March 4 (Bloomberg) -- India will tomorrow begin selling as much as $2.4 billion of shares in Oil & Natural Gas Corp., the nation's No. 1 oil explorer, in the biggest test to date of the government's ability to attract investors to state assets.

The government's sale of 10 percent of India's most valuable public company will be the nation's biggest stock offer. A successful sale, a month before elections, will underscore the government's intent to narrow its budget deficit and maintain growth in an economy expanding at its fastest rate in 15 years.

``It's an endorsement for `brand India,''' Bharat Kaushal, head of the South Asia international finance department at Sumitomo Mitsui Banking Corp., said by telephone from New Delhi. ``The government recognizes that it's flavor of the month in the investors' mind and one needs to cash in on these sentiments.''

For investors, the sale is a chance to buy into the New Delhi- based company, which supplies a third of the 105 million metric tons (770 million barrels) of oil a year used by India's billion people. Investors may bet that economic growth, expected to exceed 8 percent this year, will translate into surging demand for energy as people buy more cars and businesses use more power.

``The sale offers overseas institutional investors the first real opportunity to own a piece of India's biggest company by market value -- a chance to own a strategic asset,'' said John Burbank, who manages $500 million in assets at Passport Capital in San Francisco, including 600,000 Oil & Natural Gas shares. He said he plans to buy more.

Political Opposition

Oil & Natural Gas's sale marks the final stage of a three- week disposal of government stakes in six companies that will raise $3.2 billion by the March 31 fiscal year-end. The sale will help India meet its asset-disposal target for the first time in four years, a goal hampered by political and labor opposition and September legal action that blocked the sale of two of the country's biggest refiners.

``The sale definitely sends a positive signal,'' said Venkatraman Anantha-Nageswaran, Singapore-based regional head of investment consulting at Credit Suisse Private Banking. ``It's clear the government intends to ratchet up the privatization process.''

The government is tapping demand that drove the benchmark Sensex share index up 72 percent last year as international investors poured a record $7.6 billion into Indian stocks.

The asset sales will help narrow the budget deficit to 4.8 percent of gross domestic product, from a forecast 5.6 percent.

Limited Availability

Oil & Natural Gas shares gained as much as 26.45 rupees, or 3.5 percent, to 778 rupees on the Mumbai stock exchange. The stock traded at 768.5 rupees at 11:57 a.m. local time.

Though the company's shares have tripled in the past two years, many investors avoided the stock because of its limited availability. Selling 142.59 million shares, at 680 to 750 rupees ($16.60) a share, will raise the free float to 14 percent.

``It has good exploration assets, good cash flow and the stock is at least a third below what we believe is a fair price,'' said Rajiv Jain, managing director at New York-based Vontobel Asset Management Inc., which owns $100 million of Indian stocks, including 77,400 Oil & Natural Gas shares. ``The problem was, we could never buy it in big quantities.''

International investors now own 0.5 percent of the company.

A successful sale -- and a clearer mandate for Prime Minister Atal Bihari Vajpayee's economic policies in elections in April and May -- will pave the way for a further offering of Oil & Natural Gas shares as early as September. Indian Oil Corp. and GAIL (India) Ltd., two other state-owned energy companies, plan to sell 12 percent of the company to unwind cross-shareholdings.

Bigger Than PetroChina?

JM Morgan Stanley, DSP Merrill Lynch Ltd. and Kotak Mahindra Capital Co., in which Goldman Sachs Group Inc. has a quarter stake, are managing Oil & Natural Gas's sale, which may be bigger than PetroChina Co.'s $2.3 billion initial public offering in 2000. Oil & Natural Gas's sale closes in a week.

Some investors are concerned the company's ties to the government, which will remain the biggest shareholder with a 74 percent stake, will act as a drag on earnings.

``The government has to realize that to attract capital, it must stop treating the company as a cookie jar,'' Vontobel's Jain said.

Oil & Natural Gas, GAIL, the country's second-biggest gas distributor, and other state-controlled Indian energy companies are forced to sell gas at half global rates to keep the fuel affordable for consumers in India, where 40 percent of the population live on about $1 a day.

The government shelved a 12 percent price rise in January. A 10 percent rise would add $93 million to Oil & Natural Gas's revenue, the company estimates.

Investor Interest

Still, investors bid for three times the 84.6 million shares the government is selling in GAIL. The sale of a 10 percent stake in the company, valued at about $345 million, closes tomorrow. The government received bids for five times the 71.85 million shares it offered in Indian Petrochemicals Corp.

Some investors expect Oil & Natural Gas to benefit from higher oil prices, which have averaged $34.55 a barrel in New York this year.

``Oil & Natural Gas's profit may be 50 to 60 percent higher this year if oil prices average $35 a barrel,'' Passport Capital's Burbank said. Oil & Natural Gas has said it adds $200 million a year in sales each time oil prices rise $1 a barrel.

Oil & Natural Gas trades at 11 times its estimated 2005 earnings. Royal Dutch/Shell Group, Exxon Mobil Corp. and BP Plc, trade at 14 to 18 times, according to Bloomberg data.

The company's production costs, at $3 per barrel of oil equivalent, are lower than the $4.90 at Exxon Mobil and $4.20 at BP, the world's biggest oil companies, according to Oil & Natural Gas.

Kazakhstan, Libya, Algeria

Oil & Natural Gas is increasing exploration spending to compete with China National Petroleum Corp., the parent of PetroChina, which boosted its oil reserves fivefold last year by buying fields in countries such as Kazakhstan, Libya and Algeria.

Oil & Natural Gas plans to spend $2.2 billion a year through 2007 exploring in India, Africa, Russia, Libya and Vietnam. The company will fund exploration from internal cash resources. Oil & Natural Gas, or ONGC, had cash or cash equivalent of $2.2 billion as of Dec. 31 and was almost debt-free.

``ONGC is a lot more aggressive now, a lot more efficient,'' said Alister Morrison, a South Asia specialist at Wood Mackenzie Consultants Ltd., in Edinburgh, Scotland. ``It's thinking a lot more like a western oil major.''

To contact the reporters on this story: Ravil Shirodkar in Mumbai at rshirodkar@bloomberg.net; Sri Jegarajah in Singapore at 1554 or sjegarajah@bloomberg.net.

Last Updated: March 4, 2004 01:35 EST