Business Today

Offshore prospects

Suman Layak        Print Edition: March 20, 2011

The $9-billion deal between Reliance Industries Ltd, or RIL, and British oil major BP could open fresh chapters for both. For BP, the tie-up, which has received a thumbs up from analysts, comes as part of its continuing efforts to reposition its operations - shifting focus from the mature North Sea oilfields and pinning hopes on fresh explorations elsewhere. The deal is also about moving on from the negative impacts of last year's disastrous oil spill in the Gulf of Mexico.

For RIL, the deal, being touted as the largest FDI brought by any single company into India, could mean a way out of its current stagnating situation. The slowing gas output from the Krishna Godavari or KG Basin D6 fields in the past few months has been a real cause of worry for the company as well as the petroleum ministry.

BP's technical prowess and experience in deepwater exploration is expected to ramp up the KG D6 fields' output from the current 56-58 million standard cubic metres (mmscmd) a day. RIL's gas output had fallen in the last two quarters after it achieved 60 mmscmd in the April-June 2010 quarter.

53 mmscmd Current gas output from KG D6 block, of which 45 mmscmd is being produced from D1 and D3 fi elds

12.8 per cent Jump in India's natural gas production, to 53.59 bcm in 2010-11 from 47.51 bcm in 2009-10, primarily due to KG-D6 output

12.67 per cent Rise in India's crude oil production, at 37.96 mt in 2010-11 from 33.69 mt in 2009-10, owing to RIL's KG Basin and Cairn's Rajasthan discoveries

bcm=billion cubic meters
mt=million tonne
mmscmd=million standard
cubic metres per day
Source: Economic Survey 2010-11
BP will pay RIL $7.2 billion for a 30 per cent stake in 23 blocks along with a joint venture on gas and fuel distribution. It will pay another $1.8 billion if it strikes more oil or gas. The overall investment could go up to $20 billion.

"The negative news flow on RIL's exploration and production, or E&P, business has related to problems on production as well as commercial issues with the Indian government on gas pricing. The BP deal should be able to handle the technical challenge, but the commercial one remains," says a Royal Bank of Scotland, or RBS, report on the deal.

RIL expects to be debt-free in 2011-12

RBS had set a target price for the RIL scrip at Rs 900 based on the disappointing feedback about the company's E&P business but revised it to Rs 966 after the January 21 deal was announced.

This is the lowest value of RIL among more than a dozen views on the company so far, but all are unanimous: RIL had major challenges facing it and therefore the deal augurs we ll for it.

"Divesting a 30 per cent stake in 23 blocks is a low price to pay for RIL in return for the technology and expertise that BP will bring," says Brijesh Koshal, Managing Director (investment banking), Daiwa Capital India.

MUST READ:Post BP, cash-rich RIL could spread its wings

The script is much more complex for BP. The oil major reported a $4.9-billion loss for 2010, its first since 1992.

On the one hand, the company is still trying to recoup its losses from last year's oil spill - it talked of increasing asset sales to raise $30 billion for clean-up costs and liabilities, and set up a $20-billion fund for victims of the environmental disaster, which also cost then CEO Tony Hayward his job. On the other, BP is facing tough choices in Libya, where it has three oilfields.

The company evacuated all its employees from Libya two days after the RIL deal was announced. It is divesting its North Sea oilfields that are now mature and struck a $8-billion share swap deal in January with Russia's Rosneft to explore its Arctic blocks.

The RIL deal clearly indicates that BP will focus on new markets, play on the future, look for more deepwater blocks and monetise its producing fields. For BP, this is a 5 to 10 year play.

RIL is keen to make the most of the deal now. The RBS report says: "The implied value of RIL assets from the BP deal works out to Rs 327 per share compared to our estimate of Rs 263."

However, the report notes that only a month back RBS had sharply cut its valuation of RIL's E&P assets due to disappointing news flow on production and reserves.

"Our valuation of the same assets before this cut was nearly Rs 395 per share, i.e. BP has paid a lower price for these assets than our valuation of them just one month ago," the report adds.

RBS was probably the only one to cut RIL's exploration value. Otherwise, almost every other analyst has valued RIL's exploration assets higher than what BP seems to be paying here: Citibank at Rs 471 per share and CLSA at Rs 431 per share.

David Cameron, British PMDavid Cameron, British PM
Britain presses the gas pedal

Trivia can often be significant. The deal between Reliance and BP was signed at 11 Downing Street, the official residence of UK's Chancellor of the Exchequer, George Osborne. Less than a week before this deal was announced, British Prime Minister David Cameron had written to Prime Minister Manmohan Singh pushing for the Cairn-Vedanta deal and expressing his worries about the Rs 11,000crore tax demand on Vodafone. Clearly, the British government takes more than a passing interest in the fortunes of British companies. British High Commission's Director for Press and Communications, Marcus Winsley says, "The BP-Reliance deal has no direct relation to those other trade and investment issues involving British companies in India that have recently received public attention. It does show, however, that interest by British companies in investing in India is strong." Calling for more transparent tax regime and regulatory climate, Winsley also said the appetite for investment in India is likely to become all the more strong and as the market access increases in those sectors "where British companies are world-beaters, such as professional services, finance, retail and defence". Incidentally, only 40 per cent of BP is owned by British entities while 39 per cent is with US entities.


HSBC, however, says the deal will not solve RIL's problem of how to deploy the cash. It has quite a few options: it can find new investment areas or acquire a company, or return cash to shareholders.

It can also retire some debt - RIL's debt by 2011-12 end is estimated to be $7.4 billion, which is almost equal to the $7.2 billion that BP will pay upfront.

It can even make fresh, concerted efforts to fulfil Chairman and Managing Director Mukesh Ambani's dream of taking natural gas to millions of households in India. Ambani iterated this at the media briefing following the deal. "Hydrocarbon resources are finite natural resources and extremely valuable ... The benefit of hydrocarbon oil and gas production should reach millions of Indians because the quality of life … is critically dependant on the per capita energy consumption," Ambani said after the signing of the deal.

"With this partnership we will unleash combined expertise to further our shared goal of building this 21st century infrastructure for natural gas for India," he added.

RIL has had negative cash flow for the last five years - it made profits but invested more. It is not likely to change its course.

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