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GAIL: What determines its tariffs?

Aug 13, 2008

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.

  • Also read - Our Stockselect on GAIL

    Pipeline Tariff
    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
    Add: Premium Covers WACC
    =Net tariff 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.
    =Capital employed
    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.

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