Nomura research: Natural Gas in India

Natural Gas in India
We see strong operational growth upside for the Indian gas sector, as demand
remains far higher than capacity. In the near term, pipeline bottlenecks mean that
supply is far below capacity. Given that the share of gas in the energy basket is low
(12% vs global average of 24%), per-capita consumption in India is among the lowest
globally and gas is becoming a preferred fuel for industries (due both to better
economics and environmental reasons), the latent potential for gas remains very large.
However, as the Indian gas markets are still at a nascent stage, we think demand
growth will depend a lot on the enabling environment, supply visibility of
domestic/imported gas, pipeline network development plus clarity on both regulation
and pricing policy.
There was growth in chaos …
India has seen a sharp growth in gas production over the past year, mainly on account
of KG-D6. While exit growth in gas volume was nearly 72% y-y in FY10, it could have
been 100% without pipeline bottlenecks, in our view.
Despite knowing for many years that gas availability would increase, India was
inadequately prepared for new gas supply. Pipelines were (and in fact still are) the
immediate problem, but concerns also abounded on many other issues. Both
regulations and regulators were in place, but the regulator was without key powers (as
Section 16 was not notified). Production sharing contracts (PSC) provide for marketing
freedom and market-determined pricing, but the government seemed (and continues to
seem) reluctant to release its control over pricing and allocation. Policy/regulatory
concerns impacted/delayed investments in the upstream, midstream and downstream
segments.
… now several positive steps have eased the chaos
We had believed that these were only teething problems, due to a sudden change in
landscape and strong growth of gas in India. We are now comforted to see that several
positive developments over the past few months have considerably eased earlier
chaos. Key developments include:
 APM gas price hike
 Increase in administered pricing mechanism (APM) gas prices by over 100% to
US$4.2/mmbtu effective from 1 June 2010. Consumer and producer prices of
gas from nominated blocks were kept at artificially low levels, and both ONGC
and Oil India Ltd had for many years been demanding gas price increases.
More importantly, we believe APM gas price increases represent the beginning
of the end of gas pricing anomalies.
 Along with a gas price hike, gas marketer GAIL was given marketing margins of
Rs200/MSCM, which it had been demanding for some time.
 More importantly, despite it being a somewhat difficult political decision, the
government allowed downstream city gas distribution (CGD) companies to pass
on the entire price increase to end customers. This was a clear positive for CGD
companies, but even more importantly it was a positive signal that the
government did not want to encourage subsidy provisions in the gas space,
which is contrary to the existing system of pricing controlled petroleum products;
the key problem, in our view.
 Section 16 notification
Another very important step, in our view, was the notification of the key Section 16 of
the PNGRB Act on 15 July, 2010 — nearly three years after the PNGRB Act came into
force in October 2007.

With this notification, the regulator PNGRB now has the power to authorise an entity to
lay, build, operate or expand any pipeline (as common carrier or contract carrier) or
any city/local distribution network that has not been notified yet.
Progress post Section 16 has been quite swift.
 Bids for three trunk pipelines have already been submitted. Technical bids are
already being evaluated and final decisions are likely to be announced in the next
few weeks.
 The bidding process for two other trunk pipelines (Surat-Paradip and Durgapur-
Kolkata) is also likely to commence soon.
 The CGD licensing process that was stalled for more than a year has
recommenced with bid initiations for 16 new cities.
Gas demand — significant gas appetite
India’s gas markets have remained supply-constrained. India relied solely on domestic
production until 2004, and growth was limited by lack of growth in domestic production
(domestic production saw only a 1.8% CAGR during the decade to March 2009). With
demand chasing supply, the demand/supply gap continued to widen.
Since 2004, with the start-up of Petronet LNG’s Dahej terminal, and subsequently
Shell/Total’s Hazira terminal, the country also started to import LNG — initially through
long-term contracts and in the recent years also through spot purchases. Despite the
push provided by LNG, the share of gas in the Indian energy basket remained at only
about 9% until FY09, compared to the global average of 24%. With the recent increase
in domestic availability, we estimate that the share of gas has increased to about 12%,
which is still low compared to global averages. Per-capita gas consumption has also
remained far below global averages and also below rates in neighbouring countries.


Gas supplies — likely to double over next 6-8 years
After a decade of near stagnant growth, domestic gas production increased sharply, by
45% in FY10, as KG-D6 gas production came on line. However, domestic gas volumes
are likely to remain stagnant this year, in our view, as Reliance undertakes its reservoir
studies in KG-D6. We expect KG-D6 to reach its initial peak of 80mmscmd by the end
of FY12F. The KG-D6 block is expected to reach its peak production of ~120mmscmd
by FY15-16F, as satellite fields around currently producing D1/D3 discoveries are
brought into production.
KG-D6 is just the beginning of gas production growth, in our view. Post the opening up
of upstream exploration with the launch of New Exploration Licensing policy (NELP),
India’s sedimentary basin, and in particular its east coast, have seen significantly
increased exploration efforts. These efforts have resulted in nearly 60 discoveries in
NELP blocks, of which 51 are gas discoveries. Most of the success has been in the
deep waters off the east coast, and the east coast is being seen as a new gas hub. Of
the 51 gas discoveries, only two have been brought into production, and several other
discovered blocks are seen as having large potential. Many of the other discoveries
are currently under different phases of further appraisal, commerciality analysis and
under development phase. Production from the east coast could significantly increase
in the coming years as several of these discoveries are brought into production.
Post KG-D6 block reaching an initial peak, LNG imports would be the next big source
of gas availability in near term. India currently has ~13.7mtpa of regasification capacity
(Dahej – 10mtpa, Hazira – 3.7mtpa). In addition to existing terminals, work is in
advanced stages to complete another import terminal at Dabhol. The first phase of the
terminal of 2.5mmtpa is near to completion. The terminal will become fully operational
by 2012F after the completion of break-water facilities, in our view.