22 March2010 India Daily


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22 March2010 India Daily

  1. 1. INDIA DAILY March 22, 2010 India 19-Mar 1-day1-mo 3-mo Sensex 17,578 0.3 8.3 5.3 Nifty 5,263 0.3 8.4 5.6 Contents Global/Regional indices Updates Dow Jones 10,742 (0.3) 3.5 2.6 Economy: RBI’s surprise dose may be a preparatory one Nasdaq Composite 2,374 (0.7) 5.9 5.4 FTSE 5,650 0.1 5.6 6.0 Energy: Oil is not about oil alone Nikkie 10,825 0.8 4.1 4.3 Telecom: Run up to the 3G/BWA spectrum auctions—part I Hang Seng 20,944 (2.0) 2.8 (0.7) KOSPI 1,669 (1.0) 2.6 0.8 Media: FICCI Frames 2010—industry sticks to the basics as growth accelerates Value traded - India Cash (NSE+BSE) 177.1 171.5 160.3 Derivatives (NSE) 758.4 927.2 714 News Round-up Deri. open interest 1,344.7 1,233 1,166 Reliance Ind. (RIL IN) has renewed talks with the ONGC led consortium to pick up stake in the Corabobo 1 oil block in Venezuela. (ECNT) Forex/money market IOC (IOCL IN)-Oil India (OINL IN) may hike their combined takeover offer for Middle Change, basis points East focused oil firm Gulfsands Petroleum after the UK based firm rejected their 400 19-Mar 1-day 1-mo 3-mo million pound bid. (ECNT) Rs/US$ 45.5 1 (80) (136) IOC (IOCL IN) plans to enter the petrochemicals business in June through its polymer 10yr govt bond, % 7.9 4 - 32 Net investment (US$mn) products and expects to notch up a market share of 21% in this new initiative. 18-Mar MTD CYTD (BSTD) FIIs 156 2,575 (230) Cipla (CIPLA IN) to replace Sun Pharma (SUNP IN) on BSE's benchmark Sensex from MFs (11) (402) (282) May 3. (ECNT) Top movers -3mo basis The much awaited formation of JV between Shipping Corp. (SCI IN) & SAIL (SAIL IN) Change, % could be a reality with a formal announcement to that effect expected to be made Best performers 19-Mar 1-day 1-mo 3-mo within a week. (ECNT) MSEZ IN Equity 728.7 2.2 12.4 34.9 SIEM IN Equity 732.8 0.5 10.1 33.2 Bharti Airtel Ltd (BHARTI IN) said it obtained USD 8.3 bn in funding for its proposed JSTL IN Equity 1242.4 (0.5) 20.7 26.3 acquisition of Zain's African assets. (BSTD) FTECH IN Equity 1635.6 (0.4) 9.3 24.1 ACEM IN Equity 118.7 1.7 13.3 23.6 Bharti Airtel, Apple in tie-up to sell 3G iPhone. (BSTD-Sat) Worst performers SBI (SBIN IN) plans to open 1,000 more branches in the next financial year, taking its IBREL IN Equity 160.4 (2.7) 4.4 (24.1) IBULL IN Equity 103.1 (1.7) 7.5 (18.0) total branch network to over 13,000. (BSTD) HPCL IN Equity 321.4 (0.6) (11.5) (16.9) Yes Bank (YES IN) is likely to raise USD 80 mn in the first round of fund raising for its BPCL IN Equity 522.6 (0.8) (11.8) (14.1) private equity fund focused on clean technology. (BSTD) TCOM IN Equity 293.9 (0.4) (1.0) (13.6) The RBI today surprised banks and money market players by raising key policy rates 25 basis points. The move aimed at taming inflation and anchoring inflationary expectations, marks a reversal in the easy monetary policy regime amid signs of strong economic revival. (BSTD-Sat) The board of directors of multiplex chain PVR Ltd (PVRL IN) has approved the merger of Leisure World Private Ltd with itself. (BSTD-Sat) Fortis Healthcare (FORH IN) said on Friday it had completed the acquisition of 23.9% stake in Singapore based healthcare company Parkway Holdings for USD 685.3 mn. (BSTD-Sat) LT (LT IN) has bagged a road project worth USD 304.35mn from National Highway Authority of India. (ECNT-Sat) Source: ECNT= Economic Times, BSTD = Business Standard, FNLE = Financial Express, THBL = Business Line. For Private Circulation Only. FOR IMPORTANT INFORMATION ABOUT KOTAK SECURITIES’ RATING SYSTEM AND OTHER DISCLOSURES. REFER TO THE END OF THIS MATERIAL.
  2. 2. Economy.dot INDIA Economy MARCH 19, 2010 UPDATE BSE-30: 17,578 RBI’s surprise dose may be a preparatory one. We see RBI’s 25 bps policy rate hike as a bid to catch up and address the problem of large negative short-term real interest rates. The timing was a major surprise to the markets as it came even before the March- end. We see this as an indication of further monetary policy action in April 2010 in line with our earlier call of 50-100 bps policy rate hike on that day. We do not see any adverse impact of the move on liquidity or interest rates. RBI starts action to catch up with the curve RBI today after close of markets hiked its policy rates by 25 bps with immediate effect. Reverse repo rate, which is the operational policy rate today, has been hiked to 3.5% from QUICK NUMBERS 3.25%; • RBI hikes policy Repo rate, the policy rate that sets the upper end of the overnight interest rate corridor, has rates by 25 bps; first been hiked to 5% from 4.75% time after July 2008 We see this RBI move as a bid to catch up with the curve (see Exhibit 1). In our Economy note of • We expect further March 15, 2010, “Would inflation and negative real interest rates damage the economy?” we had pointed out that India runs the second highest CPI inflation in the world and also the most 50 bps policy rate negative short term real interest rates (see Exhibit 2 and 3). We had pointed to risks of running hike on April 20 high negative real rates, viz., (1) possible asset price bubbles building again and (2) adverse impact • India still runs the on private savings. We had mentioned that RBI may need to raise policy rates by over 200 bps largest negative even with expected fall in inflation to sub-6% by end-FY11E in order to attain positive real rates. We see RBI action as the first step in that direction. short term real rate at -12.7% We expect further monetary tightening in April 2010 We see RBI’s move as a preparatory step for more tightening on or before schedule policy date. RBI may raise policy rates by another 50 bps on April 20. A CRR hike of 25-50 bps in April is also possible if large liquidity returns. RBI may further raise policy rates by at least another 50 bps by end-July 2010, taking repo rate to 6% and reverse repo rate to 4.5% In terms of timing, today’s move was a major surprise because RBI had clearly communicated to the markets that it may act before scheduled policy date only if the underlying growth or inflation conditions change due to unforeseen events. See also our Economy note of February 15, 2010, where we said that RBI is unlikely to act to small deviations of say 1-ppt in its full year’s growth and inflation projections. Our belief was also reinforced by likely larger than expected treasury losses for banks in this quarter on account of MTM losses, which we thought would prompt RBI to act only after March 31 closing. However, RBI has chosen to act when large liquidity has been temporarily drained by March advance tax flows. We see this on account of: (1) Increased confidence amongst policy-makers that high IIP growth would sustain, (2) Inflation becoming a major political issue in India enabling RBI leeway to act, (3) further evidence that manufacturing inflation is rising and it no longer remains food inflation (see Exhibit (4) large repressed inflation coming to fore through petro price hike and likely increase in coal and steel prices RBI in its communication has cited the following reasons for its action: (1) Uptrend in IIP being maintained, (2) acceleration in capital goods production, (3) headline WPI inflation exceeding baseline projection of 8.5%, (4) CPI indices accentuating further, (5) increasing capacity utilization and (6) rising energy prices. It has also added that “it will take further action as warranted.” We retain our 10-year gilt yield call at 8% for end-FY10E and a high of 8.25% in 1QFY11E before the bond rally takes over. We see INR/USD appreciating to 45.20 in near term before weakening again. For private Circulation Only. FOR IMPORTANT INFORMATION ABOUT KOTAK SECURITIES’ RATING SYSTEM AND OTHER DISCLOSURES,REFER TO THE END OF THIS MATERIAL.
  3. 3. Economy Exhibit 1 : RBI hikes policy rates 25 bps after 75 bps CRR hike in January, but monetary policy remains very accommodative in relation to pre-crisis history RBI's repo, reverse repo rates and cash reserve ratio on LHS, SLR on RHS (%) 11 25 10 Reverse repo rate Repo rate 9 CRR SLR 23 8 21 7 6 19 5 17 4 3 15 1-Jan-01 3-Jan-02 20-Dec-02 15-Dec-03 8-Dec-04 1-Dec-05 21-Nov-06 14-Nov-07 19-Sep-08 17-May-09 12-Jan-10 Source: Reserve Bank of India, Kotak Institutional Equities Exhibit 2: India runs the second highest CPI inflation in the world CPI inflation rates in select countries, position as on March 10, 2010 (%) 30 Year-ago (%) Current (%) 20 10 0 (10) Kuwait Taiwan of Egypt Japan Euro USA Ireland Spain Hong Thailand Mexico South Iceland Iran Pakistan France Canada Malaysia China New Greece Israel Saudi Russia Argentina Ukraine UK Latvia Guatemala Singapore S. Korea Bolivia Portugal Indonesia Philippines Kenya India Brazil Sri Lanka Venezuela Germany Italy Vietnam Turkey Czrch Rep. Hungary Source: Bloomberg, compiled by Kotak Institutional Equities KOTAK INSTITUTIONAL EQUITIES RESEARCH 3
  4. 4. India Economy Exhibit 3: India still runs the most negative short term real interest rates Nominal and Real central bank policy rates data for key global economies (%)position as on March 19, 2010 Central bank policy rate Country Nominal (%) Real (%) Targeted rate India 3.50 (12.7) Reverse Repo rate UK 0.50 (3.0) Bank rate USA 0.25 (2.4) Fed Funds rate Canada 0.25 (1.7) Overnight rate Taiwan 1.25 (1.2) Rediscount rate South Korea 2.00 (0.7) Call rate Hungary 5.75 (0.7) Base rate Thailand 1.25 (0.7) Repo rate Hong Kong SAR 0.50 (0.5) Lending rate Mexico 4.50 (0.3) Overnight rate Philippines 4.00 (0.2) Overnight rate Singapore 0.16 (0.0) Overnight rate Euro region 1.00 0.0 Refinance rate New Zealand 2.50 0.5 Cash rate Malaysia 2.25 1.0 Overnight rate Russia 8.50 1.3 Refinance rate Japan 0.10 1.4 Overnight rate Iceland 9.50 2.2 Repurchase rate Indonesia 6.50 2.7 Reference rate Australia 4.00 2.8 Cash Target rate Argentina 11.50 3.3 Repo rate China 5.31 3.8 Lending rate Brazil 8.75 4.0 SELIC rate Note: (1) Real rates are nominal rates minus CPI inflation Source: Bloomberg, compiled by Kotak Institutional Equities Exhibit 4: RBI acts when inflation may fall to <6% by end-FY11E from ≅10% at end-FY11E Headline WPI inflation rate (yoy), YTD price level change, March fiscal year-ends, 2009-2011E (%) 2009 2010E 2011E YTD09 YTD10E YTD11E 14 12 10 8 6 4 2 0 (2) Apr Oct Mar Jul Jun Aug Sep Jan Feb May Nov Dec Notes: Inflation is actual data till February 2010 and Kotak Institutional Equities estimates thereafter. Source: Government of India, Kotak Institutional Equities estimates 4 KOTAK INSTITUTIONAL EQUITIES RESEARCH
  5. 5. Economy Exhibit 5: RBI action, inter alia, manufacturing inflation upsurge Inflation rate (yoy change in WPI) for major commodity groups (%) WPI primary commodities primary food energy manufacturing 25 20 15 10 5 0 (5) (10) (15) Oct-07 Oct-08 Oct-09 Feb-08 Feb-09 Feb-10 Apr-09 Apr-07 Jun-07 Aug-07 Apr-08 Jun-08 Aug-08 Jun-09 Aug-09 Dec-09 Dec-07 Dec-08 Source: Office of the Economic Advisor, Ministry of Commerce & Industry Exhibit 6: RBI action also prompted by elevated CPI inflation CPI for industrial workers (IW), urban non-manual employees (UNME), agricultural labor (AL) and rural labor (RL) (%) 20 Mar-09 Sep-09 Dec-09 Jan-10 17.6 17.4 16.2 15.5 16 12 8.6 8 4 0 WPI CPI-IW CPI-UNME CPI-AL CPI-RL Source: Central Statistical Organization, compiled by Kotak Institutional Equities KOTAK INSTITUTIONAL EQUITIES RESEARCH 5
  6. 6. tl CAUTIOUS Energy India MARCH 22, 2010 UPDATE BSE-30: 17,578 Oil is not about oil alone. We continue to be puzzled by the continued strength in crude oil prices despite its weak short-term fundamentals. Meanwhile, natural gas prices continue to correct sharply, probably cramped by concerns of surplus in the peak storage season given the rising production of non-conventional gas in the US. Optimists looking at long-dated prices to support their positive thesis may have to contend with this new and unexpected source of energy that could wreck crude oil’s fundamentals. Crude firms up while natural gas prices decline; it all boils down to speculation, it would appear Crude prices have risen over the past few weeks (+8% since February 1, 2010) upon expectations QUICK NUMBERS of (1) strong demand recovery in CY2010E, (2) long-term supply-demand imbalance due to declining OPEC spare capacity and (3) a decline in US product inventories. However, natural gas • Oil-gas price parity prices have corrected 24% over the same period, probably on account of winter heating demand ratio at 3.5X tapering off and signs of a large surplus in autumn. We understand the different usages of oil and currently in the US gas but the 3X pricing differential is a puzzle, especially as refining capacity and availability of auto fuels is not an issue and short-term fundamentals of crude appear weak. • OPEC spare capacity at around 6 mn b/d Dollar movement, speculation can ward off weak fundamentals, only for a while in CY2010-11E Oil optimists point to the increase in long-dated crude prices to justify their bullish stance on crude oil prices. However, the rapid changes in long-dated prices in sync with near-month prices suggest • Shale gas F&D cost that long-dated prices do not accurately assess long-term crude oil prices. In fact, they move up or at US$1.7/mn BTU down based on near-month prices. Also, the synchronized movement of crude futures with and production cost movement in the US dollar (DXY Index) and stock markets suggests that there is a strong link (without between the three markets and speculation in crude futures based on movements in the DXY and transportation, stock markets. taxes) at US$0.9/mn BTU Short-term and long-term views on oil no longer about oil alone In our view, the short-term and medium-term fundamentals of crude oil do not support the current level of crude oil prices. There is ample OPEC spare capacity, global inventories are comfortable and supply of alternative energy is rising sharply in CY2010E. However, speculation and DXY may have an equally big bearing on short-term crude prices. In the long term, crude will have to contend with alternative energy sources—the potential of which is difficult to even fathom at this point. In our view, it is practically impossible to factor in so many complex developments on both the demand and supply side to make any accurate assessments of long-term prices; we doubt any modeling can accurately forecast technological advancements in both conventional and non-conventional hydrocarbons and alternative fuels; a few of them would be destructive in nature. Shale gas is becoming increasingly conventional Our preliminary study of shale gas suggests that this can be a destructive force for the conventional energy world. The technology for extracting shale gas is fairly common now, resources are abundant across the world and F&D (US$1.7/mn BTU average over the past two years) and production costs (about U$0.9/mn BTU in CY2009) are in line with those of conventional gas; in fact, as the area benefits from economies of scale with more proven reserves and as conventional resources dwindle, the cost curve may shift in favor of shale gas. For private Circulation Only. FOR IMPORTANT INFORMATION ABOUT KOTAK SECURITIES’ RATING SYSTEM AND OTHER DISCLOSURES, REFER TO THE END OF THIS MATERIAL.
  7. 7. Energy India Short-term and medium-term views: Oil and gas on different planes Exhibit 1 tracks price movements of oil and gas in the US. Oil prices have increased over the past few weeks while gas prices have come off over the same period. We do not deny that the markets for oil and gas are different, notwithstanding some convergence in the heating area. However, the price difference is stark and has increased over the past 5-6 years to unprecedented levels in the US, one of the few markets with unfettered oil and gas pricing. The crude oil-natural gas price ratio now stands at 3.46X compared to 1.21X in CY2004 (average prices for the year). This would suggest that crude’s fundamentals are much tighter versus gas; however, that does not appear to be the case in light of the following factors. Gap between crude oil prices and equivalent natural gas prices has increased sharply of late WTI crude price and Henry Hub gas price, 2004-10YTD (US$/bbl) (US$/mn BTU) 160 18 WTI crude oil price [LHS] Crude price equivalent of Henry Hub gas [LHS] Henry Hub gas price [RHS] 140 16 14 120 12 100 10 80 8 60 6 40 4 20 2 0 0 Jan-04 Apr-04 Jul-04 Oct-04 Jan-05 Apr-05 Jul-05 Oct-05 Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Source: Bloomberg, Kotak Institutional Equities Ample OPEC spare capacity over the next two years. We estimate OPEC’s spare capacity at around 6 mn b/d in CY2010-11E (see Exhibit 2), in line with the current spare OPEC capacity of 6.25 mn b/d (see Exhibit 3). The supply-demand balance looks tighter in the outer years of our projections. However, this does not factor in likely increased supply from (1) Iraq resulting from the recent award of technical contracts to several global majors and NOCs, (2) contribution from Brazilian sub-salt plays, (3) recent award of contracts in Venezuela’s heavy oil plays and (4) new discoveries off the coast of West Africa (the belt stretching from Sierra Leone to Equatorial Guinea with two billion-barrel discoveries already off the coast of Ghana). KOTAK INSTITUTIONAL EQUITIES RESEARCH 7
  8. 8. India Energy We expect sharp deterioration in global-supply demand balance over the next few years Estimated global crude demand, supply and prices, calendar year-ends, 2005-14E (mn b/d) 2005 2006 2007 2008 2009 2010E 2011E 2012E 2013E 2014E Demand (mn b/d) Total demand 84.1 85.2 86.5 86.2 85.0 86.6 87.9 89.1 90.2 91.3 Yoy growth 1.6 1.1 1.3 (0.3) (1.2) 1.6 1.3 1.2 1.1 1.1 Supply (mn b/d) Non-OPEC 49.8 50.4 50.9 50.8 51.5 51.8 52.6 52.2 51.9 51.7 Yoy growth 1.0 0.6 0.5 (0.1) 0.8 0.3 0.8 (0.4) (0.3) (0.2) OPEC Crude 30.4 30.5 30.5 31.2 28.9 29.3 29.3 30.6 31.8 32.9 NGLs 4.3 4.4 4.3 4.4 4.7 5.5 6.1 6.3 6.5 6.8 Total OPEC 34.7 34.9 34.8 35.6 33.5 34.8 35.3 36.9 38.3 39.6 Total supply 84.7 85.6 85.7 86.4 85.0 86.6 87.9 89.1 90.2 91.3 Total stock change 0.7 0.2 (1.0) 0.1 (0.1) OPEC crude capacity 34.4 34.2 34.7 35.5 35.0 34.8 35.5 35.8 Implied OPEC spare capacity 3.9 2.9 5.8 6.2 5.7 4.2 3.7 3.0 Demand growth (yoy, %) 1.9 1.3 1.5 (0.3) (1.4) 1.8 1.5 1.4 1.2 1.2 Supply growth (yoy, %) Non-OPEC 2.0 1.2 1.0 (0.3) 1.5 0.6 1.5 (0.8) (0.6) (0.4) OPEC 3.0 0.6 (0.3) 2.4 (6.0) 3.7 1.6 4.5 3.8 3.4 Total 1.6 1.1 0.1 0.8 (1.6) 1.8 1.5 1.4 1.2 1.2 Dated Brent (US$/bbl) 54.4 65.8 72.7 102.0 62.0 70.0 75.0 80.0 80.0 80.0 Source: IEA, Kotak Institutional Equities estimates High OPEC spare capacity despite recent lower compliance with the production cuts OPEC crude production and sustainable capacity (mn b/d) Sustainable Spare Cut in Production (mn b/d) production capacity production (a) Compliance Oct-09 Nov-09 Dec-09 Jan-10 Feb-10 capacity (mn b/d) (mn b/d) (mn b/d) (%) Algeria 1.24 1.24 1.25 1.25 1.25 1.40 0.15 0.15 75 Angola 1.90 1.88 1.85 1.89 1.95 2.10 0.15 — — Ecuador 0.46 0.46 0.46 0.46 0.47 0.50 0.03 0.03 43 Iran 3.66 3.70 3.72 3.70 3.74 4.00 0.26 0.16 29 Kuwait 2.27 2.28 2.29 2.29 2.29 2.65 0.36 0.31 82 Libya 1.52 1.52 1.52 1.52 1.53 1.70 0.17 0.19 76 Nigeria 1.90 1.98 2.01 2.00 1.98 2.60 0.62 — — Qatar 0.77 0.77 0.80 0.80 0.82 0.90 0.08 0.03 25 Saudi Arabia 8.28 8.22 8.12 8.20 8.16 12.00 3.84 1.21 92 United Arab Emirates 2.28 2.27 2.28 2.29 2.28 2.70 0.42 0.32 84 Venezuela 2.22 2.20 2.19 2.22 2.23 2.40 0.17 0.12 33 OPEC-11 production 26.50 26.52 26.49 26.62 26.70 32.95 6.25 2.35 56 Indonesia Iraq 2.43 2.45 2.48 2.43 2.54 2.60 0.06 Total OPEC 28.93 28.97 28.97 29.04 29.24 35.55 6.31 Note: (a) Cut in production in February 2010 versus September 2008. Source: IEA, Kotak Institutional Equities 8 KOTAK INSTITUTIONAL EQUITIES RESEARCH
  9. 9. Energy India Iraq’s production target of 12 mn b/d by CY2017 may appear ambitious compared to its current 2.5 mn b/d production but even an additional 2-3 mn b/d of supply over the next 3-4 years may dramatically alter the projections in the outer years of our forecast. Iraq has awarded several technical contracts to global majors and NOCs (see Exhibit 4) in order to exploit its 115 bn bbls of proved reserves, the third largest after Saudi Arabia’s 264 bn bbls and Iran’s 138 bn bbls. We note that Saudi Arabia currently produces about 8 mn b/d and has a sustainable production capacity of 12 mn b/d. Iran produces about 3.75 mn b/d of crude oil with a sustainable production capacity of 4 mn b/d. Iraq's crude oil production may reach 12 mn b/d in seven years Summary of Iraq oil contracts awarded, CY2009 Reserves Oil fields Consortium partners (bn bbls) Comments Round 1 (June 2009) South Rumaila BP, CNPC 7.3 Production target of 2.85 mn b/d from 1.06 mn b/d currently West Qurna (Phase 1) ExxonMobil, Royal Dutch Shell 8.7 Production target of 2.3 mn b//d from 279,000 b/d currently Zubair Eni, Sinopec, Occidental, Korean Gas 4.0 Plateau of 1.125 mn b/d from 200,000 b/d in seven years Round 2 (December 2009) Badra Gazprom, Turkiye Petrolleri, Korea Gas, Petronas 0.1 Production target of 170,000 b/d Gharaf Petronas, Japex 0.9 Production target of 230,000 b/d Halfaya CNPC, Total, Petronas 4.1 Plateau of 535,000 b/d Majnoon Royal Dutch Shell, Petronas 12.6 Plateau of 1.8 mn b/d Najma Sonangol 0.9 Production target of 110,000 b/d Qayara Sonangol 0.8 Production target of 120,000 b/d West Qurna (Phase 2) Lukoil, Statoil 12.9 Production target of 1.8 mn b/d Source: Upstream Online, Kotak Institutional Equities NGL supply is rising and so is Non-OPEC supply in CY2010E. We note that the supply-demand balance of crude oil looks fairly comfortable in CY2010E, led by increased supply of NGLs (0.8 mn b/d) and from Non-OPEC countries (0.2 mn b/d). Also, OPEC capacity will likely increase by 0.8 mn b/d. Excess refining supply; in fact, refineries are being shut. A strong recovery in auto fuels demand has been one of the arguments for a more bullish view on oil. Inventory data for the US over the past few weeks shows a decline in gasoline inventories. However, we believe this merely reflects low refining capacity utilization in the US (see Exhibit 5) rather than any great resurgence in gasoline demand. Gasoline demand remains at the lowest level in the last five years (see Exhibit 6). Finally, refining is hardly a bottleneck given low global capacity utilization rates; it’s not as if the world is running out of refining capacity. KOTAK INSTITUTIONAL EQUITIES RESEARCH 9
  10. 10. India Energy US refining capacity utilization lowest in a decade Weekly refining utilization in US (%) US refining capacity utilization (%) 105 2000-2009 range 2010 2005 2006 2007 2008 2009 95 85 75 65 Mar Apr Oct Jan Feb Jun Aug Sep May Nov Dec Source: IEA, Kotak Institutional Equities Gasoline demand lowest in last five years Weekly gasoline supplies in the US (mn b/d) (mn b/d) 10 2000-2009 range 2006 2007 2008 2009 2010 9 8 7 Jan Feb Mar Apr Jun Aug Sep Oct Nov May Dec Source: EIA, Kotak Institutional Equities Crude and product inventories look ample, especially in the light of declining OECD consumption. Exhibits 7 and 8 show OECD inventories in terms of absolute and number of days of forward cover. We note that OECD demand has declined over the past few years and the IEA predicts that OECD demand may in fact have peaked. OECD demand has declined 1 mn b/d on an average over the past four years although the decline in demand may have been accelerated in the past two years by the global credit crisis (see Exhibit 9). 10 KOTAK INSTITUTIONAL EQUITIES RESEARCH
  11. 11. Energy India OECD stocks continue to remain high Total industry and government-controlled crude and product stocks in OECD countries (bn bbls) (bn bbls) 4.6 Range 2002-08 2002 2003 2004 2005 2006 2007 2008 4.4 2009 2010 4.2 4.0 3.8 3.6 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Source: IEA, Kotak Institutional Equities OECD stocks continue to remain high OECD inventory days of forward cover of demand (# of days) (# of days) 66 Range 2002-08 2002 2003 2004 2005 2006 2007 2008 2009 2010 62 58 54 50 46 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Note: Days of forward cover based on average demand over the next 4 quarters Source: IEA, Kotak Institutional Equities KOTAK INSTITUTIONAL EQUITIES RESEARCH 11
  12. 12. India Energy OECD demand has declined significantly since 2006 Summary of global oil demand (mn b/d) 2006 2007 2008 2009 2010E 2011E 2012E 2013E 2014E OECD demand North America 25.4 25.5 24.2 23.3 23.4 23.7 23.9 24.0 24.0 Europe 15.7 15.3 15.3 14.5 14.5 14.7 14.7 14.6 14.5 Pacific 8.5 8.4 8.1 7.7 7.5 7.5 7.4 7.2 7.1 Total OECD 49.5 49.2 47.6 45.5 45.4 45.9 46.0 45.8 45.6 FSU 4.0 4.2 4.2 3.9 4.1 4.3 4.4 4.6 4.7 Europe 0.7 0.8 0.8 0.7 0.7 0.7 0.7 0.7 0.7 China 7.2 7.6 7.9 8.5 9.0 9.3 9.6 9.8 10.2 Other Asia 9.0 9.5 9.7 10.0 10.3 10.4 10.6 10.8 10.9 Latin America 5.4 5.7 5.9 6.0 6.2 6.2 6.4 6.5 6.7 Middle East 6.3 6.5 7.1 7.2 7.5 7.8 8.3 8.6 8.9 Africa 3.0 3.1 3.2 3.2 3.3 3.4 3.4 3.5 3.5 Total Non-OECD 35.7 37.3 38.7 39.5 41.2 42.0 43.2 44.4 45.8 Total demand 85.2 86.5 86.2 85.0 86.6 87.9 89.1 90.2 91.3 Source: Kotak Institutional Equities estimates We would highlight that gas inventories in the US are above the five-year average for this time of the year (see Exhibit 10) and will likely build up rapidly once the winter demand starts declining in the next 2-3 weeks. Exhibit 11 shows the prices of natural gas in the US over a period of time. As can be seen, current prices are barely above same period’s price in CY2009 when industrial activity would have been presumably at a much lower level. Gas inventory in the US remains high Weekly US gas stock (bcf) (bcf) 1997-2008 range 2004 2005 2006 4,000 2007 2008 2009 2010 3,000 2,000 1,000 - Jan Feb Jun Mar Apr Aug Sep Oct May Nov Dec Source: EIA, Kotak Institutional Equities 12 KOTAK INSTITUTIONAL EQUITIES RESEARCH
  13. 13. Energy India Gas prices near last year’s level despite improved industrial activity in the current year Henry Hub spot prices (US$/mn BTU) (US$/ mn BTU) 20 Henry Hub prices 15 10 5 4 - Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Source: Bloomberg, Kotak Institutional Equities Long-term view: Nobody knows but it is going to be very different We have been reluctant to subscribe to the view that future crude strips accurately assess long-term crude prices. They seem to move in tandem with near-month prices. Exhibit 12 shows the changes in long-dated prices over various periods; the diverse movements over the past 12 months would suggest that long-dated prices do not accurately reflect long- term crude oil prices but merely follow near-month prices. Also, near-month prices seem to move with DXY (inverse correlation) and stock markets (positive correlation) in the short term. Exhibit 13 shows the strong inverse correlation between the DXY and crude oil prices. Long-dated prices do not accurately reflect long-term crude oil prices WTI forward crude prices, current, 3-months ago and 1 year ago (US$/bbl) (US$/bbl) 13-Mar-09 11-Dec-09 12-Mar-10 90 80 70 60 50 40 May-09 Aug-09 Nov-09 Feb-10 May-10 Aug-10 Nov-10 Feb-11 May-11 Aug-11 Nov-11 Feb-12 May-12 Aug-12 Nov-12 Source: Bloomberg, Kotak Institutional Equities KOTAK INSTITUTIONAL EQUITIES RESEARCH 13
  14. 14. India Energy Relationship between crude prices and Dollar index seems to be strong since 2003 WTI and Dated Brent crude oil prices versus DXY Index, 2003-10YTD (US$/bbl) 160 USCRWTIC Index [LHS] EUCRBRDT Index [LHS] DXY Index [RHS] 110 140 Correlation (Crude, DXY) = -0.8 120 100 100 80 90 60 40 80 20 - 70 Jan-03 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Source: Bloomberg, Kotak Institutional Equities In our view, long-dated prices reflect the market’s current knowledge of future supply and demand even assuming that they are not influenced by short-term prices. However, we believe that current knowledge of geology and technology will never be able to assess (1) availability of resources in unexplored areas (most of the world’s oceans including the emerging Arctic area, non-conventional resources) and (2) future advancements of technology in areas of extraction technology, electric batteries and solar, wind and nuclear power. More often than not, these technological breakthroughs will be of a ‘game-changer’ variety. For example, the recent flurry of news on and activity around shale gas suggests that this is a very exciting area of supply of natural gas. Technological advancements have finally allowed commercial exploitation of resources that have been known to geologists for the past 3-4 decades. Various sources have estimated the resource base at 5-6X against current proved natural gas reserves of 1.2 tn boe (185 tcm). We note that shale gas is no longer in the realm of futurology but is playing an increasingly important role in the US energy scene. Shale gas now accounts for 14.7% of total US natural gas production (see Exhibit 14 that shows rising contribution of shale gas total US gas production). 14 KOTAK INSTITUTIONAL EQUITIES RESEARCH
  15. 15. Energy India Shale gas production as a percentage of total gas production has increased over the last five years in the US US natural gas production break-up, calendar year-ends, 2004-09 (tcf) (tcf) 24 Conventional gas Shale gas 20 1.5 3.1 0.6 1.1 1.2 0.8 16 12 18.0 17.4 18.1 18.8 18.0 8 17.3 4 0 2004 2005 2006 2007 2008 2009 Source: Kotak Institutional Equities More important, F&D and production costs of shale gas are quite low (see Exhibit 15). This would suggest that shale gas can emerge as a viable form of cheap energy for the next several decades and potentially a few centuries if current assessments of resources turn out to be reasonably accurate. Cost structure for key shale gas companies Production, finding and development costs, 2008-2009 (US$/mn BTU) Atlas Chesapeake Newfield XTO Energy Energy Exploration Energy 2009 Production costs 0.8 0.9 0.8 0.9 F&D costs 1.2 1.0 1.6 1.5 2008 Production costs 0.8 1.0 1.0 1.1 F&D costs 1.5 2.3 1.9 2.6 Source: Company, Kotak Institutional Equities Even without these destructive forces at play, we estimate long-term crude price at US$80/bbl. We compute US$70-75/bbl as the required long-term price of crude oil for a new oil sands project in Canada to earn 10% post-tax IRR. For more details, we refer readers to our March 3 report titled Crude price outlook: Expect short-term weakness. KOTAK INSTITUTIONAL EQUITIES RESEARCH 15
  16. 16. CAUTIOUS Telecom India MARCH 19, 2010 UPDATE BSE-30: 17,578 Run-up to the 3G/BWA spectrum auctions—part I. In line with our expectations, the ‘fear of the known (potential value loss from not having a 3G offering)’ has attracted 9 applications for the 3 3G spectrum slots being auctioned. Rather unexpectedly, however, the ‘option value or hope from the unknown’ has attracted 11 applications for the 2 BWA slots being auctioned. As highlighted in our March 15 report, we expect (1) aggressive bidding and (2) value destruction for the sector. Retain Cautious view. 3G—9 applicants for 3 slots; BWA—11 applicants for 2 The Department of Telecommunications has received 9 applications for the 3 (in 17 circles, 4 in 5) 3G spectrum slots being auctioned, while 11 firms have submitted their applications for the 2 BWA slots being auctioned to private players. We note that BSNL/MTNL have already been allotted 3G/BWA spectrum and they would not be a part of the auction. We also highlight that we do not have any circle-level details yet—some of these applicants may not have put in an application for all the 22 circles. Exhibit 2 depicts the names of the applicants for the 3G and BWA spectrum auctions. On expected lines, the top-6 wireless operators in the country (Bharti, Vodafone, RCOM, Idea, the Tata Group— TTSL/TTML/TCOM, and Aircel) have submitted applications for both 3G and BWA spectrum auctions. Three new players viz. Etisalat DB Telecom, Videocon, and S Tel have applied for 3G spectrum auctions (though we suspect Etisalat and S Tel may not bid pan-India), while there are 5 other applicants for BWA spectrum auctions. ‘Fear of the known’ and ‘hope from the unknown’ drives high # of bids for 3G/BWA auctions 3G—fear of the known: As discussed in our March 15 report on the upcoming auctions, we had anticipated the ‘fear factor’ of not winning 3G spectrum and facing potential value loss from high- ARPU subs churn (see Exhibit 3), to drive serious participation from all the large 2G incumbents in the 3G spectrum auction. We expect bidding for 3G spectrum to be aggressive—we expect pan- India 3G spectrum auction clearing price to be around US$2.5 bn, with the GOI netting US$10.3 bn, including payments from BSNL and MTNL (who have to match the auction clearing price). BWA (broadband wireless access)—hope from the unknown: Wimax networks are expected to solve the last-mile access challenge that has plagued broadband penetration in India (less than 1%, compared to wireless penetration of 45%). The excitement of ‘yet unknown but potentially large BB opportunity’ will likely ensure aggressive participation in the BWA auctions as well—the large number of applications (11) for the 2 BWA slots to be auctioned can be seen as an indicator of the same. We had assumed the BWA auctions to clear at the reserve price of US$380 mn per slot (a total of US$1.14 bn from 3 slots—2 for private players and 1 for BSNL/MTNL) in our March 15 report; aggressive bidding poses upside risk to this estimate as well and the GOI could reap more than the US$11.4 bn we have estimated, from the 3G and BWA auctions. Auctions good for the fisc, negative for the sector—we remain Cautious We believe the upcoming 3G spectrum auction will be a negative for the winners as well as the losers. We expect the winning operators to end up paying more than the potential ‘tangible’ value creation from rollout of 3G services, even as the tangible ‘value accretion’ for the winners happens (at least partially) at the expense of the losers. We believe the Street would take cognizance of the potential negatives from these auctions as the auction date (April 9) comes closer, and continue to remain Cautious on the sector. We reiterate REDUCE on Bharti and Idea, and SELL on RCOM. For private Circulation Only. FOR IMPORTANT INFORMATION ABOUT KOTAK SECURITIES’ RATING SYSTEM AND OTHER DISCLOSURES, REFER TO THE END OF THIS MATERIAL.