Petronet LNG Limited

Type	Initial Public Offer by the book-building route.	Min. subscription	200 shares
Size	Rs 3.4 bn - 3.9 bn	Lead Managers	SBI Capital Markets, DSP Merrill Lynch, Enam Financial Consultants, ICICI Securities, JM Morgan Stanley.
Price band	Rs 13 to Rs 15	Listing	BSE & NSE
Face Value	Rs 10 per share	Promoters	SBI Capital Markets, DSP Merrill Lynch, Enam Financial Consultants, ICICI Securities, JM Morgan Stanley.
Shares on offer	261 million shares	Pre/Post-issue promoter holding	50%
Bid/Issue opens on	March 1, 2004	Bid/Issue closes	March 9, 2004

	Qualified Institutional Bidders	Non-Institutional Bidders	Retail Individual Bidders
No. of shares	Maximum of 117.4 m shares	Maximum of 58.7 m shares	Maximum of 58.7 shares
% of total size	Maximum 50%	Minimum 25%	Minimum 25%
Minimum Bid/Application size	Rs 50,001	Rs 50,001	200 shares
In multiples of	100 shares	100 shares	100 shares
Maximum Bid/Application size	Not exceeding the issue size	Not exceeding the issue size	Not exceeding Rs 50,000

Petronet LNG Limited (PLL) is promoted by four Navratna PSUs, namely BPCL, ONGC, GAIL and IOC holding 12.5% stake each. The purpose is primarily to set up LNG (liquefied natural gas) import and regassification facilities. Gaz De France, a French major, has been roped in as a strategic partner with a 10% stake. PLL has set up its first terminal with a capacity of 5 MMTPA (million metric tonnes per annum) at Dahej in Gujarat and plans another 2.5 MMTPA terminal in Kochi.

PLL has set up its terminal at Dahej, whereby it would be importing 5 MMTPA LNG from RasGas (Ras Laffan Liquefied Natural Gas Company) from Qatar. It further plans to import another 2.5 MMTPA, as per the take-or-pay agreement with RasGas for its Kochi terminal once the latter is commissioned. PLL has entered into a two-way take-or-pay agreement with RasGas and GAIL, IOC and BPCL (read offtakers) whereby any default in taking delivery of the gas shall result in the defaulting party paying up for the sum owed as per the Annual Contracted Quantities (ACQs). PLL shall, after importing the natural gas in liquid form, regassify it in its own terminal and supply to the offtakers, at which point, GAIL has the obligation of a 60% offtake followed by IOC (30%) and BPCL (10%).

Gas Pricing

Cost Component	($)
FOB	2.53
Transportation	0.26
Customs Duty	0.14
Regasification	0.44
Total	3.37

PLL is jointly promoted by BPCL, IOC, ONGC and GAIL with each holding 12.5% stake. Currently, GAIL accounts for 90% of the gas supply in India and has a pipeline network of around 4,600 kms across the country. It is now planning to set up a national gas grid, which means expansion beyond the existing one into southern market as well. ONGC, until recently, has been confined to upstream activities. Recently, it has planned to enter the retail market and plans to set up a plant for extraction of ethane (C2) and propane (C3) from the natural gas. For BPCL and IOC, it makes business sense to enter into the business. The two companies have been suppliers of naphtha to the industry and with natural gas proving to be a cheaper substitute, the consumers might switch over to the former. Therefore, BPCL and IOC can, retain the customers by supplying natural gas.

India is the seventh largest consumer of energy in the world, whereas it has only 0.4% of the world's natural gas reserves. Natural gas forms only 8% of the primary energy sources utilized in India, largely due to the fact that the demand for natural gas has historically been far more than the production. Gas production in India is primarily dominated by ONGC and Oil India, which together account for 85% of the total gas.

Gas Consumption

Country	Consumption (bcm)	% share
USA	616.2	25.6
Russian federation	372.7	15.5
UK	95.4	4.0
Germany	82.9	3.5
Japan	79.0	3.3
Canada	72.6	3.0
India	26.0	1.1

Natural gas predominantly finds its applications in power, cement, fertilizers and petrochemicals industry along with CNG, LPG, glass and sponge iron businesses. In India, naphtha and coal have been a major source of feedstock for the petrochemical and fertilizer industry. Currently, natural gas produced in India is to the tune of 84 MMSCMD (million metric standard cubic meters per day), whereas the demand has been ever increasing and touched 151 MMSCMD, implying a deficit of 86 MMSCMD. This demand is mainly from the power and fertilizer sectors accounting for 70% of natural gas consumption.

Despite the fact that natural gas accounts for a meager 8% of the primary energy consumption in India as against the world average of 25%, the recent shift in the retail segment from diesel to CNG and the upsurge in gas-based power plants shall lead to more demand for natural gas in the future.

• First mover advantage and high entry barriers: PLL has the first mover advantage as the country's first ever venture into import of LNG and supplying to end users after regasification through dedicated pipelines. Further, the project has high entry barriers by way of setting up the terminals and regasification plants along with the pipelines to supply to the end-users. Also, PLL shall benefit from its promoter GAIL's expertise in gas distribution.

• Promoter synergies: PLL has a take-or-pay agreement in place with its promoters where GAIL, IOC and BPCL shall offtake 60%, 30% and 10% of the regasified natural gas respectively. GAIL's has further set up a pipeline from Dahej to Vemar, thereby connecting it to its Hazira-Bijapur-Jagdishpur (HBJ) pipeline, where it would be supplying the gas to its consumers, mainly power and fertilizer units. Also, IOC and BPCL shall supply gas to their consumers and use it internally for their own refineries. This ensures PLL of a 100% offtake.

• Completely hedged: PLL has a complete hedge against all currency fluctuations and transportation cost escalation along with changes in gas prices, as the company has entered into Gas Sale Purchase Agreement (GSPA) with its suppliers where all the actual costs are a pass-through. Since the entire volatile portion of costs has been hedged, the company, to that extent, is risk free.

• GAIL's HBJ pipeline and national grid: GAIL has an established customer base along its HBJ pipeline and is now setting up a National Gas Grid (NGG), which shall give PLL access to untapped markets. Also, GAIL has entered into joint ventures for distribution of gas to cities for domestic and industrial usage. With PLL doubling its current capacity from 5 MMTPA to 10 MMTPA, this augurs well for PLL. This is because GAIL accounts for 90% of the gas distribution market, thereby being a virtual monopoly.

• Natural gas demand: Natural gas forms a meager 8% of the primary energy basket. This is largely due to lower domestic production. Currently, India accounts for a mere 0.4% of the natural gas reserves of the world. There are many factors that provide a direct trigger to the growth in consumption of natural gas in India. First and foremost, it is a cheaper and cleaner source as compared to naphtha. Secondly, with industrial activity on the rise and an upsurge in gas-based power projects, natural gas demand is likely to grow at a faster clip. A recent Supreme Court directive to replace diesel with eco-friendly natural gas as transportation fuel opens the door of the retail market for natural gas, which shall benefit PLL in particular. Further, the Long Term Fertilizer Policy states that all fresh urea capacity in the country would utilize natural gas/LNG as a feedstock and not naphtha or furnace oil.

• Major gas find in the domestic market: Any major gas find (i.e. more than 2.5 MMTPA) in India in the future shall pose a direct threat to PLL's business. This development shall change the pricing scenario of natural gas within the country, as the new company will be able to sell gas at a cheaper rate vis-à-vis PLL (due to savings in transportation charges and regasification costs by supplying the commodity in its gaseous form). Also, if the company is able to set up its own pipeline network, the forward integration shall tender to be more profitable as compared to PLL. However, this seems largely utopian than realistic but has to be accounted for.

• Deregulation of natural gas prices: With the GOI recently indicating deregulation measures in gas pricing, natural gas prices are likely to increase. Although gas shall still be competitive vis-à-vis naphtha, the benefits shall not accrue to PLL, as it shall get its revenues mainly through regasification charges and pass through costs. It is therefore, the offtakers, namely GAIL, BPCL and IOC that are the likely benefactors of this move. PLL, to that extent, shall stand to lose out on the uptrend in prices. However, the company has, as part of the GSPA, a clause whereby it can escalate the regasification charges by 5% every year, and the charges shall be reviewed every three years.

• Coal-Bed Methane (CBM) finds: Although in the nascent stage, CBM gas production could pose a threat to PLL with around 100 wells being drilled and commercial production to begin from FY05. CBM can be used for electricity generation or can be synthesized into liquid for use as industrial and transportation fuel. Further, price of CBM shall be very competitive as compared to liquid fuel and CNG. CBM fields exist in Rajasthan, Gujarat and eastern states of West Bengal and Orissa. Currently ONGC is set to being commercial production of CBM in Jharia (Jharkhand).

Petronet LNG Limited is yet to commence commercial operations and hence, no profit and loss account is available.

Since PLL has a unique business model, comparative valuations are not possible. While the company has covered itself against major jerks on the input side, margins would be on the lower side compared to the asset intensive nature of the business per se. Besides, barring the 5 MMTPA facility at Dahej, further growth is likely to come starting FY06 and beyond (along with equity dilution). It is basically a volume driven business and economies of scale would filter in only after this scale is achieved. From this perspective, the risk profile of the stock is significantly on the higher side. Besides, when one considers the energy sector as a whole, PLL has a unique business model. But whether this is attractive option on a relative basis remains to be seen.

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