Oil & Natural Gas Corporation Limited (ONGC), Reliance Industries Limited (RELIANCE): A Brighter Future for India’s Upstream Energy Sector

India’s leading oil and gas explorer Oil & Natural Gas Corporation Limited (NSE:ONGC), or ONGC, has recently reported a steep decline in quarterly earnings as it sold its output at significant discounts. The company has been suffering from aging fields as the exploration-related write downs rose by one-third from the same quarter last year to $850 million while depreciation charges doubled to $423 million in the same period. Moreover, Brent crude prices also did not help, and averaged $112.64 during the quarter, showing a decline of 5% from last year.

On the other hand, Reliance Industries Limited (NSE:RELIANCE), the owner of the world’s largest refinery located in western India, has posted a 32% increase in quarterly income to $990 million. However, unlike ONGC, Reliance Industries Limited (NSE:RELIANCE) is largely a refiner, which is a higher margin operation. In fact, like ONGC, Reliance Industries Limited (NSE:RELIANCE) has struggled with its oil and gas production business as the unit’s quarterly revenue dropped 39%. Its income from converting crude to refined products, however, rose 33% to $10.10/barrel. As a result, the business ended up with increasing profits despite recording a 1.2% overall drop in sales.

Oil & Natural Gas Corporation Limited (NSE:ONGC) and Reliance Industries Limited (NSE:RELIANCE) have significant representation in PowerShares India ((NYSEARCA:PIN) and the WisdomTree India Earnings Fund (NYSEARCA:EPI), both exchange-traded funds (ETFs). The two firms are among the top-three holdings in both of these ETFs. The PowerShares India portfolio ETF is energy focused and devotes 25.6% of the funds to this sector while WisdomTree India Earnings Fund ETF is financials-focused with total sector weight of 25.4%. But the energy sector isn’t far behind with a weight of 19.8% of the funds.

Oil & Natural Gas Corporation Limited (NSE:ONGC)’s strategy is to increase its domestic and international reserves and output. For this reason, it has increased its capital expenditure budget by 18.8% from last year’s $5.2 billion to the current $6.2 billion. The company also has a very ambitious target to spend $195 billion by 2030 on building reserves and increasing production. From this perspective, the drop in profits will put pressure on its cash reserves.

In the last fiscal year, ONGC’s total output was approximately 51.4 million tons of oil equivalents, which it expects to increase by 1.9% to 52.5 million tons. I believe that the target is modest but it is realistic. ONGC has recently announced two new discoveries of which the KG basin field will start production within three years.

India’s oil and gas sector has witnessed government reforms that have largely been received well. India, much like China, was keeping a lid on oil prices to tackle the rising inflation and as a result, Oil & Natural Gas Corporation Limited (NSE:ONGC) was forced to sell crude at steep discounts to refiners.

However, the government has increased diesel prices while refiners are given more freedom to set their own price. I believe that this will reflect positively in the coming quarters as the current levels of subsidy that ONGC gives to refiners, which was approximately $2.2 billion in the previous quarters, will fall.