After the worst quarter (4QFY20) since the oil price collapse of 2014-16, E&Ps’ profitability is expected to improve meaningfully in 1QFY21, thanks to normalized production levels and recovery in international oil prices. However, profits will remain below last year’s level.

Lifting of lockdown in Pakistan enabled major oil fields to increase output by up to 50% qoq. International crude oil prices recovered to a steady range of US$40-45/bbl. Exploratory activity is noticeably declining sector-wide, but this will help to contain earnings erosion.

We have a Market weight stance on the sector, with a Buy rating on OGDC (TP PKR147/sh) and PPL (TP PKR128/sh). We continue to assume flat crude oil prices of US$40/bbl. Even as international prices recently stabilized, the second wave of the coronavirus outbreaks will subdue global demand recovery.

Improvement in profitability expected – not a rebound…

We expect our E&P Universe (OGDC, PPL and POL) to post cumulative profits of c.PKR35bn for 1QFY21 which will be up 19% qoq (down 22% yoy) but still low by historical levels of profitability. Production levels normalized across almost all fields which were affected by the Covid-19 induced lockdowns in the previous quarter.

Meanwhile, international crude oil prices rose 46% qoq to a steady range of US$40-45/bbl amid lifting of lockdown conditions globally; however, they are still about 50% below the levels during 1QFY20. Barring OGDC, exploration expenses will remain soft, as during the previous quarter, where low oil prices have moderated activity. Payouts for the period will remain moderate, where we expect OGDC only to announce a dividend of PKR2.0/sh. Key future triggers include the imminent results of Jhandial-2 appraisal well for POL (drilled to target depth until September) and the exploratory well Qadirpur Deep (c.80% drilled).

…though much of the production has normalized

Oil and gas production of IMS Universe normalized to pre-pandemic levels during 1QFY21, oil refineries resumed normal operations and lifting of lockdowns in Pakistan increased demand for petroleum. Low furnace oil prices and a rebound in industrial activity enabled optimal FO off-take and in turn refinery operations. Production from the major oil fields – Tal block, Nashpa, Adhi, KPD – rose 30-50% qoq, as a result. However, gas production, had not fallen as steeply as oil output and hence grew modestly. Nonetheless, it will be 7% and 10% qoq for OGDC and PPL. Notably, Sui’s production was flat, while that of Uch and Qadirpur rose 9% and 2% qoq respectively. Note that realized gas prices for OGDC and PPL will not be commensurately affected by the recent collapse in international oil prices as most of their large fields are based on 2001 Petroleum policy or older pricing regimes.

Exploration expenses to continue declining

A notable consequence of low oil prices is the reduced drilling and other exploratory plans. OGDC is a notable exception. According to PPIS, OGDC is one of the two E&Ps which conducted geological studies during 1QFY21; and, of the 10 wells planned for drilling until December 2020, seven will be drilled by OGDC. Otherwise, E&Ps have noticeably scaled back capex to conserve cash. This will be positive because low exploratory expenses (including dry wells) will improve earnings. But, reserve replacement in Pakistan has been paltry in recent years, and thus future production growth will be jeopardized, in our view. OGDC will book dry-well expenses related to three unsuccessful wells, but all were low-profile and inexpensive (located in the Lower Indus basin ie. Sindh). (Intermarket Securities Limited.)