CRISIL CRBCustomised Research Bulletin

June-July 2012 CRISIL CRBCustomised Research Bulletin Oil & Gas

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CRISIL CRBCustomised Research Bulletin CRISIL Customised Research CRISIL Research, the leading independent and credible provider of economic, sectoral and company research in India, utilises its proprietary information networks, database and methodologies to provide you customised research inputs and conclusions for business planning, monitoring and decision-making. CRISIL Research provides research inputs and conclusions to support your decisions while Lending to an entity Taking a stake in an entity Transacting/partnering with an entity Feasibility of entry into a new business segment Feasibility of capacity expansion Choice of location, fuel, other inputs Choice of markets, targeted market share Product mix choices Production/sales planning CRISIL Research provides you the following inputs to help you identify/assess business opportunities or review business risks Identification/assessment of new business themes/areas Building futuristic scenarios and discontinuity analysis over the long term Assessing the impact of changes in economic variables, commodity prices on your business Field-based information on variables and tracking indicators for ongoing review of opportunities/risks in your sectors of interest Assessment of credit/investment quality of your portfolio

Foreword In this edition of Customised Research Bulletin, we present our views The sector insights in this report are based on various research assignments undertaken by our Oil & Gas sector experts. In the Opinion section, we have analysed the impact of crude oil prices on domestic oil PSUs. Since May 2012, crude oil prices have declined sharply below $100 per barrel from $120.5 per barrel in April 2012 mainly because of increased on global economic concerns. Also, production from many countries has increased significantly over the last one year. The sector insights draw upon our rich and extensive experience and knowledge base built over the last 20 years. We are confident that you will find this report highly informative and useful. Prasad Koparkar Senior Director CRISIL Research

CRISIL CRB Customised Research Bulletin Contents Opinion Hike in diesel 01 Economic Overview June 2012 05 Industry Overview Crude Oil 06 Refining & Marketing 08 Natural Gas 09 Customised Research Services Oil & Gas 11 Media Coverage 12

Opinion liquidity With the losses incurred by oil marketing companies (OMCs) on selling regulated fuels below their market prices (under-recoveries) reaching alarming levels, urgent corrective action like hiking the price of diesel has become imperative. Diesel prices were last revised in June 2011, when kerosene and LPG prices were also revised upwards. Non-revision of the administered prices of these fuels, since then, has severely impacted liquidity and profitability of OMCs and massively inflated Under-recoveries at record-high levels Petrol prices (Rs/kl) 40,000 35,000 30,000 25,000 20,000 15,000 2005-06 2006-07 2007-08 2008-09 Domestic prices (before taxes) Source: CRISIL Research 2009-10 2010-11 2011-12 International prices Trend in under-recoveries Diesel prices (Rs bn) 1,600 1,400 1,200 1,000 800 600 400 200 400 2005-06 494 2006-07 771 2007-08 1,042 2008-09 461 2009-10 782 2010-11 1,385 2011-12 (Rs/kl) 40,000 35,000 30,000 25,000 20,000 15,000 2005-06 2006-07 2007-08 2008-09 Domestic prices (before taxes) 2009-10 2010-11 2011-12 International prices Source: Industry Source: CRISIL Research In 2011-12, oil marketing companies (OMCs) incurred record-high losses of ~Rs 10 per litre on diesel, ~Rs 27 per litre on kerosene, and ~Rs 270 per cylinder on LPG. This was largely on account of inadequate revision of domestic prices, despite a sharp increase in international prices. As a result, under-recoveries have increased by 77 per cent in 2011-12 to Rs 1,385 billion from Rs 782 billion in 2010-11. LPG prices (Rs/cylinder) 700 600 500 400 300 200 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 Domestic prices (before taxes) International prices Source: CRISIL Research 1

CRISIL CRB Customised Research Bulletin Diesel prices Comparison of running cost (Rs/kl) 41,000 36,000 31,000 26,000 21,000 16,000 11,000 6,000 (Rs/km) 5.0 4.0 3.0 2.0 1.0 1.3 2.4 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 Domestic prices (before taxes) International prices Petrol car Diesel car Source: CRISIL Research Source: Industry, CRISIL Research The increase in under-recoveries was also due to increased consumption of regulated fuels (like diesel) by private car owners due to significant difference in prices as compared to other alternate fuels like petrol. The difference between running cost for a petrol car visà-vis diesel car has gone up by ~85 per cent in the last 7-8 years, which is lucrative enough for buyers to opt consumption. Consequently, proportion of diesel cars in total car sales has increased to 38 per cent in 2011-12 vis-à-vis 20 per cent in 2005-06. Hence, a hike in prices of regulated fuels, especially diesel, which accounts for 40 per cent of the overall petroleum product consumption and ~60 per cent of under-recoveries, is essential and inevitable given the crippling underrecoveries of OMCs and a fast deteriorating fiscal situation. Product-wise trend of under-recoveries 100% 80% 60% 40% 20% 0% Source: Industry 32% 38% 46% 51% 20% 36% 36% 25% 27% 38% 26% 22% 20% 17% 31% 2005-06 2006-07 2007-08 44% 59% 28% 20% 25% 22% Increase in under-recoveries severely straining profitability, liquidity of OMCs Losses arising from under-recoveries are typically shared by the government, upstream oil companies (ONGC, OIL India and GAIL) and OMCs (IOCL, BPCL and HPCL) according to a proportion determined by the government at the end of every year. Until 2010-11, OMCs were able to bear some part of the underrecoveries as they were earning adequate profits from the refining business. However, in 2011-12, when the under- share the burden. All of it was shared between the government and the upstream companies. This was 2008-09 2009-10 2010-11 2011-12 Petrol Domestic LPG PDS Kerosene Diesel 2

because the weak refining profits coupled with rising Trend in consolidated gearing of OMCs interest costs on account of higher working capital borrowings led to a situation where OMCs were not (times) 1.90 able to share any burden. 1.70 1.50 Subsidy sharing formula 1.30 1.10 100% 80% 60% 40% 20% 10% 21% 42% 33% 49% 46% 32% 68% 12% 9% 31% 39% 56% 52% 40% 60% 0.90 0.70 0.50 Mar-05 Mar-06 Source: Industry Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 0% 2006-07 2007-08 2008-09 Note: Figures on the top of the bar indicate total underrecoveries in Rs billion Source: MOPNG -recovery burden in 2011-12, the absence of a fixed annual sharing mechanism for under-recoveries and the uncertain timing of cash payouts by the government, have adversely affected their profitability and liquidity. years as clearly indicated by their rising gearing levels. The debt-equity ratio of these companies has almost tripled from 0.6 times in March 2005 to 1.7 times in March 2012. 2009-10 2010-11 Government Upstream Downstream 2011-12 As a result, their interest costs have also gone up. Over the last one year itself, the interest costs have more than doubled to Rs 105 billion in 2011-12 from Rs 51 billion in 2010-11. Consequently, their profits dropped to Rs 62 billion in 2011-12 from Rs 105 billion in 2010-11. Rising under-recoveries worsens al position Rising under-recoveries is not only hurting the OMCs finances. In 2011-12, oil subsidies constituted 32 per amounting to Rs 835 billion. Out of the total billion in 2011-12 and the balance Rs 385 billion was to be paid in 2012-13. However, for 2012-13, the government has made an overall provision of merely Rs 436 billion towards oil subsidies. Of this, more than 80 per cent will be exhausted towards payment of the balance subsidy of 2011-12. If the prices of regulated fuels are not revised upwards, the under-recoveries will continue to remain high in 2012-13. Consequently, the share of oil subsidies in the fiscal deficit, which has already increased to 27 per cent in 2011-12 from 11 per cent in 2009-10, will remain high in 2012-13 as well. The government will be left with no option but to borrow additional funds to compensate OMCs during the year, 3

CRISIL CRB Customised Research Bulletin there position, assuming other factors remain constant. This, in turn, could exert further upward pressure on interest critical social and infrastructure projects. Alignment of domestic prices with international prices critical for reigning in security Given the seriousness of the problem, it is absolutely crucial that prices of regulated fuels be raised by at least 10-15 per cent immediately and gradually linked to international prices. The alignment of regulated fuel prices with international prices may affect domestic fuel inflation in the short term, but in the long term, the move reduce wasteful consumption of regulated fuels like diesel. In addition, it will also help the OMCs by reducing their dependence on the government for reimbursement of under-recoveries and give them enough flexibility to undertake capital expenditure and make acquisitions. This, in turn, would help strengthen 4

Indian Economy Economic Overview June 2012 High Threat Medium Threat Currency IIndustrial production growth Inflation Sectoral inflation 60 55 50 45 40 Jun-10 Oct-10 Feb-11 Jun-11 Oct-11 Avg Rs per US$ Feb-12 Jun-12 18 14 10 6 2-2 -6 May-10 Sep-10 Jan-11 May-11 Mfg Sep-11 Jan-12 May-12 18 8-2 Jun-10 Oct-10 WPI Feb-11 Jun-11 Oct-11 Feb-12 CPI-IW Jun-12 25 5-15 Jun-10 Oct-10 Feb-11 Jun-11 Oct-11 Primay Fuel Manufacturing Feb-12 Jun-12 Trade growth Foreign inflow (US$ bn) Interest rates Credit growth 80 40 0-40 May-10 Sep-10 Jan-11 May-11 Sep-11 Jan-12 May-12 10 5 0-5 Jun-10 Oct-10 Feb-11 Jun-11 Oct-11 Feb-12 Jun-12 10 6 2 Jun-10 Oct-10 Feb-11 Jun-11 Oct-11 Feb-12 Jun-12 25 20 15 10 Jun-10 Oct-10 Feb-11 Jun-11 Oct-11 Feb-12 Jun-12 Exports Imports FDI+ECBs Net FII flows 1 Yr 10 Yr Non Food Credit Macroeconomic Indicators - Forecasts 2011-12 2012-13 Rationale Grow th Agriculture 2.5* 3.0 GDP in 2012-13 is expected to grow by 6.5 per cent. An increased Euro zone uncertainity, continued domestic policy logjam and low er investment demand Industry 3.9* 5.0 w ill impact grow th adversely. Moderation in export demand w ill low er grow th in IT/ITES services and low private consumption w ill impact grow th of hotels, trade and transport services, keeping the overall services sector grow th Services 9.4* 8.1 muted. Industrial grow th w ill also remain w eak due to w eak investment demand and limited scope for reduction in interest rates. Going forw ard, sub-normal monsoons and a further w orsening of the Eurozone situation may pose Total 6.9* 6.5 dow nside risks to our grow th forecast. Inflation WPI - Average 9.2 7.0 WPI inflation forecast stands at 7.0 per cent. This takes into account a higherthan-anticipated increase in food inflation, and the impact of a w eak currency on the imported content of inflation. The w eak rupee is offsetting the gains from low er global crude oil and commodity prices and is keeping the cost of imported items high. Though low er GDP grow th w ill reduce demand-side pressures on inflation, other pressure points like decisions on revision of electricity prices and revision in prices of diesel, kerosene, and LPG is likely to keep inflation high. Interest rate 10- year G-Sec 8.5 8.0-8.2 Yield on benchmark 10 year G-sec is expected to settle around 8.0-8.2 per cent (year end) by March-end 2013. We expect the Reserve Bank of India (RBI) to cut repo rate by upto 50 basis points (bps) in the rest of the fiscal year in order to support private consumption and invetsment grow th. Despite this easing, dow nside to 10-year G-sec yield is limited due to the large size of government borrow ings. Exchange rate Re/US $ (year end) 48 50.0 The rupee is projected to settle around 50 per US$ by March-end 2013 in the base case scenario. In this scenario, w e have assumed (1) an easing of the current account deficit due to moderation in global crude oil prices and (2) higher foreign capital inflow s in 4QFY13. Both of these factors w ill help currency appreciation from current levels. How ever, a further w orsening of Eurozone crisis is not accounted for in this scneario. Fiscal deficit as a % of GDP 5.5 5.8 Slow er GDP grow th is expected to translate into low er grow th of government revenue w hile subsidy burden w ill remain high. This w ill raise the fiscal deficit to 5.8 per cent of GDP. 5

CRISIL CRB Customised Research Bulletin CRUDE OIL Industry Overview After a strong rebound in 2010, oil demand growth slows down in 2011 In 2011, global crude oil demand increased to 88 million barrel per day (mbpd) from 87.4 mbpd in 2010. The demand growth slowed down to a meager 0.7 per cent after registering a growth of 3.3 per cent in 2010. This was mainly due to slowdown in global GDP growth rate to 3.9 per cent in 2011 from 5.3 per cent in 2010. The consumption in Organisation for Economic Cooperation and Development (OECD) countries declined by 1.2 per cent (600,000 barrels/day), the fifth decrease in the past six years, reaching the lowest level since 1995. The major decline was witnessed in the US and Europe, where the consumption went down by more than 300,000 barrels per day each. In non-oecd countries, consumption grew by 1.2 million barrels per day, or 2.8 per cent. China again recorded the largest increment to global consumption growth (505,000 barrels per day) followed by Russia (156,000 barrels per day), India (140,000 barrel per day) and Saudi Arabia (108,000 barrels per day) Review of world oil demand 4.5% 5.2% 5.4% 34 35 37 38 39 41 2.8% 5.3% 42 50 50 50 48 46 46 46-0.6% 3.9% 2005 2006 2007 2008 2009 2010 2011 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% -1.0% Crude oil Global oil production increased by 1.3 per cent in 2011 In 2011, annual global oil production increased by 1.1 mbpd or 1.3 per cent. Virtually, the entire incremental supply came from OPEC, with large increases in Saudi Arabia (1.2 million barrels per day), the UAE, Kuwait and Iraq more than offsetting a loss of Libyan supply (- 1.2 million barrels per day). Output reached record levels in Saudi Arabia, the UAE and Qatar. Non-OPEC output was broadly flat, with increases in the US, Canada, Russia and Colombia offsetting continued declines in mature provinces such as the UK and Norway, as well as unexpected outages in a number of other countries. The US (+285,000 barrels per day) had the largest increase among non-opec producers for the third consecutive year. Driven by continued strong growth in onshore production of shale liquids, US output reached the highest level since 1998. Dependence on OPEC for supply of crude oil to remain stable at ~36 per cent over the next few years Crude oil supply from OPEC increased to 35.8 mbpd in 2011 from 35 mbpd in 2006. Global dependence on OPEC crude oil, which is currently at ~36 per cent, is expected to remain stable over the next few years. This is due to incremental supply from new fields in non- OPEC countries to counter structural decline in their existing matured fields. In addition, many small and marginal fields in non-opec which were earlier considered unviable have now become viable at higher oil prices. Also, production of OPEC NGLs is expected to increase over the next five years. OECD Non-OECD World GDP growth (RHS) Source: IMF, BP Statistics, CRISIL Research 6

Crude oil demand and dependence on OPEC Movement in crude oil prices (million barrels per day) 89 88 87 86 85 84 83 82 84.1 85.0 86.4 86.0 84.7 87.4 88.0 2005 2007 2009 2011 World Oil demand (LHS) Dependence on OPEC (RHS) 40% 35% 30% 25% 20% 15% 10% 5% 0% ($ per barrel) 140 130 120 110 100 90 80 70 60 50 40 High growth period Renewed Euro debt crisis & increase in production Economic downturn Geopolitical tensions in MENA region May-06 Oct-06 Mar-07 Aug-07 Jan-08 Jun-08 Nov-08 Apr-09 Sep-09 Feb-10 Jul-10 Dec-10 May-11 Oct-11 Mar-12 Source: CRISIL Research Source: Industry, CRISIL Research Crude oil prices declined sharply in May 2012 after remaining high for almost two years Since May 2012, crude oil prices have declined sharply below $100 per barrel from $120.5 per barrel in April 2012 mainly because of increased concerns over the recovery of stressed European economies as well as fears of slowdown in global crude oil demand. Also, production from many countries, including the US, Iraq, Libya, Saudi Arabia, etc, has increased significantly since the last one year. The increase in crude oil production from OPEC countries and North America coupled weak global demand is expected to result pressure on oil prices going forward. Prices have declined after remaining persistently high for almost two years. Crude oil prices had increased to $120 per barrel in April 2012 from $85 per barrel in April 2010. Prices surged mainly because crude oil demand rebounded by 3.3 per cent in 2010 post the economic downturn, and also due to intensifying of geo-political tensions in various Middle Eastern & North African (MENA) countries like Egypt, Libya, Syria and Sudan. Additionally, in January 2012, the US and European Union enforced sanctions against importing of crude oil from Iran. In response, Iran threatened to block the Gulf of Hormuz. This added a significant risk premium to crude oil prices, which traded at around $120 per barrel since February 2012. 7

CRISIL CRB Customised Research Bulletin Industry Overview Refining Marketing Weak global refining capacity utilisation rates led to decline in GRMs Global refinery capacity utilisation rates fell to 81.2 per cent in 2011 as global refining capacity increased by 1.5 per cent (1.4 mbpd) to 93 mbpd, whereas global refinery throughput increased by a meager 0.5 per cent (375,000 barrels per day) to 75.6 mbpd. Throughput in non-oecd countries accounted for the entire net increase, rising by 685,000 barrels per day. While OECD throughput declined by 310,000 b/d, US throughput increased by 110,000 barrel per day and the US became a net exporter of refined products for the first time on record. With the fall in utilization rates, gross refining margins (GRMs) also declined in 2011 and have reached close to decadal low levels. Going forward too, we expect global refining utilization rates to remain at 81-82 per cent over the next 3-4 years which will keep GRMs under pressure. GRMs vs Global refining capacity utilisation rates (per cent) 87 86 85 84 83 82 81 80 79 78 77 16 14 12 10 8 6 4 2 0 Indian petroleum product demand increased by 4.9 per cent in 2011-12 led by diesel Despite high prices in 2011-12, the overall petroleum product demand in India increased by 4.9 per cent to 148 million tonnes. The increase was mainly led by increased consumption of regulated fuels like diesel which grew by 7.6 per cent as it was at a significant discount to alternate fuels like petrol. In contrast demand for petrol declined to 5.6 per cent as compared to an average growth rate of 9.3 per cent between 2006-07 and 2010-11. Going forward, we expect demand to continue to grow at ~4 per cent Domestic demand for petroleum products (mn tonnes) 160 140 120 100 80 60 40 20 0 113 2005-06 1.4 6.7 6.8 121 129 2006-07 2007-08 Source: PPAC, CRISIL Research 134 138 141 3.6 2008-09 2009-10 3.2 Consumption of petroleum product 2010-11 2.3 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 (per cent) 148 2011-12 4.9 8 7 6 5 4 3 2 1 0 Growth rate Refinery utilisation rates [LHS] USGC Heavy Sour Coking GRMs [RHS] Source: BP Statistics, CRISIL Research 8

Industry Overview Natural Gas Natural gas accounts for around 24 per cent of primary energy consumption globally Natural gas has a share of nearly 24 per cent of the overall global primary energy consumption. Global consumption rose from 2,454 bcm in 2001 to 3,223 bcm in 2011 increasing at a compounded growth rate of 2.8 per cent. The US, Russia, Iran, Japan, Canada and the UK are the key consumers, accounting for around 48 per cent of global consumption in 2011. Composition of global natural gas consumption in 2011 (3,223 bcm) Japan 3% Iran 5% UK 3% Canada 3% Russian Federation 13% Source: BP Statistics US 21% Others 52% Limited domestic gas availability resulting in increasing of share of LNG Domestic gas production has remained stagnant at around 90 mmscmd over 2005-09 due to no major discoveries baring Reliance Industries discovery in the KG-D6 basin. Domestic gas is priced at a significant discount to international prices, but due to limited domestic gas availability reliance on LNG is increasing. Further, during the second half of 2010-2011, following technical issues in the KG-D6 field, production has been on a downward trend. With declining production, consumption of gas in 2011-12 remained at the increased demand for high priced LNG. As a result, the share of LNG overall gas consumption has more than doubled to 25 per cent over the same period. Natural gas consumption in India (mcm) 60,000 50,000 40,000 30,000 20,000 10,000 0 2002-03 Source: PPAC 2003-04 2004-05 2005-06 2006-07 Price sensitive - Power and Fertiliser sectors, contribute to the lion share of gas demand Domestic natural gas consumption is driven by the fertilisers and power (including captive power) sectors, which together accounted for around 77 per cent of -12. Fertiliser sector is estimated to have accounted for 24 per cent while power (including captive power) accounted for around 53 per cent of total gas consumption. Both these sectors have limited ability to pass on higher prices to end users, which constrains their ability to absorb high cost LNG. Limited domestic gas supply to constrain demand growth CRISIL Research expects demand for natural gas to grow at modest pace of 6-7 per cent CAGR over the near term. The production growth for low cost domestic gas will be slower, particularly till 2014-15, on account of limited ramp-up in domestic gas supplies. The consumers will have to increasingly rely on high cost LNG for their incremental gas requirements. Hence, 2007-08 2008-09 2009-10 2010-11 2011-12 9

CRISIL CRB Customised Research Bulletin demand growth for price sensitive sectors will be constrained. 10

Customised Research Services Oil and Gas Coverage Oil Refining and Marketing Crude Oil Motor spirit/ gasoline/ petrol (MS) Special boiling point spirits (SBP) Aviation turbine fuel (ATF) Superior kerosene oil (SKO) Oil and Gas Sector High speed diesel oil (HSD) Light diesel oil (LDO) Mineral turpentine oil (MTO) Gas Domestic Gas LNG Low sulphur heavy stock (LSHS) Carbon black feedstock (CBFS) Fuel Oil (FO) LPG Source: CRISIL Research Oil and Gas Assessment opportunity for LNG, CNG, PNG, LPG, etc. Project feasibilities for bottling and distribution projects for LPG Domestic supply forecasting and gas pricing Investment trends and potential within the sector Assessment of current pipeline infrastructure and future development Domestic demand forecasting (end user segment-wise) (Power, Fertiliser, City Gas Distribution, Petrochemicals, Refinery, Steel, etc.) and scenario analysis Demand forecasting across regions/states Assessments of Regulatory scenario and impact analysis Player profitability analysis of players in mid-stream and down-stream segments Refining & Marketing Domestic demand forecasting (product-wise, end use segment-wise) Domestic supply forecasting (refinery-wise, product-wise) Impact of natural gas availability on different end use segments of petroleum products Second-hand refinery economics Regionwise marketing infrastructure of players and impact on marketing profitability 11

CRISIL CRB Customised Research Bulletin Media Coverage Wednesday, February 29, 2012 Friday, January 13, 2012 Tuesday, January 25, 2011 12

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