E&P sector’s charm fading?

From flattish oil and gas levels to declining volumes, production by the E&P companies have been running dry in the last couple of years – or maybe more. FY20 was a challenging year where Covid-19 restrictions presented hurdles such as low demand for fuel as well as refineries running out of storage that reduced overall crude intake from the E&P companies. At the same time, the natural decline in major fields continue with new discoveries not enough in numbers as well as in size to replace them. Overall, oil production declined by 14 percent year-on-year, while gas production which fell by 8 percent year-on-year in FY20. Production continued to fall in the ongoing fiscal year (FY21) as well; recent numbers suggest a decline of 6and 4 percent in oil and gas production respectively in 2QFY21.

In terms of oil prices, 2020 has been a harsh year for the E&P players. Not only was the year memorable for the oil price touching its lowest ever in history, but the year was also full of uncertainties and thus volatility in prices.

This was partially reflected in lowered profitability of the sector somewhat supported by currency devaluation in 1QFY21, which was negligible versus FY19. Don’t be fooled by the sector’s general performance on the stock exchange over these years as the bulk of the growth in the earnings have either emanated from exchange gains, or higher oil prices in earlier years.

And then the sector has been facing liquidity constraints as well. Companies have been facing the brunt of the circular debt, which has significantly affected exploration and drilling activity in the country. As a result of the circular debt, receivables have continued to grow rapidly, which has also limited the dividend paying capacity of E&P companies.

This picture that the sector paints is completely opposite to what historically has been considered a safe bet previously as a research note by Alfalah CLSA puts it: the sector benefited from relatively stable oil prices, decent returns backed by strong cashflows, natural USD hedge, and increasing production. However, the current situation in the sector has resulted in E&P giants trading at a 50 percent discount to the market.

Though hopes are pinned to 20 new blocks expected to be auctioned in the near term, key risks that the sector faces include the largely volatile oil prices; the possibility of large swings in prices cannot be ruled out amid jittery demand and supply. Currently, vaccine immunization news is a major factor driving crude prices.