Progressive and directionally strong

A series ofamendments have been made to pipeline tariff regulations by the Petroleum and NaturalGas Regulatory Board (PNGRB). These, believe analysts, are directionally strongpositive measures. However, there are inherent risks that need to be dealtwith, such as a delay in final tariff order, prolonged slump in gas demand, andexecution delays in new pipelines.

Two recentregulatory developments go a long way clearing a few regulatory issues thathave been in limbo for the past several years in the Indian gas sector. Recentamendments to the Petroleum and Natural Gas Regulatory Board Act (PNGRB Act)clear lingering concerns on natural gas tariffs to a great extent. At the sametime, the recommendations proposed by Kirit Parikh Committee on natural gasprices present a reasonable, phasing-out direction to gas pricing in thecountry, which has hitherto seen multiple pricing regimes and arbitrarycontractual timelines.

The proposedregulations are designed to:

i)                   Provide momentum to pipelinetransmission infra investments – specifically, long pending pipelines for GujaratState Petronet (GSPL);

ii)                  Create a relatively more stablepricing regime for the City Gas Distributors (CGDs), even if it is at a higherlevel than historical averages; and

iii)                Provide enough incentive forhigher investments in the gas upstream segment, with the premise of fullyderegulated pricing by FY26 and FY27 (depending on the type of field) toaccelerate new exploration.

Key amendmentsproposed by the PNGRB allow for a longer ramp-up period for new pipelines, asalso allow for System Use Gas (SUG) charges. The amendments create a mechanism forintegrated tariff for interconnected pipelines, and allow for only prospective applicationof lower tax rates.

Further, theamendments allow for a 5-year volume exemption for new pipelines, and increasethe number of tariff zones to 03 vs 02 earlier. Combined, industry expertsbelieve, these amendments can create a more equitable and fair tariffenvironment for the gas transmission entities and help accelerate investmentinto new pipelines by GSPL and GAIL.

Keyrecommendations of Kirit Parikh Committee include:

i)                   A floor of US$4.00 and a cap ofUS$6.50 per mmbtu for domestic gas from nomination fields, with 10 per centslope to monthly crude price to be the base formula.

ii)                  For other domestic fields,formula is proposed to be the same, without the cap and floor.

iii)                The cap be raised byUS$0.5/mmbtu annually.

iv)                For new fields, price to be ata 20 per cent premium to normal formula.

v)                 Complete deregulation of APMgas prices by 1st January 2027 and 1st January 2026 fordifficult fields

vi)                Inclusion of gas in GST, with amechanism to compensate states for revenue loss for the first five years.


Clarity and visibility more valuable than subsidy

The Kirit ParikhCommittee, with a raft of recommendations, streamlines the process of gaspricing in the country. The impetus to do this was driven by sharply increasingdomestic gas prices, driven by the surge in most international price benchmarksfollowing the Russia-Ukraine conflict. At the same time, the committee was givena mandate to ensure that the pricing, while being reasonable, also providedfair incentives to encourage ongoing investments in the upstream sector.

The committeehas also looked to simplify the pricing regime for different categories ofnatural gas produced in the country, which at this time, is a needlesslyconfusing set of formulas for different gas production in the country.

Keeping thevarious conflicting parameters in mind, the committee has made the followingproposals:

-         A ceiling of US$6.5/mmbtu forall domestic production from nominated fields of ONGC and OIL (APM), with afloor of US$4.00/mmbtu and an annual escalation of US$0.5/mmbtu every year.

-         Within the range of floor andceiling, the prices for APM to be fixed using a 10 per cent slope to Indianbasket of crude prices, calculated on a monthly basis.

-         For the range of operators thatare not on APM pricing, the proposed pricing formula will also apply, exceptwithout any of the floor and ceiling restrictions.

-         For new wells or wellinterventions in nomination fields, a premium of ~20 per cent over the APM baseprice has been proposed. The committee has also proposed to give marketingfreedom for the additional production.

-         The recommendations propose apass-through of the price reduction to the consumers by the CGDs who will beone of the biggest beneficiaries of the moderation in domestic gas costs.

-         Continuation of the current gasallocation policy, with CNG and domestic PNG on highest priority, but with astaggered plan of withdrawal from gas allocation as and when market conditionspermit.

-         Full deregulation of APM pricesrecommended by 1st January 2027.

-         For difficult fields, thecommittee has recommended the eventual removal of the price ceiling. But, inview of the macro environment, they have recommended retention of the ceilingfor the time being.

-         Complete deregulation of thedifficult field gas price by 1st January 2026.

-         Subsidies for fertilisersegment to continue, introduce subsidies for the non-refundable securitydeposit charged by CGDs to customers.

-         Removal of take-or-payobligation from power producers towards gas purchase obligations.

-         Development of a local pricediscovery mechanism for development of a gas market.

-         Gas to be brought under GST, withfive years’ compensation for the states to make up for loss of revenue. Tillthe time it is implemented, the committee has proposed a reduction in theCentral excise duty rates.

Industry experts note that the steadily rising price trajectory fordomestic gas is a long-term negative for gas costs, but they submit thatvisibility and clarity on the quantum (US$0.5/mmbtu annually) is a positive. Additionally,even after eight months of price hikes kept in abeyance for petrol and diesel,CNG prices in Delhi still trade at a discount of 46 per cent/33 per cent vspetrol/diesel respectively.

Given that every US$0.5/mmbtu increase in gas price requires pricehike of `2.3/kg for CNG and `1.7/SCM for domestic PNG, which is not material annually for next2-3 years. Also, with some normalisation, likely in petrol and diesel pricesover FY24, margin performance may also improve.


Utilisation of NG pipelines in the country at very lowlevels

One of the keyconcerns for gas pipeline operators in the country has been the very low utilisationof available capacity due to lack of adequate supply and also slower demandramp-up across segments. While utilisation for some of the major pipelines ofGAIL and the Gujarat Network of GSPL are at healthy levels of 60-80 per cent, forthe rest, utilisation levels remain well below economic levels. Overall, forthe country as a whole, pipeline utilisation at just 31 per cent is very low,given the investment made over the last 10 years.

So, what doesthe proposed change in regulations imply? The amendments have introduced a morerelaxed capacity utilisation/normative volume requirement for pipelines. Thenew norms mandate a 10-year ramp-up starting from 30 per cent to 100 per cent(75 per cent of capacity) of the nominal pipeline capacity vs 60 per cent to100 per cent (75 per cent of capacity) over five years. These norms are alsoapplicable for future expansions.

As opposed toearlier norms, capacity expansion of pipelines is to be exempted from tariffcalculations for five years, provided it caters to new gas sources. Also, inthe case of expansion of the pipeline by >10 per cent of nominal capacity,additional Capex, Opex, and volumes will now be included in tariffcalculations, as opposed to being excluded earlier.

This directlyaddresses the problem faced by new and upcoming pipelines to recoup their costsand continue to execute new connectivity plans. With a slower ramp-up ofvolumes and the exemption of five years for capacity expansion, economics ofunder-construction and newly complete pipelines improve materially for bothGAIL and GSPL.


Integrated tariffs to create a more equitable andtransparent mechanism

As of now, thereis a levelised tariff mechanism applicable for individual pipelines, with thetariff spread over two zones depending on the distance of the customers fromthe pipeline. While a unified tariff mechanism was already proposed earlier,the new amendments also propose creation of three tariff zones. This would helpspread out the tariff escalations more gradually, lowering the burden for thecustomers.

Another crucialclause is the provision to increase tariffs on an annualised basis instead ofthe same levelised tariffs applying though the life of the pipeline. Thisalleviates the pressure on customers in the initial years of low tariffs andalso compensates pipeline operators for the later years.

Lastly, theamendments introduce the concept of ‘integrated tariffs’ for inter-connectedpipelines with common tap-offs. This will be relevant – especially for GSPL’sGujarat network and for the Urja Ganga Pipeline(Jagdishpur-Haldia-Dhamra-Bokaro pipeline).


Allowing SUC charges would address a longstandingconcern for operators

Post along-pending demand from both GSPL and GAIL, the gas regulator has finallyallowed transmission loss @0.1 per cent of actual volumes multiplied by gasprice allowed as a deduction for tariff calculation. This is a materialpositive for both players and this alone can have positive impact of 4-5 percent on GSPL’s EBITDA FY24E onwards while for GAIL standalone EBITDA can see ~1.0per cent benefit.


Prospective application of the lower tax rate helpsGSPL

For companiesthat have opted for lower corporate tax rate of 25.2 per cent vs the earliermarginal tax rate of 33.3 per cent, regulations are now amended to factor thisimpact only prospectively (FY24 onwards) rather than retrospectively. Thisimplies GSPL would see a lower-than-expected hit on tariffs, as FY21-FY23impact of the lower tax rate will be excluded from tariff calculations.


Impact on individual sub-segments to be material

CGDs: Given that ~80 percent and ~87 per cent of overall volumes of IGL and MGL, respectively, come viadomestic and CNG segments, the extent of benefit for IGL and MGL will likely belarger vs GGL, which derives only ~36 per cent volumes from priority segments.Market analysts aver that:

1) IGL and MGLhave seen gross margins in Q3FY23-TD so far (till 25th November 2022)at `11.6-`13.7/SCM for CNG and `12.9-`16.5/SCM for domestic segments, and

2) If FY24Egross margins are maintained at similar levels, retail prices for CNG anddomestic can be reduced by `7.7-`8.00/kg and `4.9-`5.00/SCM, respectively. For GGL, analysts don’t expect much changein prices since it has not increased gas prices post the US$2.5/mmbtu increasein domestic gas prices from 1st October 2022.

Gas transmission companies: Both the listed gas transmission players, GAIL and GSPL, shouldlargely benefit from these measures. For GSPL, in particular, the amendmentsrelated to capacity expansion, tax rate, slower ramp-up, and SUG are welcome,given the apprehension investors have had for a long time on the extent oftariff cuts post FY23. With these amendments in place, GSPL can see as much as11-12 per cent increase in its FY24E EPS, while for GAIL, the impact would be<2.0 per cent as per estimates provided by market analysts.

Upstream companies: ForONGC and Oil India, analysts note that FY24 street estimates were largelyfactoring-in US$7.5-$8.00/mmbtu of blended gas realisations. Therefore, therecommended price of US$6.5/mmbtu would likely reduce FY24E EPS by 5.7-6.7 percent. Analysts also note that the measures to increase price by US$0.5/mmbtuevery year and also free up pricing by FY26/FY27 are material positives forlong-term earnings trends. They note that the prices of US$6.5-$8.00/mmbtu overFY24E/FY25E/FY26E are still well above average realisations over FY15-FY21 andare well above the F&D costs of ~US$3.5/mmbtu.

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