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How will doubling of gas prices impact energy stocks? - Views on News from Equitymaster

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  • Jul 2, 2013 - How will doubling of gas prices impact energy stocks?

How will doubling of gas prices impact energy stocks?
Jul 2, 2013

In a key development in the Indian energy sector, the domestic gas prices have been doubled from US$ 4.2 per million metric British thermal units (mmBtu) to US$ 8.4 per mmBtu, effective from April 1, 2014.

The prices have been arrived using a formula suggested by Rangarajan committee that takes a weighted average of netback prices of Liquefied Natural Gas (LNG) imports into India and benchmark global gas prices. The formula will be applicable for next five years. As per the move, the gas prices will be revised every quarter. While these prices will be applicable to domestically produced gas, they won't apply for fields where prices have been fixed contractually for a certain duration or where the contract provides a specific formula for indexing/fixing natural gas price e.g. Panna Mukta Tapti (PMT) fields.

The move is likely to incentivize gas production and exploration in the country. Also, it is likely to attract global players to Indian gas exploration activity. However, any such boost in gas supplies is expected to take at least 3 - 4 years.

Now let us see how this move impacts the key companies under our coverage.

Keeping other factors intact, the move is positive for Oil and Natural Gas Corporation Ltd (ONGC). As per the management, currently, the average cost of production is at US$ 3.7 per mmBtu, at which the profits were very small. With doubling of gas prices, the margins in gas production will improve. The management has suggested that for every dollar increase in gas prices, the company's bottomline is likely to be higher by Rs 21 bn to Rs 22 bn. Hence, as a result of the doubling of the prices, the net profits might increase by over Rs 80 bn. This implies around 38% increase over standalone profits (worth Rs 209 bn ) in FY13. However, the gains might be limited in case the Government decides to hike royalty charges on nominated fields or increases the subsidy burden.

As far as GAIL (India) Ltd is concerned, we believe the move is negative for company in the near term. It is to be noted that GAIL uses natural gas as the feedstock for its Petrochemical plant. In case the gas prices go up, the margins of the segment will be adversely impacted. However, the management has recently suggested that it has been assured by the Government (no written commitment) that it will be compensated for any losses due to such move by reducing the subsidy burden on sale of LPG.

In the long term, if increase in gas prices does boost up the supplies, it will lead to better utilization of GAIL's transmission infrastructure. However, any such supply gains are likely to happen only after 2016 - 17. Also, GAIL is present in exploration and production segment as well. Hence, gas price hike will be positive in the long term in this regard.

For city gas distribution companies like Indraprastha Gas Ltd and Gujarat Gas Corporation Ltd, increase in the gas costs will increase the input costs. As such, they will need to hike gas prices for consumers (costlier CNG for transportation and piped natural gas for cooking) significantly. However, the companies may not be able to pass full price hike to the consumers . And even if they are able to do so, the high cost of fuel may impact the demand and gas sales volumes adversely.

We believe that Petronet LNG will gain indirectly from the move since the decrease in the price gap with domestic gas will increase the acceptability of costlier imported gas (as of now, imported gas is around three times costlier than domestic gas).

We will incorporate the impact of gas price hike in our models for companies under our coverage and update subscribers with FY16 estimates for the stocks by early August 2013. In the meanwhile, the subscribers can refer to our latest performance review for some of the companies in the Energy sector.

We would like to gently remind you that your allocation to equities should be decided upon after keeping aside some safe cash. Also within your overall exposure to equities please ensure that you broadly follow our suggested asset allocation and that no single stock comprises more than 5% of your portfolio.

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