While admitting that the regulatory framework in oil and gas sector in India is far from robust, Nomura feels that the worst is already priced in and it’s outlook on the sector is more positive than others

Regulatory and policy headwinds continue to be a key overhang for the Indian oil and gas sector, however, the market has discounted the stock prices to unrealistically pessimistic levels and there may be significant value now, says Nomura Equity Research.

“Despite the slowdown in investment elsewhere in the energy chain, there have been several new announcements for LNG terminals. We think the continued progress on several pipelines is also a positive. Perhaps most importantly, we believe the government is eager to implement the recommendations of the Ashok Chawla Committee, which should go a long way to restoring order in the sector, in our view,” Nomura said in a research note.

According to the Japanese financial services group, the Indian gas sector has always been tempered by the fact that the regulatory framework is far from robust. "Still, we were surprised by the sudden deterioration in the regulatory environment this year. On issues where decisions or actions are necessary like for example ending the KG-D6 impasse, gas pricing and CGD (city gas distribution) licensing, there is near paralysis, while issues that we believe are minor and should have been resolved amicably like marketing margins, authorization and tariff setting, have turned into full-blown controversies.”

“This has forced us to revisit our assumptions and bring down our earnings forecasts and target prices by 25%-35% in some cases. However, we think the market has discounted the stock prices to unrealistically pessimistic levels and we see significant value now,” the report said.

Over the past two years, and especially over past few months, concerns on regulatory and policy aspects in the Indian oil and gas sector have only been aggravated. Rather than resolve issues through dialogue, arbitration and litigation seem to have become the order of day. The confrontation is not only from private companies with the government or regulators, but also from government-owned companies with government or regulators. In fact, at times even different ministries or units of government have taken differing views, and look to be confronting each other.

Similarly, over the past few years, with several corruption scandals surfacing and several investigations ongoing, government decision-making has suffered and has been widely highlighted in the media. In a bid to avoid controversies, both government bureaucrats and regulators have tried to “play safe”, by not taking decisions.

“Recently there is an increased feeling, in our view, among various stake holders that the government will have its way and the sanctity of written contracts may be compromised. There have been a few controversial decisions recently, which, in our view, have affected invested investor confidence,” Nomura said.

Due to ongoing policy and regulatory confusion, the damage is significant and a lot of it may be permanent, feels the Japanese research house. “Overall gas production in the country has declined sharply. More importantly, with gas reserves being scaled down, several blocks being relinquished and few international players deciding to exit Indian E&P, the longer-term outlook is also diminished,” it added.

Nomura, however, said all is not gloom in this sector, recently there are some positive developments like the increased reliance and acceptance of LNG, several new project announcements for LNG terminals and continued progress on various pipelines. “We think the recommendations of the Ashok Chawla Committee are path-breaking. And importantly, the government seems eager to implement these recommendations,” it said.

The Japanese research firm said corrections in oil and gas stocks in India have been far deeper and some of them are in deep value and available at undemanding valuations, on its estimates. Here are Nomura’s recommendations...

• We upgrade Reliance Industries (RIL) to Buy (from Neutral) with a target price (TP) of Rs860. We believe the worst-case scenario in E&P is priced, and the era of underperformance is behind it. We expect earnings growth to resume, aided by the weak Indian rupee and petchem expansion.

• We downgrade GAIL to Neutral (from Buy) with a TP of Rs375. We see near-term pain as gas volumes decline in FY13F/14F and realized tariff declines in FY15F.

• Indraprastha Gas (IGL) (Buy, TP Rs400) and Petronet LNG (PLNG) (Buy, TP Rs200) remain our top picks.

• IGL escaped well from the harsh tariff order, in our view. Even as uncertainty persists, the Petroleum and Natural Gas Regulatory Board (PNGRB) is virtually ‘tamed’ for now, and it is unlikely to get so aggressive again, in our view. The underlying story is intact, and IGL keeps surprising the market with its ability to hike prices. With a 35% YTD decline, the stock trades at 9x FY14F P/E, and is already discounting the worst-case scenario, in our view.

• For PLNG, given sharp growth over the past two years, earnings will likely be muted in FY13F and FY14F. But we highlight that as domestic volume declines, PLNG remains best placed to import more LNG. After a 16% YTD decline relative to Sensex, valuations are undemanding, in our view, at 11x FY14F P/E.

• Maintain Buy on Gujarat State Petronet (GUJS) (TP Rs85) for long-term growth, but concerns will remain in the near term on volume declines and tariff reviews.

• Maintain Neutral on Gujarat Gas Co (GGAS) (TP Rs300), as ownership change process gets stretched.