Best Energy Stocks to Buy in India 2024

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In this article, we will cover

• Understanding the Energy Sector
• List of Best Energy Stocks in India
• Overview of the Oil and Gas sector in India
• Overview of the Power sector in India
• Different parts of the Power sector
• Portfolio Companies of Energy Stocks
• Model Portfolio of Best Energy Stocks

So First Let’s Understand the Energy Sector

What is the Oil and Gas sector?

List of Best Energy Stocks in India 2022

The sector is divided into 3 segments:

• Upstream segment – engaged in exploration and production (E&P) of crude oil. Companies in this segment are usually characterized with high investment capital, extended duration as it takes time to locate, drill and be technologically intensive. Examples include ONGC which is engaged in oil exploration and extraction.
• Midstream segment – engaged in storage and transportation. Companies in this segment are characterized by shipping, trucking, pipelines, and storing of the raw materials. The midstream segment is also marked by high regulation, particularly on pipeline transmission, and low capital risk. IOCL and GAIL are engaged in the storage and distribution of crude oil.
• Downstream segment – engaged in refining, processing and marketing of oil. IOCL and Reliance.

Overview of the Oil and Gas sector in India

The Oil and Gas industry offers multiple opportunities including:

• Upstream Segment: 78% of the sedimentary area is yet to be explored; Secondary and Tertiary oil techniques.
• Midstream Segment: Expansion of gas pipelines and LNG imports have increased, thereby giving an opportunity to boost production capacity in segments such as terminal operation, engineering, procurement and construction services.
• Downstream Segment: India has 21 refineries and expansion is planned with FDI in export-oriented infrastructure, including product pipelines and export terminals; the development of CGD (city gas distribution) in many cities (including Tier 2 and 3 cities); and the expansion of the petroleum product distribution network.

When looking at investing in companies from the sector, one needs to assess the following factors:

• Investors need to look at the volatility and oil price trend since these are driven by multiple factors globally. Investors need to look at both WTI and Brent crude, the two primary crude prices used globally. India uses Brent crude prices to price oil and accordingly should be given more importance. Oil companies usually have hedges in place which should be assessed based on gains/losses from these contracts.
• Investors need to identify which segment of the industry does the company serve among the upstream, midstream and downstream segment. This is crucial as companies in the upstream segment derive profits from higher global crude oil prices, in the case of India, higher Brent prices. For the other segments, profits are made from the difference between crude oil prices and prices of finished products such as petrol, diesel, ATF, etc. Due to this difference being low, the operating margins range between 5-15% but these companies are known to generate healthy cash flows. Downstream oil companies also tend to be less volatile due to costs and revenues both adjusting to changing oil prices, unlike oil exploration companies which are directly affected by oil price volatility.
• Assess the reserves held by the company in proportion to how much has been extracted which can give investors an idea about the need for further capex towards drilling wells and processing of oil. Assess the refining throughput and the proven reserves held by the company. For midstream oil companies, assess their gas pipeline network. For downstream oil companies, assess the company’s refining throughput and refinery production.
• On the financial front, assess the amount of debt the company holds, specially the E&P companies as the debt obligations are mostly fixed while earnings can be affected by crude oil price volatility therefore the company should at least have enough earnings to cover costs and debt obligations. Assess the interest coverage ratio and the debt/equity ratio.
• Assess the operating cash flows generated by the companies along with the dividend payouts made by these companies. Since most companies in this sector trade at decent valuations, assess the price ratios as well as the EV/EBITDA ratios.

Overview of the Power Sector in India

• Thermal: This segment contributes to 60.36% (vs 61.5% in FY21) of total power capacity and is drawn from Coal, Gas & Lignite and Diesel based power plants. Coal is the largest among these with installed capacity of 202.20 GW in 2021; Gas & Lignite plants have installed capacity of 31.54 GW as of 2021; Diesel is the smallest among the 3 with installed capacity of  0.51 GW as of 2020. The total capacity stands at 234.72 GW.
• Renewables: This segment contributes to 25.94% of total installed power capacity. Of the renewables, Soalr is the largest power generator at 41.08 GW followed by wind power at 39.44 GW as of 2021.
• Hydro: This segment contributes to 11.96% of total power capacity with power generating capacity of 46.41 GW as of 2021.
• Nuclear: This is the smallest energy segment, contributing to 1.75 % of all installed capacity in India at 6.78 GW as of 2021.

Different Parts of the Power sector

Opportunities in the power sector:

• Demand for electricity is expected to increase – per capita consumption of electricity is estimated to be at 1894.70 TWh by FY22.
• Per capita electricity consumption in the country grew at a CAGR of 2.96% from FY16 to FY20, reaching 1,208 KWh in FY20. This growth was mainly attributed to electrification of villages and households across the country.
• Demand is currently higher than supply by about 7.5%, giving room for scaling up production capacities.
• The government is taking up multiple reforms which are aimed to improve the entire power sector over the long term.
• The government is not only taking initiatives to increase overall renewable capacity but also its share in the overall power capacity in India.
•  In order to decarbonize the energy consumption, India needs a 30- fold increase in renewable energy, 30-fold increase in nuclear energy and doubling of thermal energy, which would make 70% of energy consumed carbon free.

When looking at Power companies, an investor should keep the following factors in mind:

• Investors need to assess the debt levels of the companies, especially for discoms. This is because discoms have to first pay to buy power, either by entering a PPA (power purchase agreement) or buying it from the power exchange, and then get paid for power used by consumers. The period between paying and receiving money has to be supported using debt, therefore, discoms usually run high levels of debt.
• Assess the capacity of production and the PLF (power load factor) at which these companies generate electricity. PLF is the ratio of power generated/max capacity, a higher PLF ratio can be indicative of future capex the company may take up, since setting up capacities is highly capital intensive. This could be indicative of the way cash flows are utilized.
• Investors should assess the operating cash flows generated by a company which provide a more consistent idea vs the net profit as these companies are subject to large non-cash items such as depreciation which can affect profits.
• Assess the realisation per unit figure for the power companies to identify per unit efficiency in generating revenues. Higher the number, better it is for the revenues of the company.

Portfolio Companies of Energy Stocks

Reliance Industries

ONGC

Petronet LNG

NTPC

Torrent Power

Model Portfolio of Best Stocks

A Detailed Table with Various Parameters of Energy Stocks

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