Packs solid energy
Till the Rajasthan oil discovery commercialisation in 2009, which will propel earnings, oil prices and news will drive the stock

Cairn is an independent oil and gas exploration and production company. Listed on the London Stock Exchange since 1988, with the company’s head office in Edinburgh. Its core area of focus is South Asia: it holds material exploration and production rights in India, Bangladesh and Nepal.

Cairn India (CIL) was incorporated on 21 August 2006 to consolidate Cairn’s business and interests in India. CIL is acquiring its assets and business through acquisition of Cairn’s subsidiaries: Cairn Energy Australia Pvt Ltd (CEA), Cairn Energy hydrocarbons (CEH) and Cairn Energy India Holdings B.V.(CEIH).

In the first six months to June 2006, CIL’s gross production from existing oil assets Ravva, Lakshmi and Gauri was 87,500 barrels of oil equivalent per day (boepd). Of this, CIL had a working interest in 24,000 boepd. (22.5% working interest in Ravva field in Andhra Pradesh and 40% in Lakshmi and Gauri fields in Gujarat).

Out of the proceeds from the IPO, Rs 5525 crore will be utilised to develop the Rajasthan block and for additional drilling in Ravva and Cambay (Gujarat) blocks, Rs 691 crore for exploration and appraisal activities including funding minimum work program for capital commitments and expenditure towards any additional blocks to be awarded in NELP 6 round (2), Rs 460 crore for corporate purpose and contingencies, and the rest to be paid to Cairn UK as consideration for acquisition of its business in India.

In developing the Rajasthan field, CIL will have 70% working interest, and the rest with ONGC. In January 2004, the Mangala oil field discovery in Rajasthan by CIL was the largest oil discovery by any company in India since 1985. Mangala is the core of CIL’s future development. The other fields in Rajasthan include Aishwariya, Saraswati and Raageshwari. Cairn Plc has invested $500 million in Rajasthan.

CIL is positive of commencing production in the Mangala field in 2009. But it will take some years for it to reach the plateau rate of 1,50,000 bpd.

Strengths

• The existing cost of producing oil from Ravva field is lower than US$1 per barrel of oil. CIL is continuously producing 50,000 barrels of oil per day (bopd) on an approximate basis at this cost since 2002.
• The cost of producing oil from the Mangala field of Rajasthan will be around US $ 3.5- $ 4 (bopd). The company has targeted 1,50,000 bpd from the Mangala field at plateau rate.
• The total gross proved plus probable (2P) reserves attributable to the fields in production and under development in which CIL has interest is 754 million barrels of oil equivalent (mmboe). Its networking interest in these reserves is estimated at 472 mmboe. Most of these 2P reserves are estimated to be in the Rajasthan Block and remains to be tapped.

Negatives

• The Ravva field was expected to come off its plateau rate of 50,000 bopd in late 2007. So the production of crude will come down from its existing plateau rate. Future production to reach its plateau rate will depend upon new discoveries in the Ravva field, which the company has initiated.
• The necessary pipeline infrastructure from the Mangala field needs to be developed in time for the commencement of crude oil production in 2009. MRPL is the nominee appointed by the government of India. CIL is not satisfied with the progress of the pipeline made by MRPL. Hence, the company is considering other options like negotiating with private players and even entering such mid-stream activities. This will increase the cost to the company. Moreover, its UK parent does not have experience in mid-stream activities so far. Any delay in setting up pipeline will affect production from the Mangala field.

Valuation

The offer price band is Rs 160-Rs 190. Based on the consolidated financials of CEA, CEH and CEIH for the year ended December 2005, profit after tax (PAT) stands at Rs 92 crore, including one-time income of Rs 230 crore. Also the financials for the six months ended June 2006 are not exciting as they include a write-off of the unsuccessful exploration cost of Rs 236.73 crore on 15 wells digged in Rajasthan block prior to the successful discovery of the Mangala oil field.

Based on existing financials, there is no significant EPS. However, companies like CIL are valued based on projected earning and cash flow from the discovered reserves. Hence, the current PE ratio is irrelevant. However, it is not possible to do such valuation based on data and information available in the prospectus, nor does the company share the underlying data and assumptions behind the working of the offer price.

Parent Cairn has been allotted post-IPO stake of 20.11% at the issue price, or Rs 186, whichever is higher. However, this money will be essentially paid back to Cairn as compensation for acquisition of its subsidiaries. More relevant is the pre-IPO private placement of post-IPO stake of 11.55% at Rs 176.48 with Petronas, Malaysia, as the lead investor.

Only long-term investors should consider the issue. Fluctuations in oil prices and news flow on the progress of the Rajasthan project and other discoveries and winnings of new exploratory blocks will drive the share price post-listing. Earning will matter only after 2009.