that demand will increase from new customers once the bottlenecks in the trunk pipeline are cleared in the near to medium term. Overall, ICRA expects gas demand to rise to around 410 MMSCMD by 2019-20 from the actual consumption of around 177 MMSCMD in 2010-11. ICRA believes that India, despite the long-term contracted LNG volumes with Australia and mid-term contracts signed by GAIL, needs to secure additional supply on a long-term basis, especially in view of less-than-anticipated domestic supply and possible shortage of LNG after a couple of years. India‟s high reliance on LNG is expected to increase further, which will pose significant risks in a scenario of tight LNG supply demand scenario, leading to low availability and high prices of spot LNG. 


As regards gas allocation and pooling, an inter-ministerial committee has recently recommended i) preferential allotment of available domestic natural gas to core sectors, that is, fertiliser and power sectors, along with a certain amount reserved for the CGD/CNG sector, ii) cap on domestic gas allocation to certain other sectors and iii) inferred gas price to be used as benchmark for domestic gas pricing. The committee has not suggested any form of pooling at the all-India level across industries but the objective has been assumed to be served by indirect pooling at the end of consumers, with price-sensitive sectors (fertiliser/power/CGD) getting a higher share of cheaper domestic gas. ICRA believes that the policy recommendations, if accepted, will provide more clarity to gas usage mix and pricing, which in turn would help companies across industries to formulate their capital expenditure plans (capex) and future requirements of natural gas.


To read the full report: NATURAL GAS

>EQUITY STRATEGY: Portfolio Musings: Time to look at banks

Portfolio Musings: Continue to remain cautious

We continue to believe equity markets will stay cautious with no credible solution

yet on the European situation. Domestically too, the window of likely policy action

(relaxed FDI, fuel price and fertilizer subsidy reform) is now threatening to close for

the medium term with Uttar Pradesh state elections drawing closer (unless

prescheduled, expected in May 2012). However, while inflation remains elevated,

we believe that policy rates may be approaching a peak with expectations of

slowing global growth and increasing regulatory focus on exchange-traded

commodities. Athough valuations are beginning to look attractive for the Indian

market, investors are now increasingly beginning to look at the outlook for FY13,

where the jury, on economic growth and earnings growth,is still not in. However,

the Indian hinterland - driven by rising prosperity in tier 2 and tier 3 towns, remains

robust doing the heavy lifting for the Indian economy along with services.

Raising O/W on banks, reiterating conviction Buys on tractors & 2-wheelers

Our banking analysts Manish Karwa and Manish Shukla believe that the banking

sector is trading at trough valuations, despite conservative estimates on asset

quality (a legitimate concern, which may already be priced in). Following the high

conviction call from our banking team, we raise our overweight on banks to

179bps with SBI and HDFC Bank the top picks in our model portfolio. We continue

with our high conviction O/W call on 2-wheelers and tractors (M&M and Bajaj

Auto) as we believe that continuing strength in India’s hinterland (aided by strong

monsoon) should drive robust demand for tractors and 2-wheelers. Our key U/Ws

are: (a) Utilities - with power sector continuing to languish from coal-shortage, (b)

Metals - we see further risk to global commodity prices from slowing global

growth plus increased regulatory focus on exchange traded commodities.

Key additions: SBI, cement, NHPC & Exide; Deletions: SunTV, Bharat Forge

New additions to our portfolio: SBI - a top pick with our banking analysts as SBI’s

NIM trajectory has been improving, while its strong liability franchise continues to

help immobilize low-cost deposits. We also add 3 cement stocks (Ultratech, ACC

& Shree Cement); our cement analyst foresees rising capacity utilization and

narrowing price differentials between wholesale and retail prices benefitting key

cement players. We introduce NHPC (regulatory focus for hydro power expected

to turn favorable) and Exide (EBITDA margins to improve). Top Picks: Asian

Paints, Bharti, Bajaj Auto, Coal India, HDFC Bank, ITC, JSPL, L&T, M&M, SBI.

DB India Model Portfolio continues to outperform benchmark MSCI India

Our model portfolio has outperformed MSCI India by 102bps since 5th August

2011 (date of last change to the portfolio) driven chiefly by our O/W stance on 2

wheelers and tractors. Our Model portfolio has outperformed MSCI India byEU

384bps YTD and by 455bps YoY respectively.

To read the full report: EQUITY STRATEGY

>GOLD: Macro and financial factors driving gold returns over the past three years should remain in place for 2012.

Goose with the Golden Eggs

 Gold holds a unique historical status as a non-consumable commodity universally

recognized as a medium-of-exchange. Given the large amount of non-perishable

inventory overhang, traditional demand-and-supply dynamics do not apply in the short

term. In times of macroeconomic stress, financial factors may drive gold prices well

above physical costs of replacement for extended periods of time, thus exhibiting

“bubble-like” characteristics.

 There is a high probability that macroeconomic and financial factors which have

propelled gold prices over the last three years will continue for the next 12 to 18

months. We look at three major macro-financial drivers of nominal and real gold price

returns: denomination effects from inflation and currency adjustments, followed by real

interest rates, and finally financial demand for gold as a safe haven.

 Denomination — Nominal gold prices quoted against the US dollar must reflect

changes in the value of the denominator. Common measures of changes in the

purchasing power of the US dollar include consumer price inflation and currency

exchange rates against a weighted basket. This has accounted for some but not all of

the appreciation in nominal gold prices.

 Real Interest Rates — Once adjusting for denomination effects, real interest rates

serve as a useful proxy of the value of holding purely financial as opposed to physical

assets, thus capturing the opportunity cost of investing in gold. Given the weak

economic outlook, we expect central banks to keep nominal and real interest rates low,

providing the impetus to drive gold prices higher.

 Financial Demand — Lastly, gold has seen an unprecedented amount of financial

demand from both retail investors and central banks seeking a safe-haven against

other asset classes. Given the high level of market uncertainty and continued turmoil

from the euro-zone crisis, this financial demand should continue into 2012.

 Gold Price Outlook — We forecast nominal gold prices, which averaged $1220/t oz in

2010, to average $1575 in 2011 and $1950 in 2012.

To read the full report: GOLD

>RELIANCE INDUSTRIES: 2QFY12 results; revise EPS, target, reco

Reliance’s 2QFY12 net profit rose 0.7%QoQ to Rs57bn – 1% below expectation.

Ebitda came 7% ahead as weak refining was offset by better petchem. E&P Ebit

was also higher due to lower DD&A and higher liquids output. Forex losses and

lower other income pulled reported EPS estimates. We have cut FY12/13 EPS by

4/2% primarily to model a $0.2-0.3/bbl cut to GRMs. We also reset our 12m

forward target to Rs950/sh. After recent stock price rally, this implies only a 10%

upside; we revise our reco to O-PF noting also that the stock is again trading at a

premium to global peers with implied E&P value similar to the base BP-deal value.

2QFY12 net up 0.7% QoQ. Reliance’s 2QFY12 net rose 16%YoY/1%QoQ to Rs57bn

(Rs17.4/sh) – 1.3% below estimates. Lower refining was offset by better petchem

while E&P Ebit was also higher than expected on lower depreciation and higher liquids

output. Overall, core Ebit (Rs71.5bn, +9%QoQ) was 9% ahead. However, a large forex

loss (Rs4.4bn) and lower than expected other income pulled reported profit below our

estimates. Reliance also adjusted Rs45bn in translation losses on its forex debt on its

balance sheet driving up reported debt and fixed assets by this amount.

GRMs fall QoQ. Refining Ebit declined 4% QoQ – 10% below expectation led by a

US$0.2/bbl QoQ decline in GRMs (US$10.1/bbl) – US$0.4/bbl below estimates. As in

the last few quarters, Reliance’s realised margins continue to lag the strength in Singcomplex

margins (+US$0.5/bbl QoQ); for the quarter management attributed this to

primarily to softer light-heavy spreads, lower gasoil spread and use of higher cost LNG.

Strong petchem. Petchem Ebit rose 9%QoQ (16% above estimate), though, on

higher margins in polymers and chemicals offset by lower chain margins in polyesters.

A rebound in domestic demand (+21%QoQ in both polymers and polyesters) would

have helped while implied opex was also sharply lower (down 16%QoQ).

Mixed outcomes in E&P. Reliance adjusted the BP-deal from end Aug-11 leading to a

Rs32.2bn cut to E&P gross block; lower DD&A drove E&P Ebit up 4%QoQ even as KGD6

gas volumes declined 4mmscmd QoQ. Our interaction during the analyst meet

indicates that drilling and completions of additional wells may take 2-3 years implying

that a quick rebound in output is unlikely. Monetisation of other discoveries in KG-D6,

NEC-25 etc are also continent on government approvals and are unlikely before 2015.

Reliance also underscored that it has frozen exploration activity pending the outcome

of comprehensive review with BP. Progress in shale-gas is encouraging though, with

the Pioneer JV now producing at 6mmscmd of gas and ~25kbpd of condensate.

We lower EPS by 2-4%. We make several changes to our model, including an

US$0.2-0.3/bbl cut to GRMs, leading to a 4/2% cut to FY12/13 EPS. Lower earnings

and an alignment of NEC-25 resources to recent media comments (1.2tcf) leads to a

5% cut to our Mar-12 fair value to Rs915/sh; we set our 12-month target at Rs950/sh.

Revising rec to O-PF. After the recent rally, this implies just a 10% upside; we are

revising our reco to O-PF. We also highlight that the stock now implies an E&P value

similar to the base-value of the BP transaction (US$7.2bn for 30%) and is again

started trading at a 1-39% premium to peers on earnings based valuation multiples.

To read the full report: RIL