UBS: India Oil and Gas - Too many players in the pipeline?

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UBS Investment Research
India Oil and Gas 
Too many players in the pipeline? 
 
„ Increased competition in the gas pipeline business
We continue to expect growth in gas pipelines in India on rising gas supply and
poor infrastructure, but highlight competition as a concern. Our main concerns are:
1) new competition taking away some of GAIL’s long-term growth; 2) lower
margins,  as the bidding process implies lower tariff and/or aggressive volumes;
and 3) increased competition for potential clients due to geographical overlap.

„ GSPL consortium has won three new pipelines
The Gujarat State Petronet (GSPL) consortium, which includes IOCL, BPCL, and
HPCL, has won three new pipelines through a Petroleum and Natural Gas
Regulatory Board (PNGRB) bidding process. Though PNGRB’s authority to award
gas pipeline contracts to the consortium is still under review at the Supreme Court,
we see this as a directional signal towards increased competition in the business.
„ Competitive bidding will hurt ROEs—gas supply is critical
We believe the tariff bids for the new pipelines will lead to lower ROEs than those
of existing pipelines. Pipelines take around three years to build, much less than the
lead time to put a gas discovery to production. Yet the entrants chose to bid
aggressively assuming higher volumes. In this scenario, we are concerned about
the long-term ability of gas distribution companies to manage both profitability and
growth. We believe the prime beneficiaries will be domestic gas producers and/or
LNG importers.  
„ Positive on GAIL and PLNG—plays on booming gas distribution business
On the margin, the increased competition is negative for the incumbent GAIL, in
our view. We continue to be positive on GAIL (Buy, PT of Rs580, DCF-based)
and have initiated on PLNG (imported LNG terminal) with a Buy, Rs150 PT using
a DCF-based methodology explicitly forecasting long-term valuation drivers.


PNGRB (new regulator) awarding contracts through a bidding process
PNGRB’s primary objective is to ensure  that the customer has choice. It is
therefore logical to assume that there will be a higher degree of competition
going forward. It also means that the big incumbent will lose the most.
PNGRB, through a bidding process, has awarded the GSPL consortium
contracts to build: 1) the 1,585km pipeline from Mallavaram on the east coast of
Andhra Pradesh to Bhilwara in Rajasthan; 2) the 1,680km line from Mehsana in
Gujarat to Bathinda in Punjab; and 3) the 740km line from Bhatinda to Srinagar
via Jammu.
We believe that since the pipeline capacity was one of the bidding parameters,
companies could have overbid on capacity. The supply is still constrained and
would lead to higher capital costs, adversely effecting RoEs, in our view. Gas
distribution in India is mainly led by supply rather than demand and without
reasonable assurance on the demand front we believe the sector profitability will
be affected by such irrational overbidding.
Section 16 of the PNGRB Act, which gives the Board powers to authorise
entities to lay pipelines and build city gas distribution networks, was notified
only on 15 July 2010. Irrespective of Section 16, PNGRB had during past three
years gone ahead with inviting bids for city gas projects and pipelines, a move
that has been challenged in the Supreme Court. The apex court has posted the
matter for hearing in August 2011.