Cairn India 01apr13 New

COMPANY REPORT
Equity Research l Oil & gas
VIOLET ARCH Research

April 5, 2013
Cairn India Ltd.

Operation Desert Storm
We initiate coverage on Cairn India Ltd. (CIL) with a BUY rating. CIL is one of the best stock plays in India to have direct exposure to global crude prices. With its world-class Rajasthan Block already under production, the company has joined the big league of players in Indias E&P space. Rajasthan Blocks Gross Hydrocarbons Initially In Place (GHIIP) is 7.3bnboe, of which estimated recoverable reserves stand at 1.7bnboe. In two years production from Rajasthan Block is expected to reach 210,000bopd from the current 170,000bopd, which will contribute around 30% of Indias domestic crude production. With world-class oil production assets, exciting E&P prospects and highly competent management, coupled with high crude prices, CIL stock is an attractive investment option.
Absolute Rating Target Price Upside
BUY Rs 374
30%
Stock data
CMP Reuters Code Bloomberg Code Equity Shares o/s (mn) Market Cap (Rs mn) Market Cap (USD mn) Rs 288 CAIL.BO CAIR IN 1,908 534,160 9,891
Investment Argument
Resource-rich Rajasthan fields
CILs GHIIP in Rajasthan Block stands at 7.3bnboe, with the expected ultimate recovery of about 1.7bnboe. MBA (Mangala, Bhagyam and Aishwarya,) fields in Rajasthan Block have reserves of around 2.1bnboe, of which 2P reserves are estimated at 1.0bnboe, representing a recovery factor of 48%. Additionally, CIL has estimated recoverable resources of around 165mmboe from the Barmer Hill formation and other discoveries and another 530mmboe from the exploration upside. With the approval from government for resume exploration activities in Rajasthan block (after a gap of four years), Cairn has already embarked upon a 3-year exploration programme to drill over 100 exploratory/appraisal wells.
Stock performance (%)

52-week high / low 1M Absolute Relative (10.6) (8.1) Rs 366/283 3M (13.9) (11.4) 12M (20.2) (28.0)
Rajasthan Block production to rise by 22% by end of FY15

CIL is poised to achieve production of 210,000bopd from Rajasthan Block from the current 175,000bopd on the back of sustained production of 150,000bopd from Mangala along-with EOR (Enhanced Oil Recovery) implementation, ramp-up of Bhagyam to 40,000bopd and peak output of 20,000bopd from Aishwarya. A strong output ramp-up, along with high crude prices, will ensure healthy growth in cash-flows for the company.
Shareholding pattern (%)

DII, 10
Valuation
At the CMP of Rs 288, the stock trades at P/E, EV/EBITDA and P/BV of 5.5x, 2.7x and 0.8x, respectively, on FY14E estimates of EPS, EBITDA and BV. Since the production has begun from MBA fields, the stock has averaged at 7.8x one-year forward earnings. We value MBA fields on a NAV basis and other recoverable reserves on an EV/boe basis to arrive at a target price of Rs 374, which reflects an EV/boe of $9.5/bbl. We initiate coverage on Cairn India with a BUY rating.
FII, 15 Promoter, 59
CIL valuation
Block MBA + EOR Barmer Hill Exploration Upside Potential Ravva Cambay Total Net debt Cairn India Particulars Revenue (Rs bn) Growth (Y-o-Y) EBIDTA (Rs bn) EBIDTA margins PAT (Rs bn) PAT margins EPS P/E (x) EV/EBIDTA (x)
Source: Company, Violet Arch Research
Public & others, 16
Net 2P/ Recoverable Reserves (mmbbl) 620 116 371 14 4 1,125 FY12
118.6 15.4% 91.5 77.2% 79.4 66.9% 41.6 6.7 5.2
Rs/share 206 15 49 3 1 275 99 374 FY14E

170.4 -3.2% 122.1 58.9% 99.4 47.9% 52.1 5.4 2.6
(USD/boe) 12.9 5.2 5.2 9.1 9.1 9.5 FY15E

164.7 -3.4% 111.3 55.5% 85.2 42.5% 44.6 6.3 2.4
Relative stock movement

120
115 110 105
FY13E
176.0 48.4% 131.8 62.5% 115.1 54.6% 60.4 4.6 2.8
100 95 90
85 80
Aug-12
Nov-12
Dec-12
Apr-12
Oct-12
Sep-12
Jan-13
May-12
Mar-12
Feb-13
Jun-12
Jul-12
Cairn India Ltd
Sensex
Cairn India Ltd - Company Report
VIOLET ARCH Securities Pvt. Ltd. (Erstwhile Alchemy Share & Stock Brokers Pvt. Ltd.)
Mar-13
Scenario Analysis
Particulars Peak Bhagyam rate (bopd) Peak Bhagyam rate achieved in Peak Aishwarya rate (bopd) Peak Aishwarya rate achieved in FY14 brent price (USD/bbl) FY15 brent price (USD/bbl) Long-term brent price Discount to Brent Crude Exchange rate in FY14(Rs/$) Exchange rate in FY15 (Rs/$) LT Exchange rate (Rs/$) Cess (Rs/tonne) increases to WACC FY14 EPS Inc/dec from base case FY14 EBITDA (Rs bn) Inc/dec from base case DCF based target price Inc/dec from base case CMP Potential upside
Source: Violet Arch Research
Bear Case 30000 Q4FY14 10000 Q2FY14 105 95 85 12% 53 51 49 Rs 6500/MT in FY15 10.0% 47.5 -8.7% 110.8 -9.2% 329 -12.1% 280 17.4%
Base Case 40000 Q4FY14 20000 Q2FY15 110 100 90 12.0% 53 51 49 Rs 6500/MT in FY18 10.0% 52.1 122.1 374 280 33.5%
Bull Case 50000 Q1FY15 20000 Q4FY14 120 110 100 12% 53 51 49 Nil 10.0% 59.8 14.7% 140.5 15.1% 436 16.6% 280 55.7%
Key Assumptions
Base case
CILs management has guided an exit rate of 200,000bopd to 215,000bopd from Rajasthan block at the end of FY14, which will largely be coming from MBA fields. In our base case, we have taken a conservative stance and assumed an exit rate of 195,000bopd by end of FY14 with Mangala, Bhagyam and Aishwarya producing 145,000bopd, 40,000bopd and 10,000bopd respectively by the end of FY14. We assume a peak rate of 150,000bopd, 40,000bopd and 20,000bopd for Mangala, Bhagyam and Aishwarya respectively.
We assume Brent price to average $110/bbl in FY14 in the base case as the geo-political issues between Iran and US/Israel and continued tension in Middle-East will continue to put upward pressure on prices. However, we assume the price to trend lower in FY15 at $100/bbl and $90/bbl beyond that.
Capex of USD 2.0bn over FY14 and FY15 with 60% to be spent on Rajasthan block (30% on exploration and 30% on development) and remaining 40% to be spent on other assets and new ventures.
Direct field opex of $3.5/bbl and pipeline opex of $1.5/bbl. DDA expenses at $9/bbl. Royalty of 15.5% on revenues.

Cess is assumed at Rs 4500/tonne in the base case for five years through FY13-17 and then hiked by Rs 2000/tonne every five years.
EOR in Mangala to be implemented in FY15. Field-life of MBA fields till FY41.
Bear case
In our bear case, we assume an exit rate of 185,000bopd by the end of FY14 with Mangala, Bhagyam and Aishwarya producing 145,000bopd, 30,000bopd and 10,000bopd respectively by end of FY14. However, we assume the peak rate of 30,000bopd for Bhagyam and 10,000bopd for Aishwarya.
We assume brent crude to be $105/bbl and $95/bbl in FY14 and FY15 respectively, while for long-term we assume price to be $85/bbl.
Cess is assumed to increase to Rs 6500/tonne in FY15 and then increase by Rs 2000/MT every three years.
Bull case
In our bull case, we assume an exit rate of 215,000bopd by end of FY14 with Mangala, Bhagyam and Aishwarya producing 145,000bopd, 50,000bopd and 20,000bopd respectively by end of FY14. We assume peak rate of 50,000bopd and 20,000bopd for Bhagyam and Aishwarya respectively.
We assume brent crude to be $120/bbl and $110/bbl in FY14 and FY15 respectively, while for long-term we assume price to be $100/bbl.
Cess is assumed to remain constant at Rs 4500/tonne throughout the life of the field.
CILs production from various blocks

Cairn has three producing assets namely, Rajasthan block, Ravva and Cambay. While Rajasthan block is on a ramp-up phase Ravva and Cambay being mature fields are on decline. Currently Rajasthan block is producing at the rate of 175,000 bopd and Ravva and Cambay at ~28,000 boepd and ~6,000 boepd.
Crude production (mmboe)* Rajasthan Block Growth Y-o-Y Ravva Growth Y-o-Y Cambay Growth Y-o-Y Total Growth Y-o-Y
FY10 FY11 FY12 FY13E FY14E FY15E
3.80 3.34 -38% 1.97 -21% 9.11 16%
25.80 580% 3.03 -9% 1.63 -17% 30.47 234%
32.82 27% 2.99 -2% 1.20 -26% 37.02 21%
43.25 32% 2.68 -10% 0.96 -20% 46.89 27%
47.78 10% 2.41 -10% 0.77 -20% 50.96 9%
52.93 11% 2.17 -10% 0.61 -20% 55.72 9%
Source: Violet Arch Research;*Cairns stake in production
Rajasthan Block
Cairn began production from Mangala block in August 2009 and is currently producing at 150,000 bopd. Bhagyam has started production in Jan 2012 and is currently producing at 20,000 bopd while Aishwarya has commenced production recently.
Production (mnbbls) Mangala Growth Y-o-Y Bhagyam Growth Y-o-Y Aishwarya Growth Y-o-Y Rageshwari and Saraswati Growth Y-o-Y Total Growth Y-o-Y FY10 5.4 0.0 0.0 0.0 5.4 FY11 36.9 580% 0.0 0.0 0.0 36.9 580% FY12A 45.6 24% 1.2 0.0 0.1 46.9 27% FY13E 54.3 19% 7.3 512% 0.0 0.2 143% 61.8 32% FY14E 53.8 -1% 11.0 50% 3.2 0.3 50% 68.3 10% FY15E 52.0 -3% 14.6 33% 6.8 114% 0.4 33% 73.8 8%
Source: Violet Arch Research; Doesnt include EOR production from MBA
Cairns discount to brent moves in tandem with crude heavy-light differential 5 4 3 2 1 0 Q4FY10 Q1FY11 Q2FY11 Q3FY11 Q4FY11 Q1FY12 Q2FY12 Q3FY12 Q4FY12 Q1FY13 Q2FY13 Q3FY13
14% 12% 10% 8% 6% 4% 2% 0%
Heavy Light differential ($/bbl)

Cairns discount to brent (RHS)
The crude produced from Rajasthan block is priced according to a certain formula and is linked to Nigerian bonny Light. However, since the crude produced is heavy in nature it trades at a discount. The management has given a guidance of 10% to 15% discount to brent. Also depending on heavy-light differential, the discount varies. If the heavy-light differential widens the discount to brent may increase resulting in lower realization and if it narrows the discount may decrease resulting in higher realization.
Per boe analysis of Rajasthan Block

USD per bbl Brent Assumption Gross Realisation Royalty Govt share of profit petroleum Net Realisation Cess Direct field opex + Pipeline opex EBITDA DDA expense PBT Tax expense PAT
FY10 74.5 65.6 0.0 0.0 71.0 7.6 13.6 49.8 9.0 40.8 8.4 32.5
FY11 86.7 76.3 0.0 0.0 80.0 7.9 3.4 68.8 9.0 59.8 12.2 47.5
FY12A 115.0 103.5 24.4 5.4 73.3 7.5 5.0 60.8 8.0 52.8 10.8 42.0
FY13E 111.5 98.1 14.7 12.3 71.1 11.6 5.0 54.5 8.0 46.5 9.5 37.0
FY14E 110.0 96.8 14.5 17.7 64.5 11.9 5.0 47.6 9.0 38.6 7.9 30.7
FY15E 100.0 88.0 13.2 15.8 59.0 12.4 5.1 41.5 9.0 32.5 6.7 25.8
Cairn gross realization for crude produced from Rajasthan block is arrived at a specific formula approved by the government in the PSC. The crude produced from Rajasthan being heavy in nature is priced at a discount to brent crude. Depending on the heavy light differential discount ranges between 10% to 15% to brent crude. Cairn pays royalty at 20% of well-head value, which works out to 15%-16% of realized value. Till Q1FY12, ONGC was paying the entire royalty burden on its behalf and on behalf of Cairn as well. However, Government imposed the condition to make royalty cost recoverable to approve the Cairn Vedanta deal, which Cairn had to accept and also make provisions for royalty paid by ONGC till Q1FY12. PSC allows 100% cost recovery for Cairn before arriving at profit petroleum. Cairn is allowed to recover entire exploration and development capex, royalty cess & operating expenditure incurred before any profit petroleum is shared with the government. Governments share of profit petroleum is calculated based on investment multiple (IM = (Net Cumulative Income)/( Net Cumulative Investment)). The IM in a particular year determines governments share of profit petroleum in subsequent year.
IM (applied on fiscal year basis) <1.5 1.5-2 2-2.5 >2.5 Govt share 20% 30% 40% 50% JV share 80% 70% 60% 50%
Cairn pays cess at the rate of Rs 4500/MT which was increased from Rs 2500/MT in Budget FY13. Earlier Cairn had contested that ONGC has to bear the burden of cess for both of them. However, to approve the Cairn-Vedanta deal, government imposed the condition to make cess cost recoverable. Cairn has given a guidance of $3.5/bbl for direct field opex of and $1.5/bbl for pipeline opex which makes it one of the low cost operators in the E&P sector. Cairns DDA (Depreciation, depletion and amortization) expense has moved in the range of $8-$10/bbl and Cairn has given a long-term guidance of $9.0/bbl for the same. Cairn enjoys a seven year tax holiday from the day of start of production from Rajasthan Block. However, it has to pay a MAT at approximately 20.5% which will be eligible for set off against the applicable tax liability beyond the tax holiday period. However, for next two years it will continue to pay tax at effective tax rate of 5% to 9% as it avails the MAT credit entitlements.
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Sensitivity Analysis
Impact of 5% change in various parameters on EPS and EBITDA in FY14
Particulars Crude price Exchange rate Production volume
EBITDA impact 6.2% 6.0% 5.0%
EPS impact 6.3% 5.2% 4.3%
Cairn is a pure play on crude and as such it has a very high co-relation with how the crude prices move. The correction in crude prices during June12 from $125/bbl to $100/bbl also saw 15-20% correction in Cairn. We expect crude prices to remain stable at $110/bbl for next one year and $90/bbl in the long-term and USD-INR to average Rs 53/$ in FY14 and Rs 49/$ in long-term.
Valuation
Long-term crude price assumption (USD/bbl) 80 45 Long-term USD-INR rate assumption 47 49 51 53 320 328 337 340 349 90 348 357 367 376 385 100 380 391 401 411 422 110 412 424 435 447 458 120 444 457 470 482 495
EPS FY14
FY14 crude price assumption (USD/bbl) 100 49 FY14 USD-INR rate assumption 51 53 55 57 42.5 44.3 46.1 47.9 49.7 105 45.3 47.2 49.1 51.0 52.9 110 48.0 50.1 52.1 54.1 56.2 115 50.8 52.9 55.1 57.2 59.4 120 53.5 55.8 58.1 60.3 62.6
EBITDA FY14
FY14 crude price assumption (USD/bbl) 1 49 FY14 USD-INR rate assumption
100 98.2 103.2 108.2 113.3 118.3
105 104.6 109.9 115.1 120.4 125.7
110 111.0 116.5 122.1 127.6 133.1
115 117.4 123.2 129.0 134.8 140.6
120 123.7 129.8 135.9 141.9 148.0
51 53 55 57
SWOT Analysis
Strengths
1) World class asset 'Rajasthan Block' with GHIIP at around 7.3bnboe and recoverable reserves at about 1.7bnboe. 2) Low cost of production with direct field opex and pipeline opex at $3.5/bbl and $1.5/bbl. 3) Strong balance sheet with cash in hand at Rs 140bn as of 31st Dec'12. 4) Superior execution capabilities as seen in the case of Rajasthan block, Ravva and Cambay.
Threats
1) Delay in approvals from the government could lead to delays in achieveing the production guidance in Rajasthan Block. 2) The government raising statutory levies impacting profitability of Cairn. 3) Falling crude prices leading to a fall in profits.
Weaknesses
1) As of now, Cairn is considered a single asset player, as majority of its production is expected from Rajasthan Block in the near term. 2) Being mature fileds, Cambay and Ravva production on decline.
SWOT Analysis
Opportunities
1)The Barmer Hill formation reserves recovery factor at around 8%. Reserves of similar nature has had recovery factors of up to 20%. 2) Further exploratory efforts could lead to upgradation of 2P reserves in Rajasthan Block. 3) 10 exploratory assets in three strategically focused areas: one in Rajasthan; three on the west coast of India; six on the east coast of India, including one in Sri Lanka.
Geo-politics and crude

Country Its role in geo-politics US has recently established powerful sanctions that prevent Iran from receiving earnings to which it is entitled from its shrinking oil export trade. Under the new set of sanctions the Islamic regime has no choice but to continue with barter trades and local currencies, with limited access to the foreign exchange it desperately needs to continue its nuclear program and its customary support of international terrorism in the four corners of the world. Has been consistently mounting pressure on Iran and garnering support from EU for the same so that Iran comes to negotiation table. Though the shale oil production in US is increasing rapidly, it may not become completely import independent in the near future, which will mandate it to keep its influence over middle-east oil politics. Israel is strongly opposed to Iran going ahead with its nuclear ambitions. It has not ruled out military strike to bring Iran s nuclear program to halt. Israel has full support of US when it comes to any conflict in Iran or Middle-East as well. Declining oil exports has caused the Iranian rial to shed more than 60 percent of its value against the U.S. dollar, leading to spiraling inflation and mounting unemployment. Uncontrolled inflation has raised food and commodity prices to such a degree that the majority of Iranian citizens presently cannot afford even basic necessities. Super inflation and unemployment in Iran are now presenting a serious danger to the regime. the opportunity costs of the nuclear program has been at well over $100bn in terms of lost foreign investment and oil revenues. However, Iran is still not ready to give up on its nuclear ambitions. Saudi has a majority Sunni population while Iran has majority Shia population. Theocracy in Iran has openly challenged the legitimacy of the Royal House of Saud. Both harbor ambitions to become economic and political power in Middle-East. Saudi has made up for production losses due to sanctions on Iran. Saudi Arabia is the largest member of the OPEC and the only one with significant unused capacity to produce more. It reduced output in Dec12 by 4.9 percent to 9.025mbpd, the lowest level in 19 months primarily to stabilize oil prices. When it comes down to its foreign policies China follows its own interests without buckling down to any international pressure. Latest examples were the conflict between China and Japan for islands in South China sea. It has not also opposed North Koreas war rhetoric. And with the cha nge in leadership it is claiming Taiwan as part of China. Even in the case of Iran it has not opposed any sanctions on it and will not support any military actions against Iran. It has been getting oil from Iran at discount to international rates. However it is reducing its oil imports from Iran just to comply with international sanctions. Russia wants to curtail western powers especially US hegemony in Middle-East. It never supported any sanctions or any military actions against Iran. Russia had also helped Iran in building a nuclear reactor. However, business interests are not the main drivers of its relationship with Iran. Russia is extremely dependent on energy exports, particularly on the export of crude oil. Russia robust state finances (Russia has by far the lowest debt/GDP ratio of any major country) are almost entirely due to its sizable exports of oil and natural gas. Thus any conflict in Middle-East which supports elevated crude prices will be beneficial to Russia. Venezuela has the largest known oil reserves in the world, but oil output has slumped by almost a third because of Mr Chavezs nationalization of the industry. The country holds 17.9% of the worlds known oil reserves, compared with 16.1% in Saudi Arabia and 10.6% in Canada. However, it only represented 3.5% of global production compared with 13.2% in Saudi Arabia. It is likely that oil output could rise, should there be an easing of the countrys antagonism to foreign investors. Some believe this could lead to a fall in the oil price and a consequent boost to the global economy. However, the state oil company PDVSA has increasingly been handing over its income to fund various government programmes, leaving it with negative cash flows for the past five years. The result of this has been a lack of investments as old fields matured and new ones were not explored, hence the drop in output. Consequently, for the output to rise from Venezuela will take much more time. South Sudan seceded from Sudan in July 2011. Along with this South Sudanese independence came 75% of Sudans oil resourcesminus the infrastructure (pipelines and ports) which remains in Sudan. So South Sudan became now rich in oil which is land-locked. However recently, Sudan and South Sudan reached an agreement for the resumption of South Sudanese oil exports through Sudanese infrastructure. The deal calls for a withdrawal of troops from both Sudan and South Sudan and the creation of a demilitarized zone to facilitate the flow of o il. Oil hasnt flowed for about a year after South Sudan blocked exports via Sudan over a tariff dispute. Oil production in Nigeria, Africas biggest producer, is down by about 1.0mbpd because of violence and theft in the Niger River delta. Currently, producing at 2.5mbpd, well below its capacity of 3.7mbpd. North Korea has said that it had entered "a state of war" with South Korea in its latest threat aimed at the United States and its ally after two American B-2 bombers flew a training mission in the region. The situation on the peninsula is now more volatile, with the North controlled by a relatively new leader, Kim Jong Un, and the South Korea promising an immediate military counterstrike if provoked. North Koreas army has said it had received approval for a nuclear strike on the United States, adding that the situation on the peninsula had reached an explosive stage. Analysts say a full-scale conflict is extremely unlikely and North Korea's threats are instead aimed at drawing Washington into talks that could result in aid and boosting leader Kim Jong Un's image at home.
US
Israel
Iran
Saudi Arabia
China
Russia
Venezuela
SudanSouth Sudan
Nigeria
North Korea - South Korea US
Source: Violet Arch Research; Various news-paper articles
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Policy-Regulatory Risks / Uncertainties for Cairn

Particulars Since Aug09 Crude price Royalty Comments Arrived at a specific formula approved by the government in the PSC. Discount to brent crude ranges in between 10% to 15%. It is 20% of well-head value. However, it works out to 15-16% of realizaed value and may vary slightly depending on government calculation of post well-head value. A further 5% increase in royalty could impact FY14 EPS by ~7% and valuation by ~6%. Cess increased by government in budget FY13 from Rs 2500/MT to Rs 4500/MT. There is a chance of hike in cess going forward. However, too high a hike or too frequent a hike in cess may also impact ONGC and Oil India to a large extent with their crude realization being determined by government. An increase in cess by Rs 2000/MT further could impact FY14 EPS by ~7% and repeatedly similarly thereafter every three years could affect valuation by ~10%. Cairn is allowed to recover its capex and production costs (upto 100% of revenues) before sharing any profit petroleum. However, government may disapprove some capex or costs upon its own assessment. Government has earlier rejected USD 238mn of capex by Cairn during its previous exploration phase in Rajasthan block. Post all the cost recovery, Profit Petroleum sharing with the government as is calculated as per the investment multiple. If government disapproves some costs, the share of profit petroleum of Cairn may decrease. In FY14 government share of profit petroleum will be 30% compared to 20% in FY13 and it will impact FY14 EPS by ~12%. Seven year tax holiday form the start of production. However Cairn continues to pay Minimum Alternate Tax (MAT). Also, any gas commercialization may not come under tax holiday as natural gas is not considered as mineral oil. The contract is valid upto May 2020 and can be extended on mutual agreement but terms may be changed by DGH while giving approval for extension. As per recommendations of Rangarajan panel, the government may look into hiking the price of gas by linking it to a price arrived upon by taking into consideration gas prices across various sources. Cairn is looking forward to monetize its gas discoveries in Rajasthan block. However, Rajasthan being a pre-NELP block gas price will be determined by government. For any discovery from NELP blocks awarded to Cairn, gas price hike would be a positive step. Recently, Cairn has started commercial sales of its gas produced from Rajasthan block. At present it ~0.14mmscmd and adds about Rs 500mn to revenues. Every $1/mmbtu increase in gas price could increase its revenues by ~100mn. Under the existing production sharing contract (PSC), the contractor first recovers his expenditure before sharing profit. What is under consideration is production-linked payment, which is said to be more transparent and will have less intervention in routine exploration and development activities. Under this proposal, oil companies would have to pay the Government an agreed amount, depending on the level of output, and not on the investment in the exploration block. The existing production from Rajasthan block comes under profit sharing model. However, with Cairn embarking once again on exploration programme in Rajasthan block, any new commercial discovery may come under revenue sharing model. The petroleum ministry has allowed exploration in mining lease (producing fields) areas but exploration costs will be allowed for cost recovery only if a discovery is technically and commercially viable. The contractor will therefore carry out further exploration activities at its risk in the Mining Lease area, after the expiry of the exploration period. Positive for the whole sector. Cairn has already embarked on a 3 year exploration programme in Rajasthan block to tap 3.2bnboe of reserves of exploration upside. However, the costs will be recoverable only on the establishment of commerciality of discovery. Force majeure had been declared in Cairn's KG-OSN-2009/3, MB-DWN-2009/1, PR-OSN2004/1 blocks due to the denial of permission to carry out exploration activity in the restricted area by the Ministry of Defence. CCI in its meeting held in Mar13 has given clearance for exploration activity in small portion of the KG-OSN-2009/3 block. However, further clarity is awaited on the rest of the blocks. The government gave its approval for the Cairn-Vedanta deal only after Cairn agreed to make royalty cost recoverable in the Rajasthan block. Prior to this, as per a previous agreement, the entire royalty burden was being borne by ONGC which owns a 30% stake in the block. The government also forced Cairn to withdraw a court case against cess levied in the Rajasthan block which it was paying under protest.
Last increased in Feb12
Cess
Cost Petroleum
Since Q1FY12
Profit Petroleum
Since Aug09 Signed in May94
Tax Holiday Contract period
Government may take decision this year or next.
Gas price hike
Government may take decision this year before NELP X auction.
Profit sharing model to revenue sharing model
Allowed since Feb13
Allowing exploration in producing blocks
Defense ministry declaring certain exploration areas as No-Go areas.
Jun11 to Sept11
Cairn-Vedanta deal
Source: VioletArch Research
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Investment Arguments
Resource-rich Rajasthan fields
Recently, CIL raised its Rajasthan potential resource to around 7.3 billion barrels of oil equivalent (boe) from earlier estimates of about 6.5boe, with discovered resources in Mangala, Bhagyam, Aishwarya, Rageshwari, Saraswati and other fields at around 4.2bnboe. The Fatehgarh formation in MBARS fields hold 2.1bnboe, of which the proved and probable (2P) recoverable reserves are estimated at over 1 billion barrels, including enhanced oil recovery (EOR) reserves of 308mmboe (recently, 70mmboe has been moved from 2C reserves to 2P reserves ). Twenty other fields, including the Barmer Hill formation, are estimated to hold about 2.0bnboe, of which the gross 2P recoverable resource is estimated to be 165mmboe (compared to earlier estimates of 140mmboe). The further exploration upside potential in Rajasthan is currently estimated at around 3.1bnboe. A detailed basin re-evaluation, through re-analysis of well data, re-processing of seismic data and updated understanding of petroleum systems, has shown significant growth in the exploration portfolio, with gross risked prospective recoverable resources of 530mmboe (compared to earlier estimates of 250mmboe). The expected ultimate recovery (EUR) for Rajasthan Block currently stands at 1.7bnboe from the earlier estimate of 1.4bnboe.
Rajasthan resource potential

Gross Initial In Place Volumes Gross Reserves, Resources and Potential
250 140
Risked Prospective Resource
~2.5 Billion boe in 35+ prospects
Gas GIIP
308
BH + Others
20 additional discovered fields including Barmer Hill
Oil STOIIP
Contingent In Place
707
R & S 12
MBA EOR
1 The independent estimates of Reserves And Contingent Resourcesrecently carried out by D&M are in line with the CIL estimates 2 Top 35 prospects audited by D&M risked resource 178 mmbbls
78 293
A 66
R & S STOIIP
B 151
468
MBA Fields, Raageshwari and Saraswati FDP approved
MBA STOIIP M 477
1 293
M B A R&S
Contingent Resource
2P+2C
MBA EOR
Barmer Hill +Other Fields
Risked Prospects, Leads & Concepts
The stock tank oil initially in-place (STOIIP) of 2.1bnbbl of MBA fields has an implied recovery factor of around 30% from primary oil recovery techniques. After implementing EOR techniques, the same would increase to 48%. The Barmer Hill formation, along with 19 discoveries, with an STOIIP of 2.0bnbbl has an expected ultimate recovery (EUR) of 8%. Fields in other parts of the world with characteristics similar to Barmer Hill are being developed and have demonstrated recovery factors in the range of 7-20%. However, we prefer to maintain a conservative stance and assume a recovery factor of 8% in our valuation as per CIL. Prospective resources (35-plus prospects) in Rajasthan Block have a EUR of 17%. Recently, Government of India (GoI) has decided to permit exploration in the development area of Rajasthan block.
12

Pursuant to policy clarity on exploration, Management Committee (MC) has requested the JV to submit an exploration work programme for the Rajasthan block. The company has drilled its first exploratory well in Feb13 (first such well after a hiatus of almost 4 years) in the Rajasthan block. Rajasthan exploration and appraisal well drilling is planned over a three year period. Approximately 30 exploration and appraisal wells are to be drilled per year (divided into 20 exploration, 10 appraisal approximately). The company plans to drill over 100 prospects in total over the next three year period. Capex of approximpately USD 1.0bn is planned for these activities and depending on the technical and commercial viability of discoveries, the exploration capex will be cost recoverable. Given the proven prospectivity of the block and track record of the company, we expect further addition to its reserve potential.
Cairn reserve upgrades over the years

8.0 6.0 4.0 40% 2.0 0.0 Pre-IPO GHIIP
Source: Company; VioletArch Securities
100% 80% 60%
20% 0% Post-IPO EUR FY08 FY10 FY12 Growth in EUR Growth in GHIIP
14
CAIRN INDIA ANNUAL REPORT 2010-11
in mmboe
250 Further investment and Government of India approval
140
Risked Prospective Resource Barmer Hill + Others Aishwariya 10,000 bopd

308 EOR
308
707
in mmbbls
12
Raageshwari and Saraswati
Bhagyam 40,000 bopd
66 Aishwariya
151 Bhagyam
Mangala 125,000 bopd
477 Mangala Barmer Hill + other f elds
240,000 bopd
Risked Prospects, Leads and Cocepts
Target Potential Production
FDP Approved Production 175,000 bopd
2P+2C
2P+2C+EOR
1 The independent estimates of Reserves and Contingent Resources carried out by D&M are in line with the CIL estimates
Rajasthan resource base and vision for growth
2 Top 35 prospects audited by D&M risked resource 178 mmbbls
13
VIOLET ARCH Research Rajasthan resource base potential

mmboe MBA + EOR Barmer Hill + 19 discoveries Prospective Total
Stock Tank Oil Initially in Place 2168 2010 3100 7278
Recoverable (EUR) 1044 165 530 1739
Recovery Factor 48% 8% 17% 24%
Rajasthan Block production to increase by 22% by end of FY15

In August 2009, CIL began production at Mangala Field. Initially, it was expected to produce at the plateau rate of 125,000bopd. However, later it was observed that the excellent reservoir performance could support a higher plateau rate of 150,000bopd. Subsequently, the company ramped up production at Mangala Field from 125,000bopd to 150,000bopd in April within a day of securing governments approval, since all development wells were ready. Incidentally, Bhagyam has approval to produce at 40,000bopd, but its current production is stuck between 20,000bopd to 25,000bopd as shallow nature of the field combined with higher viscosity of oil resulted in lower well productivity than anticipated. As per management, approximately 70 additional wells (according to Bhagyam FDP, to reach 40,000bopd 81 development wells were required out of which 64 has been drilled) would be required to be drilled in the Bhagyam field to achieve the production rate of 40,000bopd. The company has already received approval for 15 such wells from the management committee and expects production to reach 40,000bopd in H2FY14. Bhagyam is also expected to produce at higher levels, but a revised FDP is yet to be submitted. However, taking a conservative stance we assume Bhagyam to achieve a peak rate of 40,000bopd instead of 50,000bopd (see the graph below). In Aishwarya field, oil-in-place is substantially higher than originally estimated. According to our calculations, the field can produce oil at the rate of 20,000bopd. However, at present, CIL has approval only for production of 10,000bopd and it has to submit revised FDP for raising the production. We expect company to be more aggressive on this front and submit FDPs in 2HFY14. The company management has guided exit rate of 200,000bopd to 215,000bopd by end of FY14, of which a major portion of production is expected from MBA fields. In our model, we have assumed exit rates for MBA fields of 195,000bopd and 210,000bopd for FY14 and FY15, respectively.
MBA production (bopd)

200000 150000 100000 50000 0 FY14E
Q4FY12
Q1FY10
Q2FY10
Q3FY10
Q4FY10
Q1FY11
Q2FY11
Q3FY11
Q4FY11
Q1FY12
Q2FY12
Q3FY12
Q1FY13
Q2FY13
Q3FY13
Mangala
Bhagyam
Aishwarya
Rageshwari & Saraswati
Q4FY13
FY15E 14

Additionally, CIL estimates about 165mmboe of recoverable resources from Barmer Hill and 19 other fields, besides another 530mmboe, compared to 250mmboe earlier, from the exploration upside. CIL expects incremental production from these resources, which will help the company to achieve its long-term target of peak production of 300,000bopd from Rajasthan Block.
MBA field production rates

CIL has the requisite approval for production in Mangala, Bhagyam and Aishwarya for 150,000bopd, 40,000bopd and 10,000bopd, respectively. It has secure approvals for further scale-up of production from Bhagyam and Aishwarya.
Current production rate (bopd) Mangala Bhagyam Aishwarya 150000 25000 N.A.* Approved production rate (bopd) 150000 40000 10000 Peak production rate (bopd) 150000 Not yet disclosed 20000 Comments All approvals in place Revised FDP for higher rate yet to be submitted Revised FDP for 20,000bopd yet to be submitted
Source: Violet Arch Research; *CIL has commenced production in Aishwarya field on 25 th Mar13. However, the data is not available
Peak rate calculation

Although the management has not given any guidance on the peak potential of Bhagyam Field, we expect the same to be about 50,000bopd as per calculations shown below.
2P Reserves (mmboe) Mangala Bhagyam Aishwarya Rageshwari & Saraswati Total 477 151 66 12 706 200000 3.53 Peak production rate as of now as per company (bopd) 150000 40000 10000 2P/Peak rate 3.18 3.78 6.60 Peak production rate as per our 2P/Peak rate estimate (bopd) 150000 3.18 50000 20000 3500 223500 3.02 3.30 3.43 3.02
Source: Violet Arch Research; This is our own assumption and is not based on any scientific theory. Peak rates could vary depending on reservoir characteristics.
MBA production schedule over FY14-15

Rajasthan Block has the requisite approval for achieving a production rate of 190,000bopd. However, due to delay in ramp-up of Bhagyam and commencement of production from Aishwarya, it is unable to clock a production rate currently beyond 175,000bopd. Also the pipeline capacity (175,000bopd) constraint has to be taken care before ramp-up at Bhagyam happens. The management has indicated that the pipeline can support 10% additional flow-rate with debottlenecking. Further, the company plans to use DRA (Drag Reducing Agents) to reduce the viscosity of oil so that flow rate could be increased further to support the upper-end of management guidance of 215,000bopd. We estimate an exit rate from MBA of 195,000bopd 210,000bopd in FY14 and FY15, respectively.
Q1FY14E Mangala Bhagyam Aishwarya Mangala EOR Total
Q2FY14E 150,000 20,000 10,000 180,000
Q3FY14E 145,000 30,000 10,000 185,000
Q4FY14E 145,000 40,000 10,000 195,000
Q1FY15E 145,000 40,000 15,000 10,000 210,000
Q2FY15E 145,000 40,000 20,000 10,000 215,000
Q3FY15E 140,000 40,000 20,000 10,000 210,000
Q4FY15E 140,000 40,000 20,000 10,000 210,000
150,000 20,000 5,000 175,000
15
Key Risks and Concerns

Delay in approvals from ONGC and DGH
The CIL management expects to hit exit rate of 215,000bopd in FY14 post-commencement of production in Aishwarya and ramp-up in Bhagyam. Revised FDPs for Bhagyam and Aishwarya are yet to be submitted, which would help the company reach beyond 215,000bopd production target in the near term. In our model, we have assumed production from Aishwarya to touch 10,000bopd in Q2FY14 and 20,000bopd in Q2FY15 and production from Bhagyam to touch 40,000bopd in Q4FY14. Any further delay could result in delayed cash-flows for the company. Further, CIL has expects to monetize the other smaller discoveries in Rajasthan block to meet its guidance rate of 215,000bopd in FY14. Any delay in seeking the regulator and JV partners approval will push back the companys cash-flows, thereby eroding investor confidence.
Falling crude prices

Being a direct play on crude oil prices, CIL is exposed to crude price volatility. In our valuation, we have assumed a long-term brent crude price of $90/bbl. Any correction in crude prices beyond that level will affect the companys profitability and share price.
CIL valuation sensitivity analysis

Long-term crude price assumption (USD/bbl) 80 45 Long-term USD-INR rate assumption 47 49 51 53 318 326 334 338 346 90 345 355 364 373 382 100 377 387 398 408 418 110 409 420 432 443 454 120 441 453 466 478 491
FY14 EPS sensitivity analysis

FY14 crude price assumption (USD/bbl) 100 49 FY14 USDINR rate assumption 51 53 55 57
105 45.3 47.2 49.1 51.0 52.9
110 48.0 50.1 52.1 54.1 56.2
115 50.8 52.9 55.1 57.2 59.4
120 53.5 55.8 58.1 60.3 62.6
42.5 44.3 46.1 47.9 49.7
Increase in statutory levies by government

In the Budget FY13, the government increased the cess from Rs 2500 per tonne to Rs 4500 per tonne, which impacted CILs profitability by USD6/bbl. The move impacted FY13 EPS by around Rs4.2 and valuation by about 8%. To be on conservative side we have assumed cess to increase by Rs 2000/tonne after every five years which resulted in CIL valuation of Rs 364/share as compared to Rs 380/share if these is no increase in cess further.
16
Failure to convert exploration assets into unrisked potential reserves

Currently, CIL is considered a single-asset player (Rajasthan Block), and any failure to convert its current exploration portfolio into unrisked potential resource base could lead to erosion of investor confidence in the company. Also Cairn has embarked upon a 3-year exploration programme in Rajasthan block to tap the ~3.1bnboe of prospective reserves from exploration upside. Any failure to convert these exploration upsides into production would be a negative trigger for the stock as the exploration costs for these are cost recoverable only upon commercial and technical success of the discovery.
Mis-use of strong cash-flow of CIL by Vedanta

Over the years Cairn India has done well in exploration and production space through a tremendous performance in Rajasthan, Cambay and Ravva. But the change in ownership has created doubts in the investors minds considering the inexperience of Vedanta in oil and gas sector as well as chance of mis-use of strong cash-flow of CIL to repay debt of its other group companies in a way that it may not be beneficial to minority shareholder. However, Vedanta has sought to allay these fears by stating to fulfill Cairn Indias commitments towards exploration and production activities in India, Sri Lanka.
17
Valuation
On the back of a further ramp-up of Bhagyam and Aishwarya, CILs production is expected to reach 195,000bopd by end-FY14 from the current rate of 175,000bopd. Rajasthan Blocks near term potential is estimated at 215,000bopd, which is expected to come largely from MBA fields. The long-term potential, as per the management guidance, is 300,000bopd, which is expected from monetization of Barmer Hill and 19 discoveries as well as exploration upsides. We value MBA fields on a NAV basis and other reserves on an EV/boe basis in order to arrive at a target price of Rs 374 per share, which reflects an EV/boe of $9.5/bbl.
Assumptions for MBA

MBA production MBA - EOR Brent crude price Discount to Brent crude Exchange rate Capex Direct field opex Pipeline opex Royalty Cess WACC
Production to be 187,000 bopd in FY14; 207,250 bopd in FY15 and ~210,000 bopd through FY16-FY20 To start in mid-FY15 in Mangala, in FY16 in Bhagyam and in FY17 in Aishwarya USD 110/bbl in FY14 and USD 100/bbl in FY15 and USD 90/bbl for long-term 12% Rs 53/USD in FY14; Rs 51/USD in FY15 and Rs 49/USD for long-term USD 2.0 bn over FY14 and FY15 USD 3.5/bbl USD 1.5/bbl 15.0% of Revenues Rs 4500/tonne for through FY13-17 and hiked by Rs 2000/tonne thereafter every five years 10%
CIL's cash-flows from MBA (Rs bn)

FY14E Revenues Production costs Cess + Royalty Capex Pre-tax cash-flows Tax Post-tax cash-flow NAV No of o/s shares (mn) NAV per share (Rs/share)
FY15E 194.9 13.9 69.0 12.4 99.6 18.0 81.6
FY16E 159.3 15.3 65.4 3.9 74.8 11.2 63.6
FY17E 147.6 16.8 65.4 3.9 61.5 8.5 53.0
FY18E 155.7 18.4 80.1 3.9 53.4 6.9 46.5
FY19E 156.2 19.3 80.1 3.9 52.9 6.8 46.1
FY20E 156.6 20.3 80.0 3.9 52.4 10.8 41.6
200.2 12.7 66.9 15.7 104.9 20.0 84.8 393.4 1908 206
CIL valuation
Block MBA + EOR Barmer Hill Exploration Upside Potential Ravva Cambay Total Debt Cash & Cash Eq Cairn India
Net 2P/ Recoverable Reserves (mmbbl) 620 116 371 14 4 1,125 -
Rs/share 206 15 49 3 1 275 0 99 374
(USD/boe) 12.9 5.2 5.2 9.1 9.1 9.5 -
18

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COMPANY REPORT

Equity Research l Oil & gas

VIOLET ARCH Research

Cairn India Ltd.

Absolute Rating Target Price Upside

Stock performance (%)

Rajasthan Block production to rise by 22% by end of FY15

Shareholding pattern (%)

Public & others, 16

Rs/share 206 15 49 3 1 275 99 374 FY14E

(USD/boe) 12.9 5.2 5.2 9.1 9.1 9.5 FY15E

Relative stock movement

Cairn India Ltd

Cairn India Ltd - Company Report

VIOLET ARCH Research

Cairn India Ltd - Company Report

VIOLET ARCH Research

EOR in Mangala to be implemented in FY15. Field-life of MBA fields till FY41.

Cairn India Ltd - Company Report

VIOLET ARCH Research

CILs production from various blocks

3.80 3.34 -38% 1.97 -21% 9.11 16%

25.80 580% 3.03 -9% 1.63 -17% 30.47 234%

32.82 27% 2.99 -2% 1.20 -26% 37.02 21%

43.25 32% 2.68 -10% 0.96 -20% 46.89 27%

47.78 10% 2.41 -10% 0.77 -20% 50.96 9%

52.93 11% 2.17 -10% 0.61 -20% 55.72 9%

Source: Violet Arch Research;*Cairns stake in production

14% 12% 10% 8% 6% 4% 2% 0%

Heavy Light differential ($/bbl)

Cairns discount to brent (RHS)

VIOLET ARCH Research

Per boe analysis of Rajasthan Block

Cairn India Ltd - Company Report

VIOLET ARCH Research

EBITDA impact 6.2% 6.0% 5.0%

EPS impact 6.3% 5.2% 4.3%

100 98.2 103.2 108.2 113.3 118.3

105 104.6 109.9 115.1 120.4 125.7

110 111.0 116.5 122.1 127.6 133.1

115 117.4 123.2 129.0 134.8 140.6

120 123.7 129.8 135.9 141.9 148.0

Cairn India Ltd - Company Report

VIOLET ARCH Research

Source: Violet Arch Research

Cairn India Ltd - Company Report

VIOLET ARCH Research

Geo-politics and crude

North Korea - South Korea US

Source: Violet Arch Research; Various news-paper articles

Cairn India Ltd - Company Report

VIOLET ARCH Research

Policy-Regulatory Risks / Uncertainties for Cairn

Last increased in Feb12

Since Aug09 Signed in May94

Tax Holiday Contract period

Government may take decision this year or next.

Gas price hike

Government may take decision this year before NELP X auction.

Profit sharing model to revenue sharing model

Allowed since Feb13

Allowing exploration in producing blocks

Defense ministry declaring certain exploration areas as No-Go areas.