2011

Submitted By: Muhammad Ali Yasir Zain ul Abiddin Syed Kazim Hussain Syed Umair Ali

OIL & GAS DEVELOPMENT COMPANY LIMITED

A Financial Insight

Analysis of Financial Statements Spring Semester

Oil & Gas Development Company Limited

Table of Contents
Introduction ............................................................................................................................................ 4 Industry Profile........................................................................................................................................ 5 Crude Oil Production Scenario ............................................................................................................ 5 Gas Production Scenario ..................................................................................................................... 7 Demand Analysis ................................................................................................................................. 8 Exploration Potential .......................................................................................................................... 8 Company Profile...................................................................................................................................... 9 Vision................................................................................................................................................. 10 Mission .............................................................................................................................................. 10 Business Strategy .............................................................................................................................. 10 Financial Goals .................................................................................................................................. 11 Oil & Gas Reserves ............................................................................................................................ 11 Production......................................................................................................................................... 11 Exploration and Development .......................................................................................................... 13 Financial Performance .......................................................................................................................... 14 Dividends Paid................................................................................................................................... 15 Risk Management ................................................................................................................................. 15 Business Risks and Challenges .......................................................................................................... 16 Crude Oil Price .............................................................................................................................. 16 Exchange Rate Risk ....................................................................................................................... 16 Exploration and Drilling Risks........................................................................................................ 16 Reserves Depletion and Under Performance of Oil & Gas Fields ................................................. 17 Legislation ..................................................................................................................................... 17 Environmental Risks ...................................................................................................................... 18 Law and Order............................................................................................................................... 18 Hedging against Risks ........................................................................................................................ 18 Oil Price Risk .................................................................................................................................. 18 Exchange Rate Risk ....................................................................................................................... 19 Circular Trade Debt ........................................................................................................................... 20 Analysis of Financial Statements Page 2

Oil & Gas Development Company Limited Impact on OGDCL .......................................................................................................................... 21 Government to Issue Exchangeable Bonds .................................................................................. 21 Financial Ratio Analysis ......................................................................................................................... 22 Financial Ratios ................................................................................................................................. 22 DuPont Analysis ................................................................................................................................ 22 Growth Rate ...................................................................................................................................... 23 Trend Analysis ................................................................................................................................... 23 Liquidity......................................................................................................................................... 23 Profitability.................................................................................................................................... 23 Asset Management ....................................................................................................................... 24 Debt Management ........................................................................................................................ 25 Market Value................................................................................................................................. 26 Cross Sectional Analysis .................................................................................................................... 26 Future Outlook ...................................................................................................................................... 28

Analysis of Financial Statements

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Oil & Gas Development Company Limited

Introduction
Oil & Gas Development Corporation (OGDC) is the national oil and gas company of Pakistan and the flagship of the countrys E&P sector. The Company is the local market leader in terms of reserves, production and acreage, and is listed on all three stock exchanges in Pakistan and also on the London Stock Exchange since December 2006. The Company was initially created as a Public Sector Corporation under an Ordinance in 1961 and was subsequently, in pursuance of the Petroleum Policy 1994, converted from a statutory Corporation into a Public Limited Company effective 23 October 1997. Government of Pakistan (GoP) divested 4.98% of its shareholding in the Company in October 2003 through an Initial Public Offering (IPO). GoP further divested 9.5% of its shareholding through Secondary Offering in the form of Global Depository Shares (1 GDS = 10 ordinary shares of the Company) to international institutional investors in December 2006 and 0.5% to the general public in February 2007. GoP now owns 85.02% of the shares of the Company. On 14 August 2009, the Government of Pakistan (GoP) launched Benazir Employees Stock Option Scheme (BESOS) whereby the GoP transferred 438,815,774 shares to OGDCL Employees Empowerment Trust without any payment by the eligible employees subject to transfer back of these shares to the GoP as provided in the Trust Deed. Accordingly, the GoPs shareholding in the Company is reduced to 74.82% from 85.02% with effect from 14 August 2009. During the year under review, the Company has witnessed improved financial results despite decline in crude oil, gas and LPG production, issue of inter-corporate debt, and law & order situation in some of the Companys operational areas. Companys sales revenue and profit after taxation increased by 9.0% and 6.5% to Rs 142.572 billion and Rs 59.177 billion respectively resulting in Earnings per Share (EPS) of Rs 13.76 compared to Rs 12.91 during the preceding year. Companys exploratory efforts resulted in six new oil and gas / condensate discoveries leading to addition of 14.07 million barrels of oil and 161.10 billion cubic feet of gas to the Companys reserves base. Subsequently, in July 2010, another gas discovery has also been made by the Company at Sheikhan1 (Kohat E.L.). In addition, three new wells namely Nashpa-1, Pakhro-1 and Baloch-1 were brought into production. The Company during the year was able to acquire 2,493 L. Kms of 2-D and 290 Sq. Analysis of Financial Statements Page 4

Oil & Gas Development Company Limited Kms of 3-D seismic survey in various concessions operated by OGDCL and spudded twenty six new wells including fifteen exploratory / appraisal and eleven (11) development wells. Work over jobs on another eleven wells has also been carried out during the year. OGDCLs production on working interest basis averaged 38,075 barrels of oil per day (bopd), 976 MMcfd of gas, 202 Million Tons/day of LPG and 70 Million Tons/day of sulphur. However, crude oil net production as on 30 June 2010 reached 41,385 bopd after commencement of production from Nashpa-1 in May 2010. OGDCL's strategic direction has recently been revisited by its top management and Company's Vision & Mission statements have been redefined in the light of Company's present standing and future outlook. Going forward, Company is following strategy of sustainable growth with the primary objective to enhance its reserves and production profile and ultimately maximize value for shareholders and ensure energy security of the country.

Industry Profile
Pakistan is still in the initial stage of exploration with one of the lowest drilling density of 2.09 wells/1,000 sq km and a higher success ratio of 30%. As of Dec09, E&P activities in the country have resulted in original recoverable reserves of 947 mn barrels of oil and 54 tcf of gas. Out of which, 303 mn barrels of oil and 28 tcf of gas are balance recoverable reserves.

Crude Oil Production Scenario

Oil production after recording a rise of 3% YoY and 4% YoY in FY07 and FY08, respectively; has witnessed a slide of 6.7% YoY and 6.9% YoY in FY09 and FY10, respectively. This is on account of natural depletion from major fields like Chanda, Kunar and Pindori, which contribute approximately 35% to 40% of the total oil production in Pakistan. Average oil production for FY10 was recorded at 65,123 bopd.

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Oil & Gas Development Company Limited

On a company wise basis, OGDC produced 35,004 bopd in FY10, which is below its 4 year average of 39,971 bopd. This is primarily due to decline in production from Chanda, Sono, Dakhni, Kunar and Mela fields, which contribute almost 60% to OGDCs total oil production. However, Adhi and Thora (contribution 9%) recorded an improvement in oil production of 4% YoY and 16% YoY, respectively. During FY10, PPL produced 4,533 bopd compared to 4,130 bopd in the corresponding period last year, marking an improvement of 10% YoY. Increase in oil production from Adhi field by 4% and commencement of Manzalai field in Nov09 were the main contributor towards rise in PPLs production. POL remained the major beneficiary in terms of crude oil production growth in FY10. Its production showed a healthy growth of 8% to 4,103 bopd from 3,792 bopd exhibited in the same period last year. The reason for this growth was commencement of Manzalai field, which is currently yielding 4,000 bopd where POLs stake is 21%.

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Oil & Gas Development Company Limited It is expected that the average crude oil production to post a growth of 8%-9% YoY to 71,233 bopd in FY11 mainly on account of production enhancement from Mela, Sinjhoro, Maramzai and Mamikhel fields. The production enhancement from these fields would be 3,500, 3,000, 600 and 1,500 bopd, respectively.

Gas Production Scenario

Over the past five years (FY06-FY10) gas production has grown at an average rate of 1.45% per annum to 4,060 mmcfd. This modest increase is a result of sluggish growth witnessed in major producing fields such as Mari and Kandkhot, which contribute 16% to the total gas production of the country. However, during the same period some other fields such as Miano, Sawan and Sui (25% contribution to total gas production of the country) have recorded a decline. The average gas production stood at 4,060 mmcfd during FY10 compared to 4,000 mmcfd in FY09, showing a modest increase of 1.6% YoY. The contribution of gas production by PPL, OGDC and POL remained at 23%, 22% and 1%, respectively in FY10.

OGDC gas production in FY10 stood at 898 mmcfd compared to 932 mmcfd in FY09, recording a decline of 4% YoY. This decline mainly emanated from Qadirpur and Uch gas fields, which cumulatively contribute 62% towards the total gas production of OGDC. PPL gas production stood at 943 mmcfd in FY10 compared to 965 mmcfd recorded in FY09, registering a decline of 2% YoY. The attribute for this decline is a 6% YoY production drop from Sui gas field, which contributes around 60% (562mmcfd) of the companys gas production. Analysis of Financial Statements Page 7

Oil & Gas Development Company Limited FY10 was a year of turnaround for POL as its gas production exhibited an unprecedented rise of 60% YoY to 60mmcfd. The cause for this phenomenal rise was Manzalai field, which came online in Nov09. Currently, this is contributing two third of total gas production of the company. It is expected that the gas production to post a growth of 6% YoY 4,300 mmcfd in FY11. The production enhancement of 215 mmcfd would come from Maramzai, Mamikhel, Sinjhoro and Qadirpur fields. The production additions from these fields would be 20, 20, 25 and 150 mmcfd, respectively.

Demand Analysis
Pakistan energy demand has grown at a CAGR of 8.4% during FY2006-10, outpacing the GDP growth rate of 6.4% for the same period. Owing to the strong correlation between energy consumption and economic growth, coupled with huge supply demand deficit, we expect that the energy demand to grow at a CAGR of 6% during FY2011-2015. Currently, Pakistan satisfies 81% of its primary energy needs through oil and gas. Total demand of oil and gas in Pakistan stands at 51mn tonnes of oil equivalent (Toe) whereas, current production is 34mn toe and the rest is met through imports. E&P companies are well positioned to reap the benefits of growing energy demand and huge hydrocarbon potential. Strong balance sheets and favorable regulatory framework may help the local E&P companies to enhance their exploration/development activities.

Exploration Potential
Pakistan has onshore and offshore sedimentary area of 827.3 Km2. The recoverable oil and gas resource potential of Pakistan has been estimated by Pakistan Petroleum Information Service (PPIS) at 27 bn barrels of oil and 282 tcf of gas. Only 3% of the estimated oil and 19% of the natural gas potential resources have been discovered so far in Pakistan from 743 exploratory wells over the past 63 years. This suggests only minor portion of the hydrocarbon reserves have been discovered so far and a gigantic portion has yet to be discovered. Therefore, E&P sector would benefit if any hydrocarbons are discovered from these zones.

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Oil & Gas Development Company Limited To date, 743 exploratory wells and 990 development/appraisal wells have been drilled in Pakistan. A total of 68 and 150 oil and gas discoveries respectively, have been made till now. This translates into an overall exploratory success ratio of 1:3.4 wells. A 5 year average comparison shows that during FY06-10, 64 wells were drilled compared to 47 well during FY01-05. A total of 57 discoveries (mainly gas/ condensate) were made during FY05-FY10. This is indicative of a rise in drilling activity over the last 5 years on the back of higher FDI investment and rising gap between demand and supply. On account of oil deficit, investor friendly petroleum policies and high success ratio, it can be foreseen that exploration and development activities will pace up going forward.

Recoverable oil and gas resource potential of Pakistan has been estimated at 27bn bbls of oil and 282 trillion cubic feet (tcf) of gas. As per the estimates, only 3% and 19% of respective oil and gas reserves have been discovered so far in Pakistan. We believe that the E&P companies are well positioned to reap the benefits of growing energy demand and huge hydrocarbon potential. Strong balance sheets and favorable regulatory framework may help the local E&P companies to enhance their exploration/development activities.

Company Profile
Guided by its vision & mission and equipped with its strategic plan, a robust debt free balance sheet and a dedicated workforce, OGDCL is well positioned to take the lead in riding the wave of enhanced E&P activity. Its portfolio includes varying blend of exploration, appraisal, development Analysis of Financial Statements Page 9

Oil & Gas Development Company Limited and production assets. The company is pursuing an aggressive exploration and development strategy to evaluate and exploit its asset potential with a view to enhance its oil and gas reserves and production base, thus creating significant value for its shareholders.

Vision
To be a leading multinational Exploration and Production Company.

Mission
To become the leading provider of oil and gas to the country by increasing exploration and production both domestically and internationally, utilizing all options including strategic alliances. To continuously realign ourselves to meet the expectations of our stakeholders through best management practices, the use of latest technology, and innovation for sustainable growth, while being socially responsible.

Business Strategy
As the leading E&P company in Pakistan, OGDCLs primary objective is to enhance its reserves and production profile and ultimately maximize value for shareholders. In order to achieve this goal, the Company seeks to execute the following strategies: Accelerate Production Growth by continuing to accelerate production growth through utilizing cutting edge technologies, allowing the Company to utilize its significant reserves base and capitalize on the strong economic growth and accelerating energy demand in Pakistan. Exploit Exploration Opportunities by building the Companys future reserves portfolio through its large onshore exploration acreage. During the fiscal year 2008-09 target of drilling is 52 wells. Maintain Low Cost Operations OGDCLs operating environment, namely the geographic concentration of its reserves base within Pakistan, will be a major factor in allowing it to control its low cost structure. Within Pakistan, the Companys leading position also enables it to access economies of scale across its significant reserves base and operations. Pursue Selective International Expansion while domestic expansion remains OGDCLs core focus, the Company intends to grow and diversify its portfolio through selective international expansion in the medium to long-term. Analysis of Financial Statements Page 10

Oil & Gas Development Company Limited Implementing International Best Practice by ensuring an efficient organizational structure and business processes that are focused on core production. As part of our restructuring plan, OGDCL has established an in-house technical services division, the Petroserv Directorate, which separates technical support services from core E&P activities.

Financial Goals
Build strategic reserves for future growth and expansion Growth and superior returns to all stockholders Double the value of the company in the next five years Make the investment decisions by ranking projects on the bases of best economic indicators Maximize profit by investing surplus funds in profitable avenues Reduce cost and time overrun to improve performance results

Oil & Gas Reserves

During the year, the estimate for gas reserves of Nandpur gas field was revised upward from 107 Bcf to 175 Bcf to cater its production profile for the remaining years. The reserves are reassessed upward for Sari gas field and Dhamraki gas/condensate field due to better production performance of these fields during the year under review. The probable reserves of Mithrao (Chak 5 Dim), Chak 5 Dim South, Kunnar, Pasahki NE & Pasahki fields are shifted to the proved reserves category. There is no downward revision in the reserves during the period. However, revision/certification of total OGDCL reserves is presently underway by reputable independent third party International Consultant. OGDCLs remaining recoverable reserves as of 30 June 2010 stood at 142.669 million barrels of oil and 9,967.594 billion cubic feet of gas.

Production
Companys production activities are focused towards acceleration of oil and gas enhancement by implementing innovative techniques. In addition, OGDCL is fully committed for seamless development of new discoveries to ensure sale of oil and gas within shortest possible time frame. OGDCL has been successful in keeping the natural decline to a minimum through rigless and with rig workovers, stimulation, and other innovative techniques as most of the wells in Southern region are on artificial lift. On the development front, OGDCL has been successful in developing some of newly Analysis of Financial Statements Page 11

Oil & Gas Development Company Limited discovered fields at its own. In this regard, Nashpa and Pakhro fields have been developed utilizing seamless development strategy and the Company is also in the process of developing Bahu, Nim West and Sheikhan (Extended Well Testing) fields using indigenous resources. OGDCL during the year has added 10 MMcfd gas from its Dakhni field and 4 MMcfd from Nandpur gas field. Moreover, 350 barrels per day of condensate has been added from Dakhni field. After the discovery at Nashpa, OGDCL using indigenous resources, put the field on Extended Well Testing (EWT) before one month of the target date producing 4,500 bopd and 15 MMcfd gas. The gas is being supplied to SNGPL and crude oil is being transported to Attock Refinery Limited (ARL). Rajian5A, a development well, was successfully completed and brought on production in a record time of five days. The well is producing 1,000 bopd of crude oil and 0.8 MMcfd gas. As part of improving operational efficiencies of the producing fields, gas compression has been installed at Chanda oil field to meet the pressure requirement of SNGPL and the Company carried out ATA of plants at Bobi, Dakhni, Uch, and Kunnar. In order to dispose off the produced water, forced evaporation system has been installed at Fimkassar and Tando Alam oil fields. Sale of gas at wellhead for four dormant gas fields namely Nur, Bagla, Jandran and Sara West has been finalized and Letter of Intent (LOI) has been issued to successful bidders. Upon completion of these projects, about 80 MMcfd of gas would be supplied for power generation. In addition, substantial enhancement in crude oil production is expected from newly discovered fields/development wells like Nashpa-1, Mela-3 and Baloch-1. Similarly, around 147 MMcfd of additional gas production is expected from Qadirpur (Compression), Dakhni, Mela, Nim West, Sinjhoro, Nur, Bagla and Bahu projects. During the year, OGDCLs average daily production on working interest basis was as follows:

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Oil & Gas Development Company Limited Compared with preceding year, crude oil production from the Companys 100% owned fields and share in operated JV fields decreased by 11.3% mainly due to natural decline in Southern region fields like Kunnar, Pasahki, Bobi, Lashari, Moolan North and Sono, partially offset by increase in production from Thora, Dakhni and start of production from Nashpa and Baloch fields. Share of crude oil production from non-operated JV fields (Badin-II, Adhi, Pindori & Manzalai fields) increased by 23.3% which resulted in net decrease of crude oil production by 7.2%. Companys gas production from 100% owned fields and share in operated JV fields decreased by 7.6% mainly due to decrease in production from Uch, Pirkoh, Dhodak, Nandpur and Qadirpur fields. This decrease in production was partially offset by increase in share of gas production from non-operated JV fields resulted in net decrease of gas production by 2.6%. LPG production during the year decreased by 7.4% mainly due to water break-through at Dhodak field and operational problems at Bobi Plant. However, share of LPG production from non-operated JV fields was higher than last year.

Exploration and Development

The year 2009-10 was another year of successful operations for the Company by making efforts to explore old areas with new ideas & innovations and new areas with well established concepts to maintain acceptable success ratio for reserves addition. OGDCL, during the year, has continued its aggressive exploration programme and strategies of exploiting exploration opportunities by building the Companys reserves portfolio through its large onshore exploration acreage. It has further enhanced its portfolio and during the year 2009-10 acquired four new exploration blocks namely Channi Pull, Mari East, Jandran West and Lakhi Rud covering an area of 4,795.70 Sq. Kms. However, three exploration licenses namely Thatta, Thatta East and Khiranwala were relinquished and operatorship of Offshore Indus-S was transferred to M/s BP Alpha. Presently, OGDCL is operating in thirty five (35) exploration blocks (twenty two (22) blocks with 100% share and thirteen (13) blocks as operated Joint Ventures (JV) including three (3) offshore blocks) covering an area of 63,581.12 Sq. Kms. In addition, OGDCL also holds working interest in another eight (8) exploration licenses operated by JV partners. Being the largest E & P Company of the Country, OGDCL has its own geological survey crew which carried out 380 L. Kms in Channi Pul E.L. and working along regional traverses in Potohar area during the year and collected 310 samples for reservoir/source studies. Analysis of Financial Statements Page 13

Oil & Gas Development Company Limited OGDCL is running five (5) seismic crews having latest acquisition technologies with the capability of 2-D and 3-D seismic surveys, equipped with on-site data processing facilities and latest quality control software. These capabilities have played a major role in enhancing the exploration activities of the Company. During the year under review, OGDCL acquired 2,493 L. Kms of 2-D seismic data in Bagh South, Guddu, Mari East, Bitrism, Thal, Mianwali, Dakhni, Tando Allah Yar, Thano Beg, Nim, and Nashpa concessions and 290 Sq. Kms of 3-D seismic data in Soghri concession and Toot Mining Lease (M.L.).

Financial Performance
During the year, Company witnessed 9.0% growth in its sales revenue over the last year mainly due to higher realized prices of crude oil, gas and LPG. However, financial performance was negatively impacted by decline in production of crude oil, gas & LPG and price adjustment of crude oil & gas from Bobi and Kadanwari fields. Products sales revenue during the period under review of Rs 142.534 billion (2008-09: Rs 130.794 billion) is inclusive of favourable financial impact of Rs 5.461 billion pertaining to the prior periods on account of price revision of Qadirpur gas w.e.f. 01 January 2008 and unfavourable financial impact of Rs 1.663 billion due to price adjustment of crude oil and gas from Bobi and Kadanwari fields. Net realized prices of crude oil, gas and LPG averaged at US$ 61.37/bbl, Rs 186.47/Mcf and Rs 51,415/M.Ton respectively compared to US$ 55.53/bbl, Rs 174.78/Mcf and Rs 36,935/M.Ton respectively during the last year. Profit before taxation for the year was Rs 88.553 billion compared to Rs 80.928 billion during the previous year, reflecting 9.4% increase in the Companys earnings performance. However, OGDCL recorded profit after taxation of Rs 59.177 billion compared to Rs 55.540 billion in the last year resulting in increase in Earnings per Share (EPS) by 6.5% to Rs 13.76 (2008-09: Rs 12.91). Cash flow from operations for the period was Rs 61.506 billion (2008-09: Rs 52.979 billion). After investing and financing activities of Rs 53.292 billion (cash outflows) and Rs 1.683 billion (cash inflows) respectively, the Companys cash and cash equivalent increased by Rs 9.897 billion with ending balance of Rs 18.837 billion as on 30 June 2010. The prevailing inter-corporate debt issue in the industry is negatively impacting OGDCL as its trade debts on 30 June 2010 include overdue Analysis of Financial Statements Page 14

Oil & Gas Development Company Limited receivable of Rs 58.159 billion from refineries and gas companies. The Management of the Company has already taken up this issue with the Government of Pakistan and position of receivables is being reported to the Government on daily basis. Early resolution of this issue is critical to ensure smooth running of Companys operations, maintaining adequate liquidity position, carrying out Companys exploration and development program and timely discharge of statutory obligations including payment of royalty, duties/taxes and dividends etc. Nevertheless, if the existing trend persists, the Company may face liquidity concerns triggering borrowing requirements which in turn, will affect the Companys financial risk profile. Financial results for the year ended 30 June 2010 are summarized below:

Dividends Paid
The Board of Directors has recommended a final cash dividend @ 15% (Rs 1.50 per share). This is in addition to three interim cash dividends @ 40% (Rs 4.00 per share) already declared and paid during the year. This makes a total of 55% (Rs 5.50 per share) for the year ended 30 June 2010.

Risk Management
Being an exploration and production company, OGDCL is exposed to operational and nonoperational risks associated with E & P business which may unfavorably affect its operations and financial performance. The Management and the Board of Directors are well aware of their Analysis of Financial Statements Page 15

Oil & Gas Development Company Limited responsibilities in this regard and ensure that an appropriate system exists in the Company for the identification and management of the business risks.

Business Risks and Challenges

Key operational and non-operational risks which can influence the operations of the Company are as follows:

Crude Oil Price

Crude oil pricing in Pakistan is based on a basket of Arabian crude oil prices adjusted for yield differential and freight adjustment. Change in international oil prices is largely uncontrollable and OGDCL is vulnerable to increase/decrease in such prices. Decline in prices of crude oil has a negative impact on the Companys earnings performance. However, the gas sales which amount around 50% of the Companys revenue are less prone to this risk. In addition, gas prices of certain fields are capped at fixed crude oil/HSFO prices and are affected only in case the international crude oil price falls below the capped price.

Exchange Rate Risk

USD/PKR parity decline has a positive impact on OGDCLs earnings, as crude revenue is tied to US$ based pricing mechanism derived from international crude prices with suitable yield differential and number of gas fields have wellhead pricing in US$ terms. Rs/US$ parity decline has a negative impact on the Companys earnings since most of the material including drilling material, plant & equipment used in oil and gas industry are imported to meet operational requirements.

Exploration and Drilling Risks

The different sedimentary basins in Pakistan represent very complex tectonics and deformation styles. The in-depth knowledge of petroleum systems present in these basins is imperative. The selection of potential exploration blocks, acquisition of geological and geophysical data, delineation of drillable prospects and their drilling are all important aspects in hydrocarbon exploration. To maintain a good success ratio is also a vital element which can only be achieved with efficient professional teams and systematic working. As easy-to-drill structures are vanishing, the drilling

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Oil & Gas Development Company Limited operations are also facing many challenges such as deep wells, lateral wells and drilling in complex geological settings. Exploration risks include selection of incorrect exploration acreage, inaccuracies in acquisition, processing, interpretation of seismic data and selection of exploratory well site. The Company is also exposed to variety of hazards during the drilling process including well blow out, fishing, fire and other safety hazards. There is always a risk of success/failure in drilling exploratory wells. Risk of unsuccessful drilling has an adverse affect on Companys earnings and growth. Though this risk is reduced in case of development fields, expertise in reservoir engineering is in place to manage pertinent risks. The Management is well aware of these risks and is taking into consideration these facts while planning and executing the exploration and drilling plans. The Company is also utilizing experienced professionals and latest technologies in selection of acreage, acquisition and processing of seismic data etc.

Reserves Depletion and Under Performance of Oil & Gas Fields

Oil & gas production usually reflects a decline after reaching its peak production. Oil and gas reserves are assumed to produce 3/4th in case of gas with compression and around 1/4 th of oil of the original reserves in place which can be further improved through Enhanced Oil Recovery (EOR) to around 1/3rd of total recoverable reserves over the reserve life. Some of the major oil and gas assets of OGDCL are mature fields which bear the risk of depletion at a faster than a predicted rate. In addition, OGDCLs investment decisions on development of newly discovered fields are made after extensive technical studies and assessment of reservoir. Reserve estimates of these fields are worked out in-house as well as are certified by reputable international consultants.

Legislation
OGDCLs revenues are subject to change in Petroleum Policies, which are usually issued for a period of 5 years. These generally offer incentives to local and foreign E & P companies to increase exploration efforts. Petroleum Policy in effect at the time of a particular discovery determines the underlying revenues from such field. Changes in legislation, taxation, regulations, royalty and pricing mechanism may affect the Companys operational and financial performance.

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Oil & Gas Development Company Limited

Environmental Risks
OGDCL is vulnerable to environmental changes including earth quakes, heavy rains, floods etc. that may materially impact production at various fields resulting into adverse impact on Companys revenues and profitability. These risks are being addressed by the Management while making investment decisions, planning and executing Companys exploration and development plans. As the Company is committed to adhere to the best Health, Safety and Environment (HSE) practices, the compliance to changes in environmental regulations relating to HSE could result into higher cost to the Company.

Law and Order

Overall law and order situation in the country is not supportive to smooth running of the Companys operations particularly in the provinces of KPK and Balochistan. This is potentially detrimental to OGDCLs exploration, drilling and development activities causing hurdle to the Companys sustainable growth. The Management of the Company is well aware of these issues and a complete set-up for handling security situation is working in the Company. A strategy has been developed by the Company to avoid disruptions at all places of the Companys operations. In this regard, close contacts are being maintained with all the stakeholders at the existing work places as well as in the new areas of exploration, development and production activities.

Hedging against Risks

Oil Price Risk
OGDC revenue mix is expected to further tilt towards natural gas with revenue contribution from gas to surge to 71% in FY15 from 53% in FY10. This is on account of rise in production from development fields such as Dakhni, Jhal Magsi and Uch. Subsequently share of oil revenues is expect to decline to 25% by FY15 from current standing of 43%. This drop is expected on account of depletion of major fields like Bobi and Chanda. Increased gas revenues are expected to provide further stability to OGDC, which are less sensitive to oil price movement. Reason is presence of floor and cap in gas pricing formula and using average price following last six months as a benchmark.

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Oil & Gas Development Company Limited

Exchange Rate Risk

E&P returns are hedged against PKR depreciation, so we believe that investing in these stocks is ideal for those who want to hedge their return against PKR depreciation. Pricing of crude oil produced in Pakistan is pegged with Arab Light crude prices quoted in US Dollar terms. Similarly, wellhead gas prices of discoveries of post 1994 are also linked with Arab Light crude prices, whereas for older fields (Pre 1994 discovered) gas prices are linked to international High Sulphur Furnace Oil (HSFO) prices, which are also in US dollar terms. With devaluation in PKR against the US Dollar, E&P sector stands out as the major beneficiary. Sectors earnings and the target prices of the companies in the AHL E&P universe are expected to surge by 3%-4%, for every 1% of depreciation in PKR against the US dollar. In FY11 we expect that the Greenback may appreciate by 3% against the PKR.

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Oil & Gas Development Company Limited

Circular Trade Debt

Pakistan E&P sector is deleveraged at the moment. Historically all E&P companies have generated sufficient funds to cater their capital expenditures and working capital requirements. However, the inter-corporate debt issue in the energy chain has severely impacted the E&Ps dividend paying capacity. Average dividend payout of E&P companies in AHL universe stood at 53% in FY10 compared to 70% over the past three years (FY07-FY09). The total trade debts of OGDC, PPL and POL have aggregated to PKR 116bn as at June10, depicting a surge of 35% YoY. So far the government has not been able to resolve the issue, despite the floating of TFCs worth PKR 162.4bn in two phases, gradually increasing power tariff and eliminating oil subsidies. Recent actions like dissolution of PEPCO and plans for further power tariff hike are some measures to ease the intensity of circular debt. Besides, interest from the foreign donors institutions (IMF and World Bank) in resolution of circular debt is painting a rosy picture on the energy canvas of the country. We do not see a complete resolution of circular debt, however above mentioned remedies may reduce circular debt to a sustainable level. Going forward if the issue is not dealt timely, we see a medium term probability of OGDC and PPL seeking external sources to meet their capital expenditure requirements. However, POL seems comfortably placed and will most likely stay unleveraged as most of POLs oil is supplied to Attock refinery, a group company which has historically paid its dues promptly.

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Oil & Gas Development Company Limited

Impact on OGDCL
Over the past few years, companys cash rich position has been severely affected due to circular debt issue. As per FY10 accounts, the company have cash and cash equivalents of PKR 19bn compared to PKR 42bn recorded in FY05. This is due to higher trade debt, which has ballooned to PKR 83bn compared to PKR 24bn witnessed in FY05. In an attempt to manage its cash flows, the company has trimmed down dividend payout ratio from 85% in FY05 to 40% in FY10. Furthermore, the company has withheld royalty payments of Government of Pakistan, which have risen to PKR 16bn, an increase of 3.72x YoY. In order to reduce the intensity of circular debt the government had issued TFCs worth PKR 162.4bn in two tranches. However, these issued TFCs did not reduce the receivable of the companies as major chunk was consumed by IPPs and OMCs before it could reach the last recipients. If trade debts perpetuate to move in the north direction and cash in the south direction then this may become a big barrier for companys vigorous exploration program and dividend payout. Dividend payout has been reduced to 40% in FY10 compared to 85% witnessed in FY05. Dividend payout expectations for FY11E and FY12F is 40% (PKR 6/share) and 43% (PKR 7/share) respectively.

Government to Issue Exchangeable Bonds

As part of the privatization program the Government of Pakistan (GoP) had planned to issue exchangeable bonds of OGDC in the international market few months back but no progress has been seen in this regard so far. The government is expected to fetch around US$500mn by Analysis of Financial Statements Page 21

Oil & Gas Development Company Limited monetizing 5%-7% of its 75% ownership in the company. News reports suggest that the GoP may use these funds either to finance some portion of its fiscal deficit or to decrease the inter corporate debt, which is afflicting the entire energy chain of the country. This will have no impact on the valuation of OGDCs stock.

Financial Ratio Analysis

Financial Ratios

DuPont Analysis

Analysis of Financial Statements

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Oil & Gas Development Company Limited

Growth Rate

Trend Analysis
Liquidity
Current ratio during FY10 declined to 3.46 from 4.08, a decline of 14%. This is mainly due to the greater increase in current liabilities as compared to the increase in current assets. While the current assets increased by 40%, the current liabilities witnessed a rise of 64%. Within the current liabilities, trade and other payables rose from Rs 18.7 billion to Rs 28.6 billion at the end of FY10. This increase is the direct result of the increase in the amount payable as royalty. Provision for tax also rose sharply, from Rs 2.5 billion to Rs 6.2 billion. Current assets on the other hand rose primarily due to the sharp increase in trade debts (receivables). Trade debts rose from Rs 56.1 billion at the end of FY09 to Rs 82.9 billion at the end of FY10. Despite the decline, the liquidity position of OGDCL stands better than that of PPL, which witnessed a Current Ratio of 3.21 this year. Along with the Current Ratio, the Quick Ratio of OGDCL also saw a decline, dropping from 3.25 at the end of FY09 to 3.03 at the end of FY10. This decline is less than the decline in the Current Ratio, possibly because Inventory saw a decline over the period.

Profitability
Profit before tax for FY10 was Rs 88. 6 billion, compared to Rs 80.9 billion the previous year. This growth of 9.4% is directly proportional to the increase in sales. In comparison to the growth in profit before tax, profit after tax increased by only 6.6% to Rs 59.2 billion from Rs 55.5 billion in Analysis of Financial Statements Page 23

Oil & Gas Development Company Limited FY09. Tax for the year increased by 15.7% as compared to the previous year, mainly due to a decline in deferred tax, which is charged at a reduced rate. However the overall increase in profit after taxation resulted into Earnings per Share (EPS) of Rs 13.76 compared to Rs 12.91 in FY09. During FY10, OGDCL s Gross Profit Margin remained relatively stable, while the Profit Margin registered a marginal decline, due to the increased effect of taxation this year. Gross profit margin dropped from 88.4% to 88.3%, while profit margin dropped from 42.5% to 41.5%. The Gross Profit Margin has been in a slightly declining trend since FY05. Although the decline has not been sharp in any year, it has led to a steady effect over time. The primary reason for this decline is that the increase in sales has been much higher than the increase in gross profits, particularly due to the increasing royalty expenses paid by the company. Return on assets and return on equity both showed a decrease during FY10 as compared to the previous year. This was primarily due to the low increase in sales as compared to the increase in assets and equity. Assets showed an increase of 28.6%, while equity rose by 24.7% compared to a 9% increase in Sales. In the past years ROA and ROE have followed a similar trend, moving upwards and downwards together. There was an increase in ROA and ROE during FY05 till FY06. In FY07 and FY08 it again started to drop slightly as the net profit did not rise as much as the assets and equity, due to low increase in sales in FY07 and due to high taxes in FY08.

Asset Management
In terms of Asset Management, OGDCL witnessed a moderate decline this financial year. While days of Inventory Turnover dropped from 44. 6 days to 37.1 days, Days Sales Outstanding saw a sharp rise from 154 days to 209 days. The Operating Cycle thus rose from 199 days to 247 days, a rise of 24%. While Inventory Turnover dropped due to the decline of almost 10% in inventory, Days Sales Outstanding rose due to the 48% rise in receivables in the form of trade debts. Increasing levels of receivables are negatively impacting the company s financial position and are the direct result of the prevailing inter-corporate debt in the industry. The company s trade debts at the end of the year include overdue receivable of Rs 58.159 billion from refineries and gas companies. Early resolution of this issue is critical to ensure smooth running of company s operations, maintaining adequate liquidity position, carrying out company s Analysis of Financial Statements Page 24

Oil & Gas Development Company Limited exploration and development program and timely discharge of statutory obligations including payment of royalty, duties/taxes and dividends etc. During FY10, both Asset Turnover and Sales over Equity ratio decreased, caused by the low growth in Sales compared to higher increases in Assets and Equity. Asset Turnover dropped from 0.74 during FY09 to 0.62 this year, a drop of 15%. Sales over Equity on the other hand decreased from 1.04 to 0.91 by the end of the year.

Debt Management
OGDCL has been facing increasing debts over the past years, especially in the sector of Current Liabilities in the form of Royalties and Taxes Provision incurred as well. As part of the companys strategy to expand and acquire new fields, cost incurred as Royalties have been high and are growing. This is leading the Debt to Assets and the Debt to Equity ratios to rise since FY06 till FY10. Both, Debt to Assets and Debt to Equity ratio show similar trends over the past years. During FY10, the Debt to Asset Ratio rose from 29.1% to 31.2%, while Debt to Equity rose from 41.1% to 45.4%. The increase in debts, i.e. from FY06 to FY10, which have been primarily a result of rises in Current Liabilities, could also be seen from the long-term Debt to Equity ratio, which showed a very slight increasing trend since FY06. This implies that although overall debt is rising, Long-term Debts are steady, reflecting company s policy to avoid the performing of investment and other activities through Long-term Debt. Yet, the below average debt ratios of OGDCL suggest a slightly lower level of leverage for the company, compared to the average industry. The Long-term Debt to Equity ratio of the company dropped from 24.2% at the end of FY09, to 23% at the end of this year. The Times Interest Earned ratio (TIE) plunged in FY07 on account of the unwinding of discount on provision for decommissioning cost, which took up the major chunk of finance costs. This process was again repeated in FY08 and similarly in FY09 when the ratio was able to rise only slightly due to the high unwinding of discount on provision for decommissioning cost. In FY09 the finance costs rose slightly but as the level of operating income showed low increase, the TIE went further down than FY08. The ratio has again dropped during FY10, from 92.9 to 74.2. Upon observation of the balance sheet we see that the company currently has no long-term loans, and thus there exists no interest element in financial charges. Analysis of Financial Statements Page 25

Oil & Gas Development Company Limited

Market Value
Earnings per Share of OGDCL rose this year from Rs 12.91 at the end of FY09 to Rs 13.76, showing an increase of 6.6%. This rise was seen despite the drop in production this year, and was the direct rise of rising oil and gas prices. Along with the increase in EPS, the Price-earnings ratio of OGDCL saw a considerable rise. After the drop in Market Price last year due to the crash of the stock exchange, the company has regained its position this year, with the price per share rising from Rs 78.5 at the end of FY09, to Rs 142 at the end of this period. The price earnings ratio was thus able to rise from 6.1 to 10.32 over the year. Dividend per share dropped considerably during this financial year, falling from Rs 8. 25 per share declared last year, to Rs 5.5 per share this year. This may be due to both the recent drop in production as well as the current exploration and development projects being carried out by the company. Book Value of OGDCL has been increasing steadily over the years on the base of its increasing assets. During FY10, the Book Value rose from Rs 29.3 to Rs 36.6, a rise of almost 25%.

Cross Sectional Analysis

TTM = Trailing Twelve Months.

Analysis of Financial Statements

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Oil & Gas Development Company Limited

From the above table, it can be observed that OGDCL has performed very strongly on all the fronts except on the P/E ratio. Despite having a high growth rate in both EPS and sales, the P/E ratio of the company has been on the decline as compared to the industry. The decline is mainly because At the current price level, OGDC is relatively less attractive as most of the positives are already priced in and the scrip is trading at near its target price of PKR 130/share for Dec 3110. Currently, OGDC is facing major problems like delay in installation of compressors at Qadirpur gas field and prolonged litigation problems at major projects (KPD TAY and Sinjhoro development projects). On the other hand, POL is the most attractive stock compared to other E&P stocks. Based on its strong reserves profile and rising production trend, we have set our price objective at PKR 300/share for Dec10. The stock offers strong dividend yield of 7.6%, and 39% upside potential from its current level.

Analysis of Financial Statements

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Oil & Gas Development Company Limited A massive Rs 148 billion of OGDC and Pakistan Petroleum Limited (PPL) has been stuck up in circular debt, creating liquidity problems for these two state-run mega oil and gas exploration companies. Different departments and organizations owed around Rs 108 billion to the OGDC and Rs 38 billion to the PPL by December, 2010. Both state-run mega companies are trying hard to recover their receivable amount worth billions of rupees. However, the Pakistan Oilfields Limited (POL) remained almost unaffected by the circular debt problem as its recoverable amount is as low as Rs 3.75 billion, compared to total recoverable amount of about Rs 375 billion of all energy sector's entities in the country.

Future Outlook
OGDCL has a strong vision and passion to contribute to the E & P sector to help enhance energy security of Pakistan. With a formidable presence in the length and breadth of the Country, OGDCL is looking beyond geographical boundaries for E & P opportunity. It plans to actively pursue overseas joint ventures. With technical prowess in onshore exploration and production it has changed focus to a more challenging area i.e. offshore exploration. OGDCL is actively participating in national bid rounds for acquiring more acreages and gearing to participate in international bidding rounds to work towards international presence in line with its Vision. OGDCL also intends to enhance its reserves and to focus on and strengthen core business (E & P) functions by incorporating international best practices and innovative thinking in Company culture. The Company plans to optimize its concessions portfolio to support aggressive exploration activities, which in turn will ensure continuous reserves additions. OGDCL is also looking at seamless development of new discoveries in shortest possible time which will add substantially to the production base of the Company. Efforts are continuing towards formulation of joint ventures with leading E & P companies both within the country and abroad. Review and improvement of internal policies and processes is also on the agenda in addition to further enhancing corporate goodwill through focused CSR activities for the benefit of the communities that OGDCL interacts with.

Analysis of Financial Statements

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