RIL's Value Creation Cycle

Reliance Industries(RIL) rained Diwali gifts with bonus shares in late 2009, after a hiatus of almost 12 years. Mukesh Ambani, the chairman of RIL said in a statement that its customary to reward its investors at the end of a value creation cycle. RIL has now entered the next value creation cycle and is seeking growth opportunities within India and globally.

Right from then, the company has been on an acquisitive mode. After its failed attempts to buy out Lyondell Basel and Value Creation, RIL had finally zeroed in on Atlas Energy. Though broadly within the energy space, all the above companies had different businesses. Lyondell was a bankrupt global Petrochemicals company, Value creation - focusing on Canadian Oil sands and Atlas Energy – A US shale natural gas producer. Looks like RIL had scanned a wide array of investment options.

In its recent deal, RIL has acquired 40% stake in Atlas Energy’s Marcellus shale assets for $1.7 billion. The cost of acquisition will involve an outright payment of $340 million and $1.36 billion spread over 5 ½ years. RIL expects the total investment in the assets to be around $5 billion. The deal gives 120,000 net acres in Atlas’s Marcellus Shale acreage, the biggest and one of the promising shale gas fields in the US. The shale is characterized by low cost extraction and its proximity to the North east gas markets.

What is Shale Gas : Shale gas is natural gas extracted from sedimentary rocks, having very low permeability. Shale gas is considered to be unconventional resource due to its extraction techniques. Conventional resources, involve drilling of vertical wells into reservoirs, the minerals seep into the well enabling easier extraction, just like a water well. Shale gas extraction is much more complex as there is no seepage because of the rocks very low permeability. New techniques like horizontal drilling, hydraulic fracturing has made the extraction process easier and cost effective.

US Gas Demand / Supply & Pricing: Conventional natural gas production in the US has been on the decline curve and it was widely expected that Liquefied natural gas (LNG) from middle east will fill the supply shortfall. To benefit from demand – supply mismatch, many companies in US started investing heavily in unconventional resources. The frenetic pace led to technological advancements, which has brought down the cost of extracting shale gas, earlier considered uneconomical. But all is not gung-ho, as more and more companies jumped on the bandwagon, supply over ran demand and now US seems to have more gas than ever.

Same is the case on the pricing front, back in July ‘08 when oil was at $140 /bbl , natural gas was trading at $14/mcf. (Ratio 1:10). Thanks to the recession & the shale boom, the excess supply has brought down the current price to $4 /mcf, while crude is trading at $80 / bbl (Ratio 1:20), almost half its usual spread to crude. While in the near term, excess supply is bound to prevail, companies in the business are hopeful to see a $6 / mcf in the medium term(next 2 to 3 years).

Where is the Value to RIL?: The near term outlook of the US natural gas space is nothing but bleak, so not much expected from an earnings perspective. From an acquisition stand point, RIL’s timing could probably be good if not near perfect, as the company has bought the assets at the lower end of gas prices. It also gives a start for its global foot print and a share of the US natural gas business. “Reliance” for sure will have a better brand recall. But there sure are other take aways - the technology and the technical know-how. But where could these be used ?. INDIA. Our country is believed to holds huge shale deposits across the Gangetic plain, Assam, Gujarat, Rajasthan, and many coastal areas. Unfortunately our exploration policy (NELP) does not covers unconventional resources(shale gas) as of date.

India's gas requirement for FY 10 stands close to 150 mmscmd of which RIL is already producing about 65 mmscmd and will reach a peak plateau of 80. The shortage would be met by LNG, burning India's trade surplus and with it the forex reserves.

Well, things might change in the future. A new format of India's exploration licensing policy called OALP(Open Acreage Licensing Policy) is being worked and unconventional resources could well be exploited under the new regime. RIL's technical knowledge could well be the piecing point in its next real value creation. While, many companies with similar expertise could cash in, RIL for sure has a clear advantage operating in India. You guys know what i am talking about.

If “All Iz Well” a day would come when, India could potentially meet its energy needs domestically and may well turn into a net exporter of gas.

--Vishnu