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India’s largest gas distributor – GAIL (India) Ltd. – has been consistent in its underperformance in the oil & gas space for the last three years. In 2018, the share prices declined by nearly 4%, in 2019 it declined by one-third, while in 2020 so far it has declined by one-fifth.
This is despite rising gas consumption and the country’s focus on increasing the share of natural gas in the energy basket.
We take a look if the overhangs justify the dismal stock price performance, and if there’s reason to be optimistic.
India has targeted to increase the share of natural gas in its overall energy basket to 15% by 2030, while the consumption has been increasing due to an increase in offtake from power, fertilizer, city gas distributors, and petrochemical segments. In 2020, offtake was partially impacted due to the lockdown.
A combination of factors related to a weak commodity – oil and gas – prices, lower than expected pipeline tariff hike, weaker petrochemical margins, and concerns around splitting of its two businesses and payment of AGR dues have kept the share prices weak for the gas distributor.
GAIL operates in four business segments. It not only transmits gas through over 12,000 kilometres of pipelines laid across India but also sells liquified natural gas. It is also in the business of producing and selling liquified petroleum gas and petrochemical products.
#1The gas transmission and gas marketing businesses of GAIL supplement and complement each other and the government’s plan to split these could impact the performance of both segments. Click To Tweet
Since 2018, there have been various media reports, which state that the Government of India is looking to hive off the pipeline transmission business to a separate entity and sell its majority stake to a private player.
Currently, GAIL transmits its own long-term purchase contracted gas. Users have often complained about not getting access to transport their own fuel. This creates a balance for both the businesses of the company, as it not only assures the sale of its contracted gas but also utilisation of its pipeline. Hiving off the pipeline business to a strategic partner will give access to these assets to the third parties on a non-discriminatory basis, which could in turn impact the earnings of the gas marketing segment.
Also, the unbundling of GAIL would be tedious and pipeline privatization is even tougher. Apart from legacy issues – trade union opposition, leadership, etc. – and strategic developmental considerations, pipelines is a high capex-low return business.According to industry experts, in the event of unbundling of Gas Marketing and Transmission businesses, the sustainability of the latter business alone is doubtful given the high capital expenditure intensity and low utilisation… Click To Tweet
GAIL still seeks support from the government in the form of viability gap funding (VGF) for completing gas grid projects.
VGF is a grant to support projects that are economically justified but are not financially viable. Earlier, GAIL did not start executing the Jagdishpur-Haldia-Bokaro-Dharma (JHBDPL) pipeline until it received approval for viability gap funding of 40% from the government. Similarly, for Indradhanush Gas Grid Ltd., it recently got VGF approval of 60% of the estimated costs.
This also increases the concern of whether a private entity would be willing to invest in the pipeline business without any guarantee on the volume off-take or government support. Despite, China and Japan, being much ahead of India in terms of consumption of natural gas and infrastructure development, are experimenting with the same in piecemeal manner gradually. While in India, the gas market is yet to mature.
So far neither the company nor the government has been given a roadmap nor has there been a conclusive decision on how and when the businesses will be split.
On the marketing side, GAIL buys LNG at contracted prices in the international market and sells at contracted and/or spot prices in both the domestic and international markets. Currently, GAIL has four active long-term LNG contracts to buy gas – one each with the U.S., Russia, Australia, and Qatar.
Of these four contracts, the U.S. LNG contract has been troubling the company for a while. Nearly 50% of imported LNG volumes are from the U.S. and the prices of the same are linked to Henry Hub – benchmark gas price in the U.S. As per the contracts, LNG is bought at 115% of Henry Hub price plus a fixed liquefaction charge of $3 per million British thermal units (mmBtu).
As an example, If the Henry Hub price stands at $2.6/mmBtu, then the price at which GAIL can buy the LNG at the U.S. port will stand at $6/mmBtu. Add to this, the transportation cost which ranges between $1.5-2/mmBtu.
This is all about the buying prices, but the problem lies with the selling price which is not in sync with buying price. In India, where GAIL has been selling half of the U.S. LNG, the selling price is linked to oil prices, while in the international market it is either done at pre-determined (contract) prices or spot prices.
Due to the sharp fall in crude prices, the landed cost of U.S. LNG in India has been at over 25% premium to the crude linked selling prices in the current financial year. Add to this, continued weakness in spot LNG prices, the cost of U.S. LNG is now at 60% plus premium.
Supply glut and high inventory have kept spot gas prices in the Asian market lower.
In Q1FY21, due to this wide gap between the cost and selling price, the company reported an EBIT loss of Rs 545 crore in the marketing segment.
One year ago, the Petroleum & Natural Gas Regulatory Board approved an integrated tariff rate for two of the key pipelines managed by GAIL. While the new rate was 18% higher than the previous, it was still nearly 58% lower than what the gas producer had asked. Separately, the regulator has also floated a public consultation document to carry out the tariff review for natural gas pipelines based on the change in the corporate tax rates to 22% from 30% earlier.
As the company has adopted for a lower tax rate, the pipeline tariffs could also be revised downwards to match the pre-determined returns used to calculate tariffs.
Along with this, GAIL had also received a provisional assessment order from the Department of Telecommunications for AGR claims amounting to ₹ 1.73 lakh crore – over three times its market capitalisation. The company had the time and again communicated that it won’t be liable to pay any dues, but confirmation on the same was received only in June.
GAIL has a small business under the entity GAILTEL that has optic fiber running along its pipelines and is used for internal purposes. The company had an ISP (Internet Service Provider) license from 2002 to 2017 and the business accounted for less than 0.5% of total revenue in 2017. Over 15 years (2003-17), GAILTEL reported revenues of ₹ 180 crore and paid telecom license fees of ₹ 14 crore, implying 8% of overall telecom revenues.
GAIL produces liquified petroleum gas using domestically produced gas – The government sets the price every six months. So while input cost if fixed, selling price of LPG is a function of crude price. With a decline in crude prices, the prices of LPG also fall with a lag. This is in turn impacted the LPG segment earnings in the first quarter of the financial year 2021. Earnings before interest and tax for the LPG segment was down 50% compared to last quarter.
Buoyed by supernormal cyclical profits over FY13-14, GAIL committed large investments in its petrochemical business. But the expansion was ill-timed. It was not only hit by declining prices, but phase-2 took a long time to ramp-up capacity and GAIL took several shut-downs over the years.
Though in FY20, technical issues that had impacted production earlier have been resolved, and new capacity has ramped up to full utilisation levels, the segment has been impacted by a sharp decline in polymer prices. To make matters worse, the segment has also been impacted by high input costs as it has been forced to use higher-priced LNG from its long-term contracts and also higher priced domestic gas from fields of ONGC.
In each of the first three-quarters of FY20, GAIL has reported EBIT loss in the petchem segment. However, in Q4, it managed to report profits as it was able to replace some of its high-cost feedstock gas with lower-priced spot LNG. Again, in Q1FY21 due to lockdown, high gas cost, and lower realisation, the petrochemical segment reported losses.
PNGRB has recently proposed a draft amendment to implement unified tariffs for integrated gas pipelines of GAIL. This could result in improved returns on under-utilised pipelines and enhance volumes/economics for upcoming large projects. Along with this the transmission and marketing segment is likely to benefit on the back of an incremental rise in gas consumption by four upcoming fertiliser plants and ramp-up by new CGD players in recently won geographical areas.
Fertiliser plants are somewhat indifferent to LNG pricing as it is a pass-through under the urea subsidy scheme. In the gas marketing segment, despite the adverse price gap, the losses for the company are expected to be limited.As per the recent management commentary, nearly 90% of long-term LNG volumes for 2020 and 70% for 2021 have been placed through adequately priced or hedged contracts. Click To Tweet
The LPG and petrochemical segment are expected to benefit from Q2 as not only oil prices recovered, but the prices of gas which is used to produce these products were also lower.Looking ahead, with AGR concerns done and stock trading at cheap valuations, the share prices of GAIL could see an upside as these green shoots start resulting in earnings upside. Click To Tweet
The National Green Tribunal passed an order banning all coal gasifiers in Morbi. As a result, the consumption of gas almost doubled in that region. Similar orders for other industrial clusters may result in a significant jump in gas volumes.
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