India Hikes Gas Prices to $8.4/mmbtu for five years from April 01,2014 - Microsec

Finally the convergence between economics and politics play out and India able to hike output gas prices to $8.4/mmbtu from $4.2/m mbtu for five years commencing from April 01,2014.to induce more capital investments in the domestic Exploration & Production (E&P) space. The cabinet has given their nod to the formula developed by the C. Rangarajan committee with a minimal adjustment of removing the spot prices factor out of the formula. It looks pretty evident from the Oil Minister & Finance Minister's verbal interaction with the media that their prime focus is to ramp up the investment cycle in the domestic E&P space both from the domestic as well as from the overseas investors.

The rationale behind this hike in gas prices to ramp up the gas production by way of attracting more investments which ultimately lower the import of gas that in turn facilitate to curb down the high Current Account Deficit (CAD).

This new gas pricing policy will applicable only to the new contracts and not on the existing contracts subject to conditionality. Moreover the gas price will be reviewed on quarterly basis.

The Ministry officials stated that this gas price hike is only to gas producers only and not to those who use gas as an input material. The GoI also mentioned the gas price is still below the international rates even after the hike which happened after three years owing to the stiff resistance from the fertilizer and the power ministeries.The input price of the gas will be decided in due course of time and more clarity will come up as the time passes.

The government rationalizes it's move by citing the dire condition through which India is going right now both in terms of domestic production coupled with falling investment in the oil & gas space. The production has dipped to ~111.40mmscmd in 2012-13 from ~143 mmscmd in 2010-2011. The domestic production from the PSU players is stagnated at ~70mmscmd whereas production from the private players has plummeted to ~40mmscmd from ~73mmscmd for the period ranging from 2010-11 to 2021-13. The investment cycle in 2011-12 has also trimmed to $1.8bn from $6.3bn in 2008-09. The increasing demand for gas will lead to more import unless the issue is somewhat addressed by ramping up the domestic production which can only be done by bringing investment as felt by the GoI.

Broadly this step will bring some sentimental boost for all the market participants as it could be perceived as the government's intent to carry out the proposed reformatory steps ahead and this move will definitely compliment the vision. This step will uplift the segment as a whole of which ONGC, OIL & Reliance Industries (RIL) seem to be the biggest beneficiaries. Apparently ONGC & Oil India Ltd. is being preferred in this space but it is not all rosy for these companies. We all know that the GoI has a share in the profits of these companies which means the inceremental profit is likely get back into the governments' hands by way of higher royalty, corporate tax and dividend from the investments. Around ~65% of the ONGC's realization goes to the Central Government and State Government treasury in the proportion of 50% & 15% respectively. The management stated that for every $1 hike in gas price would result to an increase of INR8500crores in the bottomline ceteris paribas so tentatively an increase of 1.42x from the existing EPS (subsidy & other things are not considered). For Oil India every $1 hike in gas price will lead to around incremental revenue of INR 400crores and INR200 crores in the bottomline but the subsidy sharing mechanism is still an overhang for the public upstream companies. A back of the envelope calculation get us an upside of ~22% in the EPS ceteris paribas. In regards to RIL the company can take advantage of this gas price hike only if they able to ramp up production from their oil & gas blocks otherwise this benefit of hike in gas price would be negated by the dipping output. Hence we believe this step is good enough to keep our positive view intact on the Oil & Gas sector as a whole. The hike in gas prices will enable the companies to monetize the financially unviable projects as well as to increase E&P activities which would add to their margins. We envisaged that the impact will only be seen not before 2015-16 at the least.

However GAIL India expected to face the heat on near term basis because of this hike in gas prices but their management opined that they are capable enough to create infrastructure by way of capex to boost their operational efficiency in the long–term.

The conundrum for the power & fertilizer industries will be resolved efficiently as assured by the Finance Ministry that they will not resort to any step where power and fertilizer becomes unaffordable.

C. Rangarajan Committee recommended some amendment in the existing Production Sharing Contract (PSC) to revive the Indian Oil & Gas sector. The implementation of proposed reforms is expected to induce more investments in the Indian oil & gas sector. The committee use the netbacks price (i.e. net off transportation costs, liquefaction costs etc.) to make it off the variables which enables to get a more fair price. The recommendation norms is designed to simplify the process which in turn pace up the E&P activities although the recommended norms will only be applicable on the future blocks i.e. blocks to be awarded under NELP 10 auction. The proposed norms will bring more revenue to the government exchequer with the hike in oil & gas price and production.

Source : Equity Bulls

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