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Energy
India
The hangover. We see a big negative impact on the profitability and profit of city gas
distributors from a decision by the Petroleum and Natural Gas Regulatory Board
(PNGRB) to cut IGL’s network tariffs significantly. We have long highlighted concerns
about sustainability of tariffs of CGD networks, given their high returns on investment.
We will look for potential negative developments in other parts of the gas sector.
PNGRB slashes IGL’s tariffs; move expected to be a big disappointment for the Street
Our interaction with investors suggests that the sharp reduction to IGL’s network tariffs and
compression charges will likely come as a big disappointment for the market. Investors were
largely of the view that the regulator would not reduce IGL’s tariffs and that marketing margins
were outside the purview of the regulator.
Significant negative impact on IGL’s profitability and profits
Exhibit 1 shows the proposed network tariffs and compression charges of the regulator and
compares them with those proposed by IGL. We note that the new tariffs will be applicable from
April 1, 2008 and consequently IGL will have to make large refunds to its customers. Exhibit 2
shows our computations of the impact on IGL’s gross margins (based on FY2011 reported figures);
we use FY2011 data since we do not cover the IGL stock. We have been concerned about the
sustainability of IGL’s profitability and have highlighted this over the past several years and as
recently as a month ago (see our March 9, 2012 comment, The regulator wants to regulate).
Other gas stocks may de-rate, pending clarity on the regulator’s next moves
We would not be surprised to see the whole gas sector getting de-rated as the regulator’s move
would come as a big disappointment for investors who generally believed in continued regulatory
leniency in interpreting and applying regulations. We note that most companies in the gas sector
earn very high returns on investment (CRoCI, RoAE, or RoACE), a result of regulatory oversight in
the past, in our view. Thus, we note that gas companies are vulnerable to potential stricter
applications of extant regulations and ensuing negative impact on their financials. Exhibit 3 shows
the returns over FY2006-11 for GAIL (pipeline segment only), GGAS, IGL and PLNG.
GAIL may be the best play in the gas sector
In our view, GAIL may be the best play in the gas transmission and distribution sector, given
potential relatively lower risks to its earnings compared with those of its peers and lower Street
expectations of its prospects. (1) GAIL derives 60-65% of its EBIT from gas transmission and
trading (see Exhibit 4) and (2) concerns about low gas transmission volumes over the next 2-3
years are largely known (see Exhibit 5, which gives our key assumptions for GAIL’s earnings model).