Merrill Lynch puts a BUY on Cairn With a target of Rs 219

Merrill Lynch
Cairn India-BUY
PO Rs 219

Current low Duri-Widuri oil price not worrying; retain Buy The pricing of crude from the main Rajasthan block of Cairn India (CIL) has not yet been finalized. Production is scheduled to start in 2H 2009E. Rajasthan crude is similar to and therefore is expected to priced as per Indonesian Duri-Widuri. The discount of Duri-Widuri crude to Brent has risen sharply to 32-33% in the last two months. Our earnings and valuation assume 8% discount to Brent. The prevailing steep discount is not a serious concern as average discount over reasonable time period like one year has been 8.4-11%. CIL is not yet producing in Rajasthan and so will not be hit by steep discounts. We retain Buy on CIL.

Rajasthan crude similar to Indonesian Duri-Widuri

As per the PSC Rajasthan crude has to be priced in line with the price of the most similar international crude in terms of quality. CIL's Rajasthan crude is believed to be most similar to a basket of two Indonesian crude Duri and Widuri.

Duri-Widuri discount to Brent over 30% now; 8% assumed

The discount of Duri-Widuri to Brent has widened sharply to 32-33% in November and December 2008. We are assuming Cairn's Rajasthan crude will be priced at 8% discount to Brent in our earnings and valuation. CIL management guidance has been of a 5-10% discount of Rajasthan crude to Brent.

Average annual discount of Duri-Widuri to Brent 8.4-11%

The 5-year average discount of Duri-Widuri to Brent is 9.1%. The average annual discount in the last 5 years is in a range of 8.4-11.0%. The average annual discount was 8.4% in 2005 and is 11% in 2008. There have been months in 2008, when Duri-Widuri discount to Brent was as low as 3.4%. In fact from January to September 2008 the discount of Duri-Widuri to Brent was 3.4-8.1%.