We have mentioned in our recommendation on GAIL that while we expect incremental volumes to flow through the company's natural gas pipelines, we are concerned about the situation regarding the tariffs that the company is allowed to levy. In this article, we shall clarify how pipeline tariff is determined.
The Petroleum & Natural Gas Regulatory Board (PNGRB) provides separate regulations to determine tariffs for city gas distribution and for bulk transport. Since GAIL's main business continues to be the bulk transport of natural gas, we shall examine the latter.
The tariff is determined in a manner, which allows the company to recover its operating expenses and earn a reasonable rate of return on capital employed (ROCE).
The net tariff has two components. First is the benchmark rate, which is the rate at which Reserve Bank of India (RBI) issues long-term government securities. Securities issued over the past 12 months are considered for the purpose. Second is the premium allowed, which will provide the company to recover its weighted average cost of capital. PNGRB examines the rate of premium every year.
This net tariff is then grossed up at the rate of income tax to arrive at the 'Reasonable rate of return' (RRR). The reasonable rate of return can be earned on the capital employed (defined as net fixed assets + 30 days of working capital) over approximately 25 years.
The tariff is reviewed by PNGRB every 3 years.
What determines GAIL's tariffs?
Calculation of RRR
Long term G-sec rate
Over last 12 months
Covers operating expenses + ROCE
Gross up: Income tax rate
=Reasonable rate of return
Levy throughout the life of the project
Application over 25 years on
Net fixed assets
Actual or assessed by PNGRB
Add: 30 days of working capital
Excluding financial charges.
Tariff per unit of gas
(RRR * Capital employed) / Volume of gas= Tariff per unit of gas
What to expect?
While the process adheres to commercial principles on paper, we believe the government still has significant discretionary powers in influencing the components of tariffs. Hence, we continue to hold our view that GAIL's transmission tariffs could face a downward pressure to provide relief to its most important user in the future, the fertilisers industry that is gasping for cash.
GAIL (India) Ltd has announced results for the quarter ended June 2016. The company has reported 14.6 % year on year (YoY) decline in sales, while bottom-line grew 244% YoY. Here is a brief summary of the results.
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