The Government of India had appointed a committee of experts headed by Kirit Parekh to look into the challenges faced by the city gas distribution (CGD) companies in the pricing of the gas sold to the end consumer. The problem of pricing became even more critical as globally the prices of natural gas rose sharply (more than doubling), while the CGDs were forced to calculate the price as per the administered price mechanism set by the government. This put pressure on their margins and impacted their profitability.
Committee recommendations
The Parekh Committee submitted its proposal to the government on November 30, in which it has proposed a gas price ceiling of $6.5 per metric million British Thermal Unit (mmbtu) (currently at $8.57 per mmbtu) for legacy fields with a floor price of $4 per mmbtu. Gas prices will rise $0.5 per mmbtu annually, with complete liberalization of domestic gas by 2027.
The committee has also proposed the removal of the price ceiling on deep-water gas production in 2026 and gas allocation to fertilizers and the city gas sector under the priority sector. Experts from the sector believe that this should help lower government fertilizer subsidies and also help raise gas penetration in the country as new city gas networks are built.
The proposal also dwells on providing complete freedom to new gas fields on pricing and marketing.
The Cabinet now has to take a final decision on the committee’s recommendations after the same are vetted by the oil ministry.
“Some tweaking by the Cabinet cannot be ruled out,” said analysts at the global research house, CLSA. In this regard, CLSA expects gas consumers, led by city gas players, to primarily argue for the removal of the proposed annual $0.5 per mmbtu of escalation in the ceiling price. On the other hand, it expects oil producers to largely lobby for a higher ceiling price than the $6.5 per mmbtu proposed by the committee. “Barring these possible tweaks, we believe the final decision of the government would likely be close to the recommendations of the committee,” the analysts said.
Benefits for stakeholders
The draft recommendations are a material relief to the gas sector which has seen the macros turn deeply unfavorable over the last six months or so. Experts believe that in addition to the absolute relief of $2 per mmbtu in FY24 (vs October 2022 price), the pricing direction announced for the next few years (i.e., escalation of $0.5 per mmbtu annually) provides the much-needed visibility and clarity on priority sector gas costs for CGDs. It also provides scope to tweak the pricing strategy to end consumers, depending on alternate fuel pricing and customer acceptance.
According to a report by the global investment bank, Morgan Stanley, “For gas consumers, a more gradual increase in gas costs should cushion any demand shock and CNG prices in India would decline marginally (4-5 percent) at first, if the policy is implemented.” For CNG players, a key overhang of potential gas cost increases and margin reduction should also lift.
This gas pricing policy, if implemented, would significantly reduce the risks of spikes in raw material costs for the CNG and residential PNG businesses of CGDs.
At the same time, the analysts at CLSA are of the opinion that “such a cut in gas price from the current level could bring back the discount of CNG to diesel to a respectable 30-40 percent, which could notably improve the pricing power and outlook for CGDs”.
This is a big positive for Indraprastha Gas Ltd (IGL) and Mahanagar Gas Ltd (MGL) and to a certain extent Gujarat Gas Ltd (GGL).
Given the fact that ~80 and ~87 percent of overall volumes of IGL and MGL respectively, come via domestic use and CNG segments, the extent of benefit for the two players will be larger vs GGL which derives only ~36 percent of it volumes from priority segments.
According to a note by ICICI Securities, the two companies (IGL and MGL) have seen gross margins in Q3 so far (till 25th November 2022) at Rs 11.6-13.7 per standard cubic meter (scm) for CNG and Rs 12.9-16.5 per scm for domestic segments, and if FY24 gross margins are maintained at similar levels, retail prices for CNG and the domestic segment can be reduced by Rs 7.7-8/kg and Rs 4.9-5/scm respectively.
Experts believe that full freedom in the marketing of gas by 2027 and steady increases in producer gas average selling prices should drive upsides to multiples as well as earnings for upstream producers. The range of $4-6.5 per mmbtu is similar to domestic gas prices in most emerging markets (EM) and developed market countries.
According to the analysts at Morgan Stanley, “No gas price caps for deep-water fields should lead street estimates to rise for ONGC, Oil India, and Reliance, considering that the majority of India's gas production growth is driven by the deep-water fields.” They see a 10-12 percent potential upside in earnings ― and more importantly, net asset value (NAV) upside of about 15-20 percent, while assuming a $70 per bbl long-term oil price environment.
Morgan Stanley prefers refiners, fuel retailers, and upstream oil plays over city gas distributors into 2023. For gas consumers plays, it likes only IGL and GAIL.
According to an update note from CLSA, “Using $75 per bbl of crude realization, the current stock price of ONGC/Oil India is baking in a gas price of sub-$2/mmbtu, but given the floor price of $4/mmbtu and the fact that a price lower than the ceiling may only be applicable if crude falls below $65/bbl, a rerating to price in $6.5/mmbtu should play out soon.” These policy measures would limit the volatility of earnings of ONGC/Oil India and a re-rating above their current target multiples, which is based on a 20-25 percent discount to the historical average, could be easily argued, the analysts at CLSA said. ONGC and Oil India remain their top ‘buys’ with a target price of Rs 225 and Rs 285 respectively.
CLSA has an ‘outperform’ call on IGL with a target price of Rs 420, a ‘buy’ rating on MGL with a target price of Rs 1,020, and a ‘sell’ rating on GGL with a target of Rs 420.
Domestic brokerage ICICI Securities has maintained a ‘buy’ for both IGL and MGL, while it has an ‘add’ rating for GGL.
Its assumptions for CGDs factor ~90 percent of priority sector requirements being met via the nominated domestic gas fields, with the balance being met via other domestic sources and LNG. With these lower gas costs in the system, ICICI Securities remains sanguine about its gross margin assumptions of Rs 9.5 per scm for IGL, Rs 12.5 per scm for MGL, and Rs 10.7 per scm for GGL. “We keep estimates unchanged and reiterate ‘buy’ on IGL and MGL with an ‘add’ rating on GGL, owing to a material slowdown in volume growth trends for GGL in the next 12-18 months underpinning our relatively cautious call,” it said in its note. For IGL and MGL, it has kept a target price of Rs 526 and Rs 1,025 respectively, while for GGL, the target price is Rs 554.
Disclaimer: The views and investment tips of investment experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.
Disclosure: Moneycontrol is a part of the Network18 group. Network18 is controlled by Independent Media Trust, of which Reliance Industries is the sole beneficiary.
