Shares of India’s state-run Oil and Natural Gas Corporation (ONGC) surged by as much as 6% to hit an intraday high of INR 298 on the Bombay Stock Exchange (BSE) Tuesday.
The surge comes following a significant endorsement from Hong Kong-based brokerage CLSA, which called the government’s recent cut to upstream royalty rates a “big positive” for both the explorer and the wider oil and gas sector.
The government’s unexpected decision to lower the royalty on crude oil and natural gas production is expected to significantly benefit ONGC and Oil India, The Economic Times said in a report.
According to CLSA, this move could boost the fair value of ONGC by 7-9% and that of Oil India by 9-11%.
Following this news, Oil India’s shares climbed 7.5% to reach a day’s high of INR 491.
A global brokerage has initiated a ‘High Conviction Outperform’ rating on the stock, setting a target price of INR 405, which represents a 44.4% potential upside.
The brokerage views this development as significant, not just for the direct boost to earnings, but also because it alleviates investor anxiety over the possibility of a new windfall tax, similar to the one implemented in 2022.
Revised royalty framework and rates
CLSA noted that previous concerns regarding higher upstream taxation had severely impacted ONGC and Oil India, leading to them being among the poorest-performing global upstream energy stocks.
In a related move, the government has revised the royalty framework for nomination blocks, which constitute a large portion of ONGC’s and Oil India’s production.
Royalty rates for hydrocarbon production have been significantly revised.
The effective royalty on onshore crude oil production has dropped from 16.66% to 10%, and the rate for offshore crude has decreased from 9.09% to 8%.
Furthermore, the royalty on natural gas has been reduced to 8% from the previous 10%.
According to analysis by CLSA, these adjustments translate to a blended royalty reduction of approximately 3 percentage points for ONGC’s crude output, considering that about one-third of its production is from onshore fields.
Financial impact and brokerage outlook
The brokerage estimates that this reduction could increase ONGC’s net crude realization by $2.4 to $3 per barrel, assuming crude prices range from $80 to $100 per barrel.
CLSA estimates that changes, including reduced gas royalties and Goods and Services Tax (GST) savings, could boost ONGC’s earnings per share by approximately INR 2.5 to INR 3.
The brokerage applies an 8x price-to-earnings multiple to this increase, projecting a fair value rise of INR 20-24 per share.
This increase represents a potential 7-9% rise from the stock’s current market price.
CLSA estimates that Oil India, which has entirely onshore production, will see a significant decrease in royalty rates.
This is projected to increase Oil India’s net realisation by $5.3 to $6.7 per barrel when crude prices are between $80 and $100.
According to the brokerage, this improvement could boost Oil India’s Earnings Per Share (EPS) by INR 5.2 to INR 6.4, resulting in an estimated fair value increase of INR 42 to INR 51 per share.
CLSA noted that the royalty cut sends a clear policy signal, particularly amidst rising crude oil prices and high fiscal pressures.
According to the brokerage, the move indicates the government’s priority is to incentivise upstream exploration and production activities rather than impose higher taxes on producers.
CLSA has reiterated its “High Conviction Outperform” rating for ONGC.
The brokerage notes that ONGC’s current valuation effectively prices in Brent crude at only $65 per barrel, significantly lower than the $80 per barrel assumption priced into Oil India’s stock.
Based on an $80 per barrel oil price, CLSA projects a 43% potential upside for ONGC, along with an attractive dividend yield of 7%.
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