Indian OMCs: Buy at current attractive valuations.

30 January 2012

Sector Update

Oil & Gas

BPCL Financial summary (INR b)

Y/E March 2011 2012E 2013E

Net Sales 1,536

EBITDA

Net Profit

EPS (INR)

45.2

EPS Gr. (%)

0.2

BV/Sh.(INR) 425

P/E (x)

12.5

P/BV (x)

1.3

EV/EBITDA(x) 10.8

EV/Sales (x) 0.3

RoE (%)

11.1

RoCE (%)

5.5

Consolidated



Indian OMCs: Buy at current attractive valuations

Preference order - BPCL, HPCL and IOC



1,979

43.9

-2.9

456

12.9

1.2

8.1

0.2

10.0

7.0

1,918

49.9

13.6

494

11.3

1.1

7.6

0.2

10.5

7.4



OMCs (oil marketing companies - HPCL, BPCL and IOC) have corrected 25%/15%/11% in the

last six months and have underperformed the broader indices, led by their worst ever

financial performance (highest quarterly losses in 1HFY12).

The poor quarterly financial performance is transitory, in our view, and the government/

upstream will eventually compensate the OMCs, ensuring no erosion of book value.

Nevertheless, the stocks are trading at significant discount to their 10-year historical

averages (HPCL: 35%, BPCL: 8% and IOC: 21%). HPCL and IOC are trading at their lowest P/

B (except 2008 crisis) in the last seven years. We believe that this is a good buying

opportunity given: a) Brent is at ~USD110/bbl with a downward bias led by demand

concerns; b) likely moderation in the interest rates; and c) reducing headline inflation

which would make government proactive in price hikes (obviously after state elections!).

Over the long term, emergence of diversified earnings (non-subsidy linked) and subsidy

rationalization would be positive triggers. Buy OMCs; preference order BPCL, HPCL, IOC.

HPCL Financial summary (INR b)

Y/E March 2011 2012E 2013E

Net Sales 1,309 1,693 1,769

EBITDA

Net Profit

EPS (INR)

45.4 29.7 35.8

EPS Gr. (%) 18.3 -34.5 20.5

BV/Sh. (INR) 370 389 412

P/E (x)

6.2 9.5 7.9

P/BV (x)

0.8 0.7 0.7

EV/EBITDA (x) 8.0 8.7 5.1

EV/Sales (x) 0.2 0.2 0.1

RoE (%)

12.8 7.8 8.9

RoCE (%)

8.6 6.2 7.3

Despite high under-recoveries, OMCs’ book value unlikely to erode



FY12 gross under-recoveries are likely to cross INR1.3t (up 67%), led by continued

high oil prices and INR depreciation. We currently build in OMCs’ share for under-

recoveries at 2%/8% for FY12/13 and do not rule out nil sharing (similar to FY09)

if 2HFY12 GRMs are lower than estimates.



The combined debt of the OMCs stands at INR1.2t, and given the lending norms

of the banks, the government is unlikely to allow OMCs to bleed. Hence, we

believe that their book value will not erode.

Price hikes inevitable; timing contingent on state elections and inflation



We continue to believe that over the long term, while reforms in the sector are

extremely necessary, in the near-term, price hikes are inevitable. OMCs are

currently losing INR13/liter in diesel, INR28.5/liter in kerosene and INR326/

cylinder in LPG.



We believe that the political compulsions would ease post the five state assembly

elections. As headline inflation has reduced from double-digits to 7.4% in

December 2011 and is likely to moderate further in 1HCY12, we expect some

price hikes.

Emergence of non-subsidy-linked revenue streams a long-term positive



We expect OMCs’ dependence on subsidy to reduce to some extent with the

emergence of non-subsidy-linked earnings avenues and result in lower earnings

volatility in the longer term.



Various new earnings streams are: (a) JV refineries in HPCL and BPCL – earnings

outside the purview of subsidy, (b) upstream foray – BPCL’s E&P portfolio has

met with huge success, and (c) downstream foray – IOC’s INR144b Panipat cracker.

Buy OMCs; preference order BPCL, HPCL and IOC



We value OMCs on average of P/B, EV/EBITDA and P/E methodologies. Our target

price for BPCL at INR683/share implies 21% upside, HPCL at INR348/share implies

23% upside, and for IOC at INR332/share implies 18% upside. Maintain

Buy.

IOC Financial summary (INR b)

Y/E March 2011 2012E 2013E

Net Sales 3,081

EBITDA

125

PAT

EPS(INR)

32.3

EPS Gr. (%) -26.9

BV/Sh.(INR) 237

P/E (x)

8.7

P/BV (x)

1.2

EV/EBITDA (x) 9.2

EV/Sales (x) 0.4

RoE (%)

14.2

RoCE (%)

11.2

Consolidated

4,085

189

30.4

-5.8

258

9.3

1.1

6.0

0.3

12.3

12.6

3,641

194

33.8

11.3

281

8.3

1.0

5.8

0.3

12.5

12.1

Harshad Borawake

(HarshadBorawake@MotilalOswal.com); +91 22 3982 5432

Deepak Dult

(Deepak.Dult@MotilalOswal.com); +91 22 3982 5445

Oil & Gas

Despite high under recoveries, OMC's book value unlikely

to erode

FY12 gross under-recoveries are likely to cross INR1.3t (up 67%), led by continued

high oil prices and INR depreciation. We currently build in OMCs’ share for under-

recoveries at 2%/8% for FY12/13 and do not rule out nil sharing (similar to FY09) if

2HFY12 GRMs are lower than estimates.



The combined debt of the OMCs stands at INR1.2t, and given the lending norms of

the banks, the government is unlikely to allow OMCs to bleed. Hence, we believe

that their book value will not erode.



OMC GRM performance poor

in 6MFY12

HPCL

FY12

FY11

FY10

FY09

FY08

FY07

BPCL

IOC

Expect government to fully compensate OMC's in FY12

FY12 under recoveries are set to exceed INR1.3t and given the subdued core

earnings of OMC's due to lower GRM and forex losses we expect government to

fully compensate the subsidy losses in FY12.



In FY09 when under-recoveries had exceeded INR1t, downstream was spared

from subsidy i.e. compensated fully by government and upstream companies.



FY12 under-recoveries at INR1.3t; chances of nil sharing by OMC's high (INR B)

FY07

FY08

FY09

FY10

47.5

69.6

144

316

461

260

145

461

100

FY11

45.6

86.3

375

405

780

410

303

780

FY12E

47.6

112.2

754

550

1,304

756

522

1,304

FY13E

50.0

100.0

550

505

1,055

552

409

1,055

Fx Rate (INR/USD)

45.2

40.3

46.0

Brent (USD/bbl)

64.4

82.3

84.8

Gross Under recoveries (INR b)

Auto Fuels

208

426

575

Domestic Fuels

286

347

458

Total

494

773

1,033

Sharing (INR b)

Oil Bonds/Cash

241

353

713

Upstream

205

257

329

OMC's sharing

163

-9

Total

494

773

1,033

Sharing (%)

Government

Upstream

OMC's sharing

-1

Total

100

* Model INR1/liter diesel price hike from July 2012

Under recoveries (U/R) sensitivity

Oil Price: For every USD1/bbl variation in oil price



Gross U/R changes by INR40b.



Diesel U/R changes by INR28b (~71% of gross change).



Kerosene U/R changes by INR3.8b (~9% of gross change);



LPG U/R changes by INR7.9b (~20% of gross change).

Exchange rate: For every INR1/USD variation in exchange rate changes



Gross U/R changes by INR90b (oil at USD100/bbl).

Product Price Hikes



INR1/ltr diesel price hike reduces gross U/R by ~INR81b.



INR1/ltr kerosene price hike reduces gross U/R by ~INR12b.



INR25/cyl LPG price hike reduces gross U/R by ~INR24b.

Source: Company/MOSL

FY12E under recovery to

cross INR1.3t…..

….expect full

compensation to OMC's

100

Source:

100

Company/MOSL

30 January 2012

Oil & Gas

Delayed government compensation results in increase OMC debt levels

Combined OMCs' net debt has risen five times since FY05 and as of September

2011 it stands at INR1.2t. Major reasons for high levels of debt are (1) high working

capital - led by delay in government subsidy and (2) capex for expansion (partly to

comply with fuel regulations) and diversification projects.



Borrowing cost for OMCs' has increased significantly. Adding to OMC's woes is

~15% INR depreciation in FY12TD which made it difficult for these companies to

service their foreign debt at time when domestic borrowing costs are high. The

percentage of foreign loan in total debt was 52/16/36% for BPCL/HPCL/IOCL,

respectively in FY11.



Increasing net debt levels (INR b)

1,400

1,050

700

350

IOCL

BPCL

HPCL

Increasing net debt/market cap (x)

IOCL

3.0

2.3

1.5

0.8

0.0

BPCL

HPCL

Forex loans increased borrowing cost in FY12 (INR b)

INR debt

Forex l oa n

Increasing borrowing cost (INR b)

100

IOCL

BPCL

HPCL

207.6

129.8

251.7

BPCL

40.6

250.2

578.2

HPCL

IOCL

Source: Bloomberg/Company/MOSL

2HFY12 profits are worst ever, but not an indication of full year performance (INRb)

300

150

HPCL

BPCL

IOC

Net s ha ri ng

Quarterly performance is

not a true indicator for

OMC finances

-150

-300

2Q 3Q 4Q

FY08

1Q 2Q

3Q 4Q 1Q

2Q 3Q 4Q

FY10

1Q 2Q

3Q 4Q 1Q

FY09

FY11

FY12

Source: Company/MOSL

30 January 2012

Oil & Gas

However, we do not expect OMC's book value to erode

OMC's have never made losses and in consequence their book value has never

eroded.



Leaving apart their strategic importance in the country's energy security, we believe

that, given their borrowing levels govt. would not let them report losses even in

future. Because losses would result in banks cutting the credit lines.



Despite difficult years,

OMC's book value has

never declined

OMC's book value has never declined (INR/sh)

IOCL

BPCL

HPCL

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

Source: Company/MOSL

30 January 2012

Oil & Gas

Price hikes inevitable; timing contingent on state

elections and inflation

We continue to believe that over the long term, while reforms in the sector are

extremely necessary, in the near-term, price hikes are inevitable. OMCs are

currently losing INR13/liter in diesel, INR28.5/liter in kerosene and INR326/cylinder

in LPG.



We believe that the political compulsions would ease post the five state assembly

elections. As headline inflation has reduced from double-digits to 7.4% in

December 2011 and is likely to moderate further in 1HCY12, we expect some price

hikes.



Reforms still alive, price hikes inevitable in near term

Price hikes inevitable…

...moderating inflation

and completion of 5 state

election to be trigger for

price hikes

While, historically government has balked on reforms, nevertheless it has

understood the impact of the delay on its own fiscal situation. Government's

fiscal health for current year is not in a good shape due to (1) lower than expected

tax receipts; (2) increased subsidy burden; and (3) uncertainty in achieving

disinvestment targets and is set to miss FY12 fiscal deficit target of 4.6% by ~100bp.



While, the improvement of overall economy and fiscal situation will be contingent

on many factors; for the oil sector, key driving factors for reforms are inflation and

political issues.



Our base case inflation estimate indicates moderation from current level of 7.5%

to 5.4% in July-12 itself. Lower inflation and end of state elections should relatively

ease the pressure on government and help it to take the bold steps like price

hikes at the least.



Worsening fiscal deficit situation (%)

6.0

4.0

3.3

2.5



6.4

5.6

4.7

5.0

3.9



Deteriorating

fiscal

health of Government

would also force it to

reduce oil sector under-

recoveries by price hikes

or sector reforms.

The Government is set to

miss its FY12 fiscal

deficit target by ~100bps

to 5.6% and MOSL

predicts fiscal deficit at

5 for FY13.

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12E

FY13E

Moderating inflation to help in bold steps

WPI (Proj. Sta ti c Index)

7.5

5.4

4.2

2.5

Pos i tive Scena ri o

Ba s e Scena ri o

Source: GoI/MOSL

30 January 2012

Oil & Gas

Expect some price hikes post elections

Politically critical UP

election voting to get

over by early March 2012

State

Manipur

Uttarakhand

Punjab

Uttar Pradesh

Goa

Assembly seats

117

403

Election date

28-Jan-12

30-Jan-12

Feb 8 to March 3, 2012

3-Mar-12

Source: GoI/Industry/MOSL

Continued high losses in petroleum products

1H Aug-11

1H Sept-11

1H Oct-11

1H Nov-11

1H Dec-11

1H Ja n-12

Di es el (INR/l t.)

Kero (INR/l t.)

LPG (INR/cyl )

- RHS

400

325

250

175

100

Source: GoI/Industry/MOSL

Stock performance after price hikes in FY10/11

1,000

750

500

250

HPCL

BPCL

IOC

Earlier price hikes in June

2010 and 2011 had

boosted OMC stock prices

Petrol deregulation

and price hikes

Impact of Price hikes and duty cuts

largely offset by high crude oilprices

Source: GoI/Industry/MOSL

30 January 2012

Oil & Gas

Emergence of non-subsidy linked revenue streams

positive over longer term

We expect OMCs’ dependence on subsidy to reduce to some extent with the

emergence of non-subsidy-linked earnings avenues and result in lower earnings

volatility in the longer term.



Various new streams of earnings are: (a) new JV refineries in HPCL and BPCL –

earnings outside the purview of subsidy, (b) upstream foray – BPCL’s E&P portfolio

has met with huge success, and (c) downstream foray – IOC’s INR144b Panipat

cracker.



New JV refineries in HPCL and BPCL – earnings out of subsidy purview

BPCL’s 6 mmtpa Bina refinery and HPCL’s 9mmtpa Bhatinda refinery are being set

up in Joint Venture (JV) and hence their earnings would be out of purview of the

subsidy burden.



Further, these refineries will help PSU partners in meeting the product

requirements in the northern and central regions of the country and reducing

their dependence on outside purchases.



Bina and Bhatinda refinery will require GRM’s ofUSD7.8/bbl and USD7.5/bbl to

break-even.



New refineries have higher complexity than the current OMC refineries

Refinery

Higher complexity of new

JV refineries would

ensure higher GRM

…JV structure would

protect these refineries

from subsidy sharing,

similar to other

independent refiners

Capex

(USDm)

2,604

3,750

Capacity

(kbpd)

120

180

Complexity

Nelson Index

9.1

9.6

Capex (USD/

complexity bpd)

2,385

2,170

Source: Indusrty/MOSL

BPCL

HPCL

Bina

Bhatinda

Break-even GRM’s at ~USD7.8/bbl and USD7.5/bbl for Bina and Bhatinda

Bina

Capacity

Capex

Breakeven GRM

Opex

EBITDA

Depreciation

Interest

PBT

kbpd

USDm

USD/bbl

120

2,604

7.8

2.0

5.8

2.9

Bhatinda

180

3,750

7.5

2.0

5.5

2.8

2.7

Source: Indusrty/MOSL

Upstream foray – BPCL’s E&P portfolio has met with huge success

BPCL’s E&P portfolio has turned out to be a huge success with multiple discoveries

in its Brazil and Mozambique acreage.



BPCL’s E&P business is carried through its 100% subsidiary Bharat PetroResources

Ltd. Which has 27 E&P blocks of which 9 are in India and 18 are abroad. It overseas

presence is in Australia, Brazil, East Timor, Indonesia, Mozambique and UK. Of its

total acreage of 81,000sqkm, ~91% is offshore acreage.



BPCL’s E&P Strategy:

BPCL’s entry into E&P business is led by the thought process

to be self-sufficient to some extent vis-à-vis its crude requirement for its refineries



30 January 2012

Oil & Gas

(shielding from vagaries of crude price at entity level). BPCL has consciously

entered into countries with a very low political risk. Further, at this stage BPCL

prefers to enter only into exploratory blocks and would not be entering into

producing blocks.

BPCL’s E&P discoveries till date

Discovery

Date

Basin

Operator

BPCL

Stake (%)

12.5

20.0

10.0%

12.5

Oil/Gas

Pay

Zone (m)

Brazil - Offshore

Wahoo - 1

Wahoo-2

Barra

Mozambique - Offshore

Windjammer

Barquentine

Lagosta

Tubarao

Barquentine-2

Camarao

Barquentine-3

Lagosta-2

Indonesia - Offshore

Badik-1

Oct-08

Nov-09

Oct-10

Mar-10

Oct-10

Nov-10

Feb-11

Aug-11

Oct-11

Nov-11

Jan-12

Nov-10

Campos

Sergipe-Alagoas

Rovuma

Tarakan

Anadarko

Petrobras

Anadarko

Oil

Oil & Gas

Gas

365

126

168

202

237

Oil & Gas

Source: Company/ MOSL

Resource potential of Wahoo and Mozambique

Source: Company/ MOSL

Brazil Portfolio - Expect further upsides from Sergioe - Alagoas basin

BPCL has announced three discoveries in its Brazil with two in Campos

basin(Anadarko operator) and one in Sergipe-Alagoas basin (Petrobras operator).



Of the three discoveries, the JV partner Anadarko has indicated the likely

recoverable reserves of 150-200mmbbl in Wahoo discovery. While, appraisal wells

are planned in the Sergipe-Alagoas basin block (JV partner Petrobras) and post

that we expect to get some indication on the recoverable numbers in the block.



30 January 2012

Oil & Gas



We currently value BPCL's 12% stake in Wahoo discovery at INR8/sh (150mmbbl of

recoverable reserves based on USD5/boe, production start in FY17). We do not

assign any value for other two blocks and would await more clarity from the

operator in terms of the reserve size.

Mozambique indicative

recoverable reserves at

15-30tcf and counting…

…to develop LNG

terminal to export gas

Expect production start in

2018-19

Mozambique – Lot more to come

In Mozambique acreage, BPCL’s JV partner Anadarko (operator) has estimated

recoverable reserves of 15-30tcf and in-place resources of 30-50+ tcf of natural

gas after the drilling of sixth successful well Rovuma offshore basin. To put in

perspective, this compares with the 12tcf reserves announced by RIL for its KG-D6

block.



Anadarko has deployed 2 rigs in this acreage and has as active drilling program

ahead. As the acreage is still in the exploration and appraisal stage; similar to

prior instances we expect the recoverable reserve number to expand further.



Anadarko has decided to build a two train LNG facility to monetize this large

resource base which is expandable to six trains. The distance of basin from shore

is only 50km and geographic location of Mozambique is also perfect as it is near to

high gas demand areas of Asia. The pre-FEED activity for LNG development is

nearing completion and FEED activity is expected to start soon. Final investment

decision (FID) is expected to come by July-Aug 2013 and production is expected in

2018-19.



Location of Mozambique fields

Mozambique: Likely project timelines

Source: Anadarko/MOSL

Recently, Cove Energy (8.5% JV partner in Mozambique acreage) has put itself on

sale which is largely valued on its 8.5% stake in Rovuma offshore block in

Mozambique. If we value Cove Energy 8.5% stake in Mozambique at its current

market cap of ~USD1b then BPCL’s 10% stake value comes at USD1b (INR133/sh).



We value Mozambique at an average of recoverable range at 22.5tcf at USD3.5/

boe (similar to implied valuation to Cove Energy stake).



30 January 2012

Oil & Gas

IOC’s Panipat Petchem plant gaining traction

IOCL, though already had diversified into downstream (LAB and PX/PTA), it’s new

INR144b Naphtha cracker at Panipat marks a big entry into non-refinery business.



While, in the initial period the cracker reported losses due to start-up issues, we

believe that eventually the operations will stabilize.



With stabilization of cracker, we expect earnings sustenance for IOCL to increase

which is currently marred by ad-hoc subsidy sharing. As against near losses in

FY12, we expect petchem PBT contribution at INR12b in FY14 (INR3/sh).



Proposed Paradip refinery and Ennore LNG terminal would further add to earnings

in a longer term. LNG terminal and planned Petchem plant at Paradip will diversify

earnings and reduce company’s dependence on subsidy linked products.



Panipat Petchem plant turned EBIT positive in 2QFY12

635

Product slate of Panipat naphtha cracker

Product

LLDPE/HDPE

MEG

DEG

LPG/Butadiene

BENZENE

Pyrolysis Gasoline & C9+

Pyrolysis Tar (CBFS)

Fuel & Loss

KTPA

650

600

300

140

125

318

235

Source: Company/MOSL

-1,598

-2,291

-4,000

Source: Company/MOSL

Annual stock performance: BPCL and IOC better placed due to lower share of marketing volumes

Year

CY03

28.8

51.9

107.7

187.6

-21.0

34.8

114.8

CY04

38.3

-8.5

1.9

12.3

-21.5

-11.2

-0.8

CY05

54.4

-17.9

-5.2

8.6

-60.3

-47.5

-33.8

CY06

65.4

-15.3

-22.3

-19.2

-62.0

-69.0

-65.9

CY07

72.6

32.6

54.9

76.6

-14.5

7.8

29.5

CY08

97.8

-26.1

-28.2

-46.4

26.3

24.3

6.0

CY09

61.7

43.0

69.0

43.6

CY10

79.6

0.3

3.6

11.9

CY11

111.0

-35.4

-27.4

-25.9

Avg. Brent price (USD/bbl)

Absolute return (%)

HPCL

BPCL

IOC

Relative return (%)

HPCL

BPCL

IOC

BPCL and IOC have

outperformed HPCL in

each calendar year in last

9 years…

…this could be due to

HPCL's highest share of

pure marketing in total

sales, thereby making its

earnings more sensitive

to subsidy sharing

Increasing share of non-

subsidy linked revenues

to be positive over longer

term

-38.0 -17.1 -10.8

-12.0 -13.8

-2.8

-37.4

-5.5

-1.2

Source: Company/MOSL

HPCL's pure marketing volumes are highest of the three OMC's (mmt)

Refi nery thr'put

Ma rketi ng s a l es

HPCL

BPCL

IOC

45.4

25.2

29.1

27.4

Purcha s es

Ma rketi ng vol ume s ha re (%)

72.9

27.0

Source: Company/MOSL

30 January 2012

Oil & Gas

Valuation and view

While, the near term stress on the OMC balance sheet would continue, we expect

government to announce final subsidy sharing toward the end of the year and

expect some price hikes post the ongoing elections in 5 states.



On a 1-year forward P/B multiple, OMC stocks are trading at 8% to 35% discount to

the 10-year average.



We value OMCs on average of P/B, EV/EBITDA and P/E methodologies. Our target

price for BPCL at INR683/share implies 21% upside, HPCL at INR348/share implies

23% upside, and for IOC at INR332/share implies 18% upside. Maintain

Buy.



Trading at historical low valuations; Buy

On a 1-year forward P/B multiple OMC stocks are trading at 8% to 35% discount to

10-year average.



Discounts are on account of lack of clarity on subsidy sharing and delays in

Government compensation which have led to increased borrowing costs.



Political interest and high inflation has kept Government away from taking any

price hikes in any of the sensitive petroleum products. However, we expect price

hikes for petroleum products post 5 state assembly elections in February-March

and subsiding inflation.



HPCL P/B Band chart

On a 1-year forward P/B multiple

HPCL is trading at 35% discount to 10-year average

and 37% discount to 15-year average.



BPCL is trading at 7% discount to 10-year average

and in-line with 15-year average.



IOCL is trading at 18% discount to 10-year average

and 21% discount to 15-year average.



2.2

1.7

1.2

0.7

0.2

P/B (x)

Avg(x)

Pea k)x)

Min(x)

2.0

1.1

0.7

0.5

BPCL P/B Band chart

2.4

1.9

1.4

0.9

0.6

0.4

1.3

1.2

P/B (x)

Avg(x)

Pea k)x)

Min(x)

2.1

IOCL P/B Band chart

P/B (x)

2.4

1.8

1.3

1.2

0.6

0.0

0.6

1.0

Avg(x)

Pea k)x)

Mi n(x)

2.1

Source: Bloomberg/MOSL

30 January 2012

Oil & Gas

BPCL Financial summary (INR b)

Y/E March 2011 2012E 2013E

Net Sales 1,536

EBITDA

Net Profit

EPS (INR)

45.2

EPS Gr. (%)

0.2

BV/Sh.(INR) 425

P/E (x)

12.5

P/BV (x)

1.3

EV/EBITDA(x) 10.8

EV/Sales (x) 0.3

RoE (%)

11.1

RoCE (%)

5.5

Consolidated

1,979

43.9

-2.9

456

12.9

1.2

8.1

0.2

10.0

7.0

1,918

49.9

13.6

494

11.3

1.1

7.6

0.2

10.5

7.4

BPCL: Reiterate Buy; expect E&P portfolio to surprise

On FY13 basis, we assign a P/B multiple of 1x, EV/EBITDA multiple of 5x and P/E

multiple of 9x. Of the 27 E&P blocks held by BPCL it has reported significant

discoveries in two of its blocks in Brazil and Mozambique.



Investment value of INR250/sh comprises of INR98/sh from its E&P potential,

INR70/sh from listed investments (post 25% discount), INR43/sh from Bina refinery

(post 15% discount) and INR39/sh for treasury shares.



We value BPCL at INR683/sh based on average of P/B , EV/EBITDA and P/E valuation

methodologies Implying a 21% upside from current levels.



EV/EBITDA Valuation

FY13E EV/EBITDA Multiple (x)

EBITDA (INR b)

EV (INR b)

Net Debt (INR b)

Implied M Cap (INR b)

No of Shares (In m)

Implied Mcap (INR/sh)

Investments (INR/sh)

Fair value (INR/sh)

4.0

217

140

362

213

250

463

4.5

244

140

104

362

288

250

538

5.0

272

140

131

362

363

250

613

5.5

299

140

159

362

439

250

688

6.0

326

140

186

362

514

250

763

P/B Valuation

FY13E PB Multiple (x)

FY13 Book Value (INR/sh)

Implied Value (INR/sh)

Investments (INR/sh)

Fair value (INR/sh)

0.8

494

395

250

645

0.9

494

444

250

694

1.0

494

250

744

1.1

494

543

250

793

1.2

494

593

250

842

P/E Valuation

FY12E PE Multiple (x)

Cons. FY13 EPS* (INR/sh)

Implied Value (INR/sh)

Investments (INR/sh)

Total Value

*adjusted for investments

7.0

49.0

343

250

593

8.0

49.0

392

250

642

9.0

49.0

441

250

691

10.0

49.0

490

250

740

11.0

49.0

539

250

789

Fair value (INR/sh)

EV/EBITDA

P/B

P/E

Average

CMP

% upside/(downside)

463

645

593

567

564

538

694

642

625

564

613

744

691

683

564

688

793

740

564

763

842

789

798

564

BPCL's investment valued at INR240/sh

Investments

Oil India

Petronet LNG

Indraprastha Gas

Treasury Shares

Unlisted Investments

Bharat Oman

E&P Potential

Total

30 January 2012

INRb

4.6

13.0

7.6

14.3

15.5

35.4

90.3

INR/sh

250

25%

discount

CMP/TP

15% discount to investment

Brazil, Mozambique discoveries

Source: Company/MOSL

Oil & Gas

HPCL Financial summary (INR b)

Y/E March 2011 2012E 2013E

Net Sales 1,309 1,693 1,769

EBITDA

Net Profit

EPS (INR)

45.4 29.7 35.8

EPS Gr. (%) 18.3 -34.5 20.5

BV/Sh. (INR) 370 389 412

P/E (x)

6.2 9.5 7.9

P/BV (x)

0.8 0.7 0.7

EV/EBITDA (x) 8.0 8.7 5.1

EV/Sales (x) 0.2 0.2 0.1

RoE (%)

12.8 7.8 8.9

RoCE (%)

8.6 6.2 7.3

HPCL: Buy; highest delta to subsidy sharing

On FY13 basis, we assign a P/B multiple of 0.7x, EV/EBITDA multiple of 5x and P/E

multiple of 7x. Of the three OMC's HPCL has highest exposure to marketing losses

due to its higher marketing to refining capacity multiple at 1.8.



Investment value of INR111/sh comprises of INR53/sh from its listed investments

(post 25% discount) and INR58/sh for Bhatinda refinery (post 15% discount).



We value HPCL at INR348/sh based on average of P/B, EV/EBITDA and P/E valuation

methodologies Implying a 23% upside from current levels.



EV/EBITDA Valuation

FY13E EV/EBITDA Multiple (x)

EBITDA (INR b)

EV (INR b)

Net Debt (INR b)

Implied M Cap (INR b)

No of Shares (In m)

Implied Mcap (INR/sh)

Investments (INR/sh)

Fair value (INR/sh)

4.0

177

160

339

111

161

4.5

199

160

339

115

111

226

5.0

221

160

339

180

111

291

5.5

244

160

339

246

111

357

6.0

266

160

105

339

311

111

422

P/B Valuation

FY13E PB Multiple (x)

FY13 Book Value (INR/sh)

Implied Value (INR/sh)

Investments (INR/sh)

Fair value (INR/sh)

0.5

412

206

111

317

0.6

412

247

111

358

0.7

412

289

111

399

0.8

412

330

111

441

0.9

412

371

111

482

P/E Valuation

FY13E PE Multiple (x)

FY13 EPS* (INR/sh)

Implied Value (INR/sh)

Investments (INR/sh)

Fair value (INR/sh)

*adjusted for investments

5.0

34.8

174

111

285

6.0

34.8

209

111

319

7.0

34.8

243

111

354

8.0

34.8

278

111

389

9.0

34.8

313

111

424

Fair value (INR/sh)

EV/EBITDA

P/B

P/E

Average

CMP

% upside/(downside)

161

317

285

254

284

-10

226

358

319

301

284

291

399

354

348

284

357

441

389

395

284

422

482

424

442

284

HPCL's investment valued at INR111/sh

Investments

Bhatinda Refinery

Oil India

MRPL

Total

INRb

19.6

4.6

13.4

37.6

INR/sh

111

15% discount to investment

25% discount to our TP/CMP

Source: Company/MOSL

30 January 2012

Oil & Gas

IOC Financial summary (INR b)

Y/E March 2011 2012E 2013E

Net Sales 3,081

EBITDA

125

PAT

EPS(INR)

32.3

EPS Gr. (%) -26.9

BV/Sh.(INR) 237

P/E (x)

8.7

P/BV (x)

1.2

EV/EBITDA (x) 9.2

EV/Sales (x) 0.4

RoE (%)

14.2

RoCE (%)

11.2

Consolidated

4,085

189

30.4

-5.8

258

9.3

1.1

6.0

0.3

12.3

12.6

3,641

194

33.8

11.3

281

8.3

1.0

5.8

0.3

12.5

12.1

IOC: Buy; current earnings relatively less volatile to subsidy sharing

On FY13 basis, we assign a P/B multiple of 0.9x, EV/EBITDA multiple of 5x and P/E

multiple of 8x. Of the three OMC's IOC has least exposure to marketing losses due

to its lower marketing to refining capacity multiple at 1.4.



Investment value of INR90/sh comprises of INR85/sh from its listed investments

(post 25% discount) and INR5/sh for treasury shares (post 25% discount).



We value IOC at INR332/sh based on average of P/B, EV/EBITDA and P/E valuation

methodologies Implying a 18% upside from current levels.



EV/EBITDA Valuation

FY13E EV/EBITDA Multiple (x)

EBITDA (INRb)

EV (INRb)

Net Debt (INRb)

Implied M Cap (INRb)

No of Shares (In m)

Implied Mcap (INR/sh)

Investments (INR/sh)

Fair value (INR/sh)

4.0

194

777

444

332

2,428

137

227

4.5

194

874

444

429

2,428

177

267

5.0

194

971

444

526

2,428

217

307

5.5

194

1,068

444

623

2,428

257

347

6.0

194

1,165

444

721

2,428

297

387

P/B Valuation

FY13E PB Multiple (x)

FY13 Book Value (INR/sh)

Implied Value (INR/sh)

Investments (INR/sh)

Fair value (INR/sh)

0.7

281

197

287

0.8

281

225

315

0.9

281

253

343

1.0

281

371

1.1

281

310

400

P/E Valuation

FY12E PE Multiple (x)

Cons. FY13 EPS* (INR/sh)

Implied Value (INR/sh)

Investments (INR/sh)

Fair value (INR/sh)

*adjusted for investments

6.0

32.1

193

283

7.0

32.1

225

315

8.0

32.1

257

347

9.0

32.1

289

379

10.0

32.1

321

411

Fair value (INR/sh)

EV/EBITDA

P/B

P/E

Average

CMP

% upside/(downside)

227

287

283

266

281

-5

267

315

299

281

307

343

347

332

281

347

371

379

366

281

387

400

411

399

281

IOC's investment valued at INR90/sh

Investments

INRb

INR/sh

25%

discount

TP/CMP

Source: Company/MOSL

30 January 2012

CPCL

14.5

Gail (India)

10.3

ONGC

159.4

Petronet LNG

13.0

Oil India

9.1

Treasury Shares (BRPL merger) 6.8

Treasury Shares (IBP merger) 5.5

Total

218.6

Oil & Gas

Annexure 1: FY13E Subsidy and its sensitivity to oil price and exchange rate

Gross Under recoveries (INR b)

Brent (USD/bbl)

100

110

120

130

239

543

942 1,341 1,741 2,140

290

706 1,122 1,538 1,954 2,370

436

869 1,302 1,735 2,167 2,600

583 1,032 1,482 1,931 2,381 2,830

Gross under recoveries without Diesel (INR b)

239

270

301

332

355

391

427

463

100

472

513

554

594

110

589

634

680

726

120

705

756

806

857

130

822

877

932

988

Diesel (INR b)

Brent (USD/bbl)

135

251

187

314

442

569

100

110

120

1,036

1,198

1,361

1,524

130

1,319

1,493

1,668

1,842

470

753

609

904

748 1,055

887 1,206

Diesel (INR/ltr)

100

110

120

130

Kerosene (INR b)

Brent (USD/bbl)

191

206

221

236

229

245

262

279

100

266

284

303

321

110

304

324

344

363

120

342

363

384

406

130

379

402

425

448

Kerosene (INR/ltr)

100

110

120

130

LPG (INR b)

Brent (USD/bbl)

127

146

165

185

100

206

228

251

273

110

285

310

336

362

120

364

393

422

451

130

442

475

507

540

LPG (INR/cylinder)

105

121

153

173

193

213

100

235

258

281

304

110

316

343

369

396

120

397

427

457

487

130

479

512

545

579

30 January 2012

Oil & Gas

Annexure 2: Petroleum pricing and subsidy mechanism

in India

Historical background on petroleum product pricing in India

Pre-APM Regime



1920s:

Kerosene was the key product marketed by private oil companies and

pricing was not controlled.



1939-48:

During and after World War II oil companies maintained price pools for

major products.



1948 - First attempt to regulate prices:

The government of India and Burmah Shell

agreed to control prices under the Valued Stock Account (VSA) procedure. (Under

VSA, Selling prices = sum of FOB Ras Tanura price, ocean freight, insurance, ocean

loss, import duty, interest and other charges, and 10% remuneration).



1959:

VSA pricing was terminated and the government priced petroleum products

based on actual costs with reasonable profit.



1960 -70s:

Various pricing committees were set up. The Damle Committee (1961)

and the Talukdar Committee (1965) recommended the fixing of prices based on

an import parity basis. The Shantilal Shah Committee (1969) did not agree to the

import parity system and recommended continuing the import pricing system

and government commitment to foreign oil companies in terms of "refinery

agreements".

APM Price Regime: 1970s, 1980s and mid 1990s

Pricing under APM was based on the retention concept in which (1) oil companies

were compensated for operating costs and returns at the rate of 12% post-tax net

worth; (2) ex-storage ceiling selling prices were uniform at all refineries; (3) prices of

kerosene, LPG (domestic) and feed stocks for fertilizer were subsidized for socio-

economic reasons. Fuels like petrol, ATF, LPG (industrial) were priced above

production cost to discourage their inessential use and (4) prices were reviewed and

revised periodically to see that oil pool accounts were balanced.



1976:

Emergence of APM: The government appointed the Oil Prices Committee

(OPC), which recommended discontinuance of the import parity pricing system

and introduction of a pricing system based on domestic cost of production, leading

to the emergence of the Administered Pricing Mechanism (APM).



1984:

The Oil Cost Review Committee (OCRC) modified OPC recommendations.



1989-91:

Another OPRC was constituted, but its recommendations were never

processed.



1995:

The ability of oil companies to generate investible surpluses was reduced

considerably by the APM, which allowed returns on the depreciated net fixed

assets. The government set up an industry study group under the chairmanship of

Mr U Sundararajan, CMD, BPCL. A report of this committee formed the main input

for the strategic Planning Group on Restructuring of the Indian Oil Industry ('R'

Group) headed by the then Secretary, PNG, Dr Vijay Kelkar.



1997-2002:

Import Parity System: The R group recommended dismantling APM

and this was in-principle approved by the government. Later, an Expert Technical

Group (ETG), headed by Mr Nirmal Singh, Joint Secretary Refineries, MOP&NG

30 January 2012

Oil & Gas

recommended (1) phased deregulation over 4-5 years by 1 April 2002; (2) the first

phase would encompass the full deregulation of upstream/refineries and partial

deregulation of marketing sectors, (3) subsidies would be phased out within

acceptable limits, which would be provided through the Budget.

Post-APM Regime

From 1 April 1998, APM was dismantled for the upstream and refining sector and

partial deregulation took place for the marketing sector. Subsequently, from 1 April

2002, the government announced the complete dismantling of the APM.



April 2002 to December 2003:

Oil companies used to set prices of petrol and diesel

every fortnight. However, PDS kerosene and LPG (domestic) prices were kept

largely stable.



2004:

Crude price started rising and though oil companies were given the freedom,

they were taking informal clearance from the government before revising prices

culminating in no price revision in petrol and diesel from January to June 2004.



August 2004:

A new methodology was devised, which gave freedom to oil

companies to change prices within +/-10% of the mean of the rolling average C&F

prices of the past 12 months and the last quarter.



FY05 to date:

Regulated retail fuel prices, increasing oil prices resulted in

increasing under-recoveries. Although the government earlier announced

formulae to share the burden equitably among itself (via bonds), upstream and

downstream marketing companies, the final sharing varied from year to year and

quarter to quarter.

Subsidy sharing formula - largely ad hoc

Ups trea m

Government

OMC s ha ri ng

FY08

-1

FY09

FY10

FY11

FY12E

FY13E

Source: Company/MOSL

The committees and their recommendations

Over the past few years the government set up various committees to find a permanent

solution to price petroleum suitably.

Key recommendations of the Rangarajan Committee Report

The prices of petrol and diesel to refineries should be the weighted average of

import parity and export parity prices in the ratio of 80:20. This was based on data

that about 20% of refinery products are exported.



The customs duty on petrol and diesel should be reduced to 7.5%, reducing

protection to refineries.



The government should allow oil marketing companies to fix the retail prices of



30 January 2012

Oil & Gas



petrol and diesel, subject if necessary, to ceilings. This would encourage

competition.

The principle of freight equalization should be discontinued. The government

may consider some other manner of mitigating the impact of this measure on

remote areas.

The ad valorem levies should be replaced with specific levies at the rate of INR5/

liter of diesel and INR4.75/liter of petrol.

Subsidised kerosene should be available only to BPL families.

The price of domestic LPG should be raised by INR75/cylinder (14.2 kg) and

thereafter the price should be adjusted gradually to eliminate the subsidy.

The subsidy sharing by upstream companies (ONGC, GAIL and OIL) should be

discontinued and instead the OIDB cess collected from them should be increased

to INR4,800/MT (from the present INR1,800/MT).

The share of the subsidy to be borne by the government should be met through

Budget provision.

Key recommendations of Chaturvedi Committee Report



Pricing of petroleum products in India will be based on prices quoted at major

refining centers in the world/FOB export price. The new pricing mechanism will

replace the current trade parity/import parity mechanism. The committee

observed prices computed by trade parity are higher than average international

FOB prices and a shift to export parity pricing will help to reduce under-recoveries.

Reduce import duties on petrol and diesel from 2.5% to nil (import duty on PDS

kerosene and LPG is already nil).

Shift from the current mechanism of fixing retail prices inclusive of state taxes to

before state taxes (this is likely to resolve large inter-state differences in tax

rates).

Conversion of mass transportation from diesel to CNG.

Special oil tax: Imposing this tax will be a temporary measure to finance under-

recoveries until retail fuel prices are in line with market rates (the committee

wants fuel prices to be revised over the next 1-2 years). The tax is not seen as a

general revenue measure.

i. Special oil tax to be imposed on ONGC and OIL for 12 months: 100% tax on

realizations above USD75/bbl.

ii. Cut-off price of USD75/bbl to be reviewed periodically in view of investment

needs of E&P companies. For private E&P players and JVs, special oil tax rate

will be 40% for blocks prior to NELP.

iii. Special oil tax will be fully deductible for assessment of income tax, any other

tax and royalty.

Product price adjustment recommendations: (1) HSD prices to be adjusted in 24

months through regular and small price adjustments; (2) petrol prices to be

adjusted by March 2009 (temporarily reduce excise duty from INR13.35 to INR10/

liter); (3) restrict subsidized kerosene supply to BPL (below poverty line) families

by issuing smart cards and (4) subsidy element in LPG to be phased out in three

years.

No special tax on refining companies as the refining business is similar to other

industrial or commercial businesses and taxation should be similar and consistent

across business segments.

30 January 2012

Oil & Gas

Key recommendations of the Kirit Parikh Committee

The Kirit Parikh Committee made the following recommendations:



Petrol and diesel to be deregulated;



Increase kerosene price by INR6/liter and revise in step with per capita agricultural

GDP at nominal prices;



Increase LPG price by at least INR100/cylinder and future revisions must be based

on the increase in per capita income.



Financing under-recoveries



Nil under-recovery on petrol and diesel;



Cut PDS kerosene allocation and increase prices of kerosene and LPG;



After savings through these measures, the remaining subsidy will be shared

by upstream companies as per ONGC's proposed formula.



The remaining gap will be provided by the government through the Budget in

the form of cash subsidies.

The Kirit Parikh Committee also proposed subsidy sharing at different oil prices, based

on ONGC's formula. However, the government has not approved it yet.

ONGC's proposed subsidy sharing formula

Crude Oil

Windfall Tax Rates

Up to USD60/bbl

USD60-70/bbl

USD70-80/bbl

USD80-90/bbl

Over USD90/bbl

Special Oil Tax /

Price Equaliz. Disc. /

Nil

20%

40%

60%

80%

Gross Incremental

100

Realization (USD/bbl)

Net

realization

Prices

Source: Company/MOSL

price

USD60/bbl

USD70/bbl

USD80/bbl

USD90/bbl

Current situation: Petrol deregulated, June 2010; Prices hiked, duties cut,

June 2011

On 25 June 2010 the government announced the deregulation of petrol and diesel.

Key announcements:



Petrol: Retail prices to be market-determined. As per data of the latest fortnight,

the price hike is ~INR3.5/liter.



Diesel: Though the Empowered Group of Ministers (EGoM) has decided to

eventually deregulate diesel prices, it has decided to increase prices by just INR2/

liter.



LPG: Domestic LPG cylinder prices to be hiked by INR35/cylinder (current loss is

INR262/cylinder).



Kerosene: PDS kerosene price to be hiked by INR3/liter from INR9/liter to INR12/

liter (current loss is INR17.9/liter). Previous hike was in March 2002.

Although the government took bold steps of deregulation and price hikes, it did not

address the subsidy sharing issue.

30 January 2012

Oil & Gas

Unprecedented price hikes

Product

Petrol

Diesel

Kerosene

LPG

Unit

INR/litre

INR/Cylinder

Before

47.93

38.1

9.23

310.35

After

51.43

40.1

12.23

345.35

Chg

3.5

Chg (%) Last Price Hike

7.30

Feb-10

5.20

Feb-10

32.50

Mar-02

11.30

Jun-08

Source: Company/MOSL

June 2011 price hikes, duty cuts

After a gap of one year the government of India has taken a bold step to rein-in

under-recoveries with the EGoM announcing price hikes for diesel, kerosene and

LPG, eliminating 5% custom duty on crude oil and reducing the specific excise duty on

diesel.

Key changes in retail fuel prices, impact on under-recoveries

Earlier

Petrol (INR/ltr)

58.4

Diesel (INR/ltr)

40.1

Kerosene (INR/ltr) 12.0

LPG (INR/cyl)

345.0

Total

Revised

58.4

43.1

14.0

395.0

Chg

(INR)

0.0

3.0

2.0

50.0

Chg

(%)

0.0

7.5

16.7

14.5

Impact

(INR b)

Key changes in duties and impact on government receipts

Earlier

(%)

Revised

(%)

Impact

(INR b)

225.0

24.0

47.5

296.5

Source: Company/MOSL

Customs duty on crude (%)

5.0

0.0

260.0

Specific excise duty on diesel (INR/ltr)4.6

2.0

230.0

Total

490.0

Source: Company/MOSL

Trend in price hikes (INR/liter)

Petrol (INR/ltr)

Chg (%) - RHS

20%

10%

-10%

-20%

Di esel (INR/l tr)

Chg (%) - RHS

20%

10%

-10%

-20%

Keros ene (INR/ltr)

Chg (%) - RHS

30%

20%

10%

-10%

LPG (INR/Cyl )

400

350

300

250

200

Chg (%) - RHS

20%

10%

-10%

-20%

30 January 2012

Motilal Oswal Sector Gallery

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