BP’s Bet on Indian Natural Gas Market Will Help Country & Company Growth

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This year BP (NYSE:BP) has taken a huge stride into the developing Indian natural gas market.  In August 2011, the oil giant paid $7 billion to acquire a 30% interest in 21 oil and gas production sharing agreements operated by Reliance Industries Limited (RIL) – India’s largest private sector company.  A further $1.8 billion of contingent consideration will be payable by BP upon exploration success and subsequent commercial development of certain blocks.  [1]  The transaction constitutes one of the largest foreign direct investments into India. The strategic alliance with Reliance comes as BP, and other oil majors such as Chevron (NYSE:CVX) and Exxon Mobil (NYSE:XOM), announce large increases in exploration spending and a sharper focus on obtaining access to new production opportunities across the globe.

The acquired interests include the producing KG-D6 block, which in 2010 accounted for almost 35% of total gas consumption in India and 44% of the total domestic gas production.  [2]  BP estimated that had the acquisition occurred on the 1st January 2011, the acquired activities would have contributed revenues of $689 million and profit of $147 million.  A healthy profit margin of 21%, despite the significant decline in production experienced at the KG-D6 block during the year.

The ‘transformational partnership’ that BP has formed with Reliance, extends further than just exploration and production.  The alliance will also see BP move into the country’s midstream natural gas market.  In November 2011, BP and Reliance formed a 50:50 Joint Venture – India Gas Solutions Pvt.Ltd., which will focus on the sourcing and marketing of natural gas in India.  The newly formed entity will take over the administration of the existing gas contracts to KG-D6 customers and will also pursue other opportunities including LNG import.  [3]

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The Trefis stock price valuation for BP is $55, which is 34% higher than the current market price of $41.  Natural gas production makes up 14% of the Trefis stock price valuation.

BP’s partnership with Reliance provides it with access to an emerging market with a rapidly growing thirst for energy.  Energy demand in India has been growing exponentially, with a compounded annual growth rate (CAGR) of 7% over the last five years.  The share of natural gas in the energy mix is low at 10%, versus the global average of 24%.  Demand for natural gas in India is expected to grow at a CAGR of 10% over the next five years.  [2]

The Indian natural gas industry is currently characterized by supply deficit and inadequate infrastructure for transmission and distribution.  Whilst demand for natural gas has seen significant growth, domestic production remained flat for the decade to 2009.  Thanks to the commencement of production at Reliance’s KG-D6 field, production in 2010 increased by 28.6% to 1,848 billion cubic feet.  Whilst India was ranked as the world’s 21st largest natural gas producer in 2010, it was the 13th largest global consumer of gas, importing approximately 19% of its total gas requirement for the year. In recent years, the Indian Government has been aggressively promoting the build-up of gas transmission infrastructure.  Significant pipeline expansion plans are currently being pursued by both private and public sector companies.  [4]

There has been a significant decline in production at the KG-D6 field during 2011, with Reliance reporting a 23% drop in output during the July to September quarter.  BP, however, remains confident that further development of the surrounding areas will lead to production regaining upward momentum by 2014.  [5]

Notes:
  1. Company Filing []
  2. Reliance [] []
  3. BP and Reliance Industries Announce Incorporation of India Gas Solutions Pvt. Ltd., Reliance []
  4. Exploring Opportunities – Growth Potential in the Indian Natural Gas Market, Ernst & Young []
  5. BP Strategy to Boost KG-D6 Output, Business Line []