Decarbonization Trends Will Erode Fossil Fuel Markets

Key Takeaways

• Structural decline in demand and pricing power due to accelerating renewables adoption and supportive clean energy policies threatens ONGC's long-term revenue prospects.
  
• Rising operational costs, regulatory burdens, and investor divestment are set to squeeze margins, restrict financing access, and depress earnings quality going forward.
  
• Oil and Natural Gas is boosting production, controlling costs, and expanding petrochemical operations to stabilize long-term earnings and diversify revenue through strategic asset development and efficiency initiatives.

Catalysts

Engages in the exploration, development, production, and distribution of crude oil, natural gas, and value-added products in India and internationally.

• Intensifying global decarbonization efforts, coupled with rapid advancement and adoption of renewable energy and battery storage technologies, threaten to erode ONGC's long-term addressable market, driving persistent declines in both oil and gas revenue over the next decade as fossil fuel demand structurally contracts.
  
• The steadily diminishing cost gap between renewables and hydrocarbons, alongside aggressive policy support for clean energy, is likely to accelerate the displacement of oil and gas in the power and transportation sectors, significantly reducing ONGC's future sales volumes and pricing power.
  
• Rising development, maintenance, and regulatory compliance costs associated with extracting oil from aging and deepwater fields, highlighted by recent increases in depreciation and depletion expenses, are expected to cause persistent pressure on ONGC's net margins, limiting operational profitability.
  
• Escalating environmental risks, regulatory scrutiny, and the threat of costly litigation or remediation for potential environmental incidents create long-term uncertainty, increasing the likelihood of higher cash outflows, reduced earnings quality and suppressed company valuation multiples.
  
• Increasing global investor divestment from fossil fuel assets and the looming implementation of carbon pricing mechanisms will restrict ONGC's access to low-cost capital and put structural pressure on future net earnings, making it difficult for the company to sustain current return levels.

Oil and Natural Gas Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on Oil and Natural Gas compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming Oil and Natural Gas's revenue will decrease by 3.1% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from 5.5% today to 6.7% in 3 years time.
• The bearish analysts expect earnings to reach ₹402.4 billion (and earnings per share of ₹31.88) by about August 2028, up from ₹360.6 billion today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 9.5x on those 2028 earnings, up from 8.3x today. This future PE is lower than the current PE for the IN Oil and Gas industry at 17.6x.
• Analysts expect the number of shares outstanding to grow by 0.1% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 14.06%, as per the Simply Wall St company report.

Oil and Natural Gas Future Earnings Per Share Growth

Risks

• ONGC has successfully stabilized and is increasing crude oil production, with guidance indicating continued ramp-up from key assets like KG Basin and expectations of reaching higher peak production levels, which could lead to revenue growth and improved earnings.
  
• The company's increased focus on monetizing new hydrocarbon discoveries, developing deepwater and ultra-deepwater fields, and ongoing enhanced oil recovery initiatives suggest the potential for offsetting declines from mature fields, supporting long-term production and revenue stability.
  
• Strategic initiatives such as the switch to cheaper ethane imports for Opal, optimization of logistics (switching ports, reducing transportation costs), and targeted operational cost reductions could materially improve net margins over time.
  
• The petrochemical subsidiary OPAL is now EBITDA positive and running at over 90% capacity utilization, with management expecting further gains as the petrochemical cycle turns positive, potentially diversifying revenue and reducing earnings volatility.
  
• Upcoming developments, like the expected lifting of force majeure in Mozambique and stable/increasing production from international assets, could open new export opportunities and strengthen recurring revenue streams, benefiting long-term consolidated earnings.

Valuation

• The assumed bearish price target for Oil and Natural Gas is ₹205.0, which represents the lowest price target estimate amongst analysts. This valuation is based on what can be assumed as the expectations of Oil and Natural Gas's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of ₹340.0, and the most bearish reporting a price target of just ₹205.0.
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be ₹5970.6 billion, earnings will come to ₹402.4 billion, and it would be trading on a PE ratio of 9.5x, assuming you use a discount rate of 14.1%.
• Given the current share price of ₹237.93, the bearish analyst price target of ₹205.0 is 16.1% lower. Despite analysts expecting the underlying buisness to improve, they seem to believe the market's expectations are too high.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.