Domestic gas production to increase over the long term
Post the decline from 97 MMSCMD in FY 14 to 92 MMSCMD in FY 15, the domestic natural gas production from existing or already discovered fields is projected to increase to around 130 MMSCMD by FY 20/21 on the back of likely commencement of GSPC’s Deen Dayal block and ONGC’s KG basin blocks along with marginal increase in RIL’s KG production. ICRA projects the domestic production level to increase further to around ~140 MMSCMD by FY 25. On the demand side, while the demand potential for natural gas is high, the actual offtake could critically depend upon the price competitiveness of gas/R-LNG against alternative fuels (especially in current low crude oil price scenario). ICRA believes the gas demand will rise to ~275 MMSCMD by FY 20 and ~330 MMSCMD by FY 25 from the current demand potential of more than 225 MMSCMD.
India’s LNG regasification capacity to increase significantly over the medium- to long-term
The total regasification capacity in India is currently around 25 MMTPA; however, the operational capacity is about 17 MMTPA as the 5 MMTPA Kochi terminal of Petronet LNG Ltd (PLL) lacks full pipeline connectivity and 5 MMTPA Dabhol terminal is being operated at low capacity utilizations in the absence of breakwater required for protecting LNG ships during the monsoon season. Going forward, additional RLNG capacity of 10-15 MMTPA would be available with expansions at Dahej and Hazira along with possible improvement in capacity utilisation of Kochi terminal upon pipeline connectivity coming in place. The major greenfield projects, finalised by the sponsors and expected to be executed in the next 4-5 years are: 1)Floating Storage & Regasification Unit (FSRU)/RLNG terminal at Kakinada port, Andhra Pradesh (by GAIL, AP Gas Distribution Company, GDF, Shell and Kakinada port); 2) FSRU / RLNG terminal Pipavav, Gujarat (by Swan Energy Ltd); 3) Terminal at Mundra, Gujarat (by GSPC-Adani JV); and 4) Terminal at Ennore, Tamil Nadu (by Indian Oil Corporation Ltd). Apart from above, many other terminals are proposed and are still in the preliminary stage. Based on relatively “firm” regasification terminals plans in India, ICRA projects the regasification capacity to significantly increase to around 47 MMTPA (~165 MMSMCD) by FY 20 and around 55 MMTPA (~190 MMSMCD) by FY 25.
A key challenge for the new terminals is their ability to tie up LNG supplies through long-term contracts at competitive prices and the competition faced by RLNG from liquid fuels. The risk related to tie up of LNG is partly mitigated by the fact that the global LNG supply demand balance is expected to ease from FY 16 onwards. Besides, for terminals planning to operate on tolling basis, the ability to achieve optimum utilisation of terminals through long-term commitment of booking slots of terminals on use or pay basis by gas marketers would be critical from credit perspective. Overall, the ability to complete the projects in a timely manner without material cost and time overrun and to tie up with the LNG suppliers as well as RLNG customers or to book the optimum capacity on tolling basis would be key risks for the regasification segment, where the competition is expected to increase significantly over the longer term.
Significant increase in regasification capacity to materially reduce the gap between demand and supply potential and lead to higher competition in the regasification segment Total supply potential is expected to increase significantly over the next 7-8 years with higher domestic gas production and commissioning of firm regasification capacity during FY 18-21. With the increase in supplies, the difference between the projected demand and supply potential is expected to narrow down over FY 20 – FY 23, although the demand is expected to remain higher than supply potential. However, the demand for RLNG could be affected because of significant competition from liquid fuels, and as a result the actual consumption of RLNG could be lower leading to significant competitive pressures in the regasification segment over the medium-term. Thus, although RLNG consumption could grow at modest pace, upcoming LNG capacities may operate at relatively lower utilisation than the current utilisation of regasification capacities in the country due to high capacity additions. The price sensitivity of RLNG demand would be critical in this regard. ICRA believes that if many regasification terminals, as planned come on stream over the next 4-5 years, the new entrants would face significant pressure on volumes and margins as they will have to compete with the existing terminals / brownfield expansion which are more cost efficient due to lower capital intensity. Sub-optimal capacity utilisation and lower regasification margins could put significant pressure on returns and credit profile of new entrants especially in the initial few years of operations.
Ambitious target to double gas pipeline infrastructure
With KG-D6 production coming on-stream during FY10 in Andhra Pradesh, the emphasis on enlarging the pipeline reach to other parts of India increased and various players had announced projects to connect some of the high-demand areas in south, east and central India. Post its election in mid 2014, the GoI has set an ambitious target of doubling the gas pipeline capacity to ~30,000 km under the National Gas Grid Mission. Various options being placed on the drawing board are a partnership between GAIL (India) and Gujarat-based GSPC, taking up certain strategic pipeline projects based on budgetary support, public-private partnership (PPP) and bidding on viability gap funding (VGF). The proposed pipelines are expected to significantly improve the connectivity all over India.
Gas availability a major hurdle in the growth of the segment…
In line with the marginal improvement in domestic gas supply and the significant addition in the regasification capacities planned in the next 3-4 years, ICRA expects the capacity utilisation of pipeline network to improve in the long-term. However, capacity utilisation levels of some pipelines would continue to remain at sub-optimal levels in the medium term. Besides, despite the ambitious plan of the GoI to double the pipeline capacity, the constrained gas availability may be a key hurdle for the viability of new pipeline projects, which require large investments. Though the GoI is willing to provide VGF for the new projects, the interest of private players may be limited in absence of much clarity on the availability of gas supplies and anchor customers who can consume high-price RLNG.
…land acquisition and obtaining Right of Use (RoU)/Right of Way (RoW) are other key challenges
Land acquisition has become a more complex issue over the last few years which pose a significant challenge for new pipeline projects. Besides, the already awarded contracts may have material cost overruns due to the multi-fold increase in cost of land from the time when the projects were awarded. Moreover, the increasing cost of construction and contractors’ charges in line with inflation would increase capital expenditure for the projects, which have faced material time overruns. Another key issue the industry faces is timely approvals especially related to RoU/RoW as some projects have been stuck due to protests and political hindrances. These issues along with concerns related to gas supply and RLNG competitiveness have discouraged the players to start work on many already awarded projects. The regulatory reforms in the consuming sectors (like regular increase in LT power tariffs, introduction of time-of-day tariffs and use of gas based power plants for peak-load requirements, deregulation of domestic LPG prices etc) would be critical to improve the competitiveness of natural gas, especially RLNG against alternate liquid fuels. Besides, push from the GoI and state governments to ease process of approvals and land acquisition would be other key enablers for the natural gas transmission projects.
APTEL verdict could provide boost to the returns of transmission players; however, recent public consultation document of PNGRB for GAIL’s KG network reflect its conservative approach
In the past, gas transmission companies had been filing appeals in the Appellate Tribunal for Electricity (APTEL) against PNGRB orders due to materially lower tariffs approved by PNGRB than those proposed by the players. During Nov-2014, APTEL directed PNGRB to reconsider tariffs fixed for GSPL pipelines as GSPL had contested various parameters of the rate Target of building ~15,000 km of pipeline under national gas grid mission Constrained gas availability, competitiveness of RLNG and lack of clarity on initiatives like VGF could keep the interest of private players at low level Regulatory reforms are essential to improve competitiveness of RLNG Ease in process of approvals and land acquisition to be key enablers for gas pipeline projects ICRA Limited P a g e | 6 Executive Summary determination used by PNGRB, such as gas volume, inflation rate, capex, removal of future spur lines, treatment of number of employees and depreciation rate. The APTEL in its verdict emphasised that it is important for gas transmission players to achieve adequate returns (of 12% post-tax RoCE) in the interest of all stakeholders. The verdict of APTEL could set a precedent for similar litigations for GAIL’s pipelines and could improve profitability of the gas transmission industry. However, PNGRB has released public consultation documents regarding review of tariffs for GAIL’s KG pipeline network and Dabhol Bangalore pipeline in August 2015 and September 2015 respectively, amidst the litigation going on in APTEL for the same between GAIL and PNGRB. The PNGRB in its consultation documents has reiterated its approach of tariff setting by highlighting the differences in its normative values of the parameters (used in tariff determination) and the actual values submitted by GAIL. The consultation documents reflect that the upside revision in tariffs by PNGRB would not be easy despite the APTEL verdict as PNGRB may continue to follow its conservative approach to fix pipeline tariffs based on normative parameters which may be practically difficult to be met by the transmission players. Therefore, the litigation processes of appeals of gas transmission players against PNGRB could be stretched to higher judiciary levels (High Court and/or Supreme Court from APTEL) and may take a long time to settle. Thus, ICRA Research expects the profitability of transmission players to be subdued in the short to medium-term due to lower-than-expected pipeline tariffs approved by PNGRB as well as inadequate gas availability
Higher R-LNG imports to meet shortfalls in domestic gas production
Import of regasified natural gas in Q1 FY16 at 3.63 million metric tonnes (MMT) was about 21.4% higher on a yoy basis from 2.99 mmt in Q1 FY15 due to low international spot gas prices during Q1 FY16. R-LNG demand is expected to remain high in the near term because of the low natural gas production from the KG-D6 fields and limited upside in production expected from other fields. Over the medium to long term, even though domestic natural gas supply is expected to increase due to commercialization of new gas discoveries, the demand for RLNG will continue to derive support from i) sectors which have demonstrated the capacity to absorb higher priced gas like the industrial segment, ii) improvement in affordability of the fertilizer sector due to policy changes iii) the narrowing of differential between domestic gas and spot gas prices iv) increase in global RLNG supplies and v) setting up of several new R-LNG terminals thereby increasing the capacity to import gas.
Ease in global LNG supply demand to benefit Indian regasification terminals
Global LNG registered a demand CAGR of 5.6% over the past five year period from CY09 to CY14 due to increasing energy demand, production lagging demand in many countries, favourable economics vis-à-vis alternate fuels, increasing thrust by governments to use cleaner fuels and decline in the cost of liquefaction, regasification and transportation. Going forward ICRA research expects the global trade in LNG to grow at a CAGR of about 5% over the long term driven by increase in global demand, start up of new liquefaction capacities and commencement of imports by new markets. However LNG supply is expected to boost significantly during the period CY 2015 to 2017, on account of addition of several new liquefaction plants with Australia adding about 58 million tons and the US about 18 million tons of liquefaction capacity over the next three years which is expected to ease the supply demand situation over the long term. The ease in LNG market from CY 2015/16 onwards could significantly benefit the planned regasification terminals in India which are expected to come on stream by CY 2020.
Prices of Spot gas recover from earlier lows
Asian spot LNG prices currently at $8.0/mmbtu, have recovered from their earlier lows. However the start up of Japanese nuclear plants could reduce the demand of LNG which could have a dampening effect on the spot prices. Additionally current low crude oil prices at $ 48-50/barrel would also weigh on spot gas prices. However long term RLNG remains outpriced by competing fuels due to price floors linked to crude oil price averages or higher absolute crude oil prices. Accordingly customers are trying to renegotiate long term contracts with suppliers to defer volumes and repalce long term volumes with spot volumes. Moreover, to improve competitiveness, reagsification terminals are deferring purchase of long term contract volumes and replacing these volumes with cheaper spot gas.
Fall in the domestic gas prices to lead to improved economics of conversion to CNG; industrial PNG demand faces stiff competition from liquid fuels due to soft crude oil prices
Based on the recent trends in global gas indices, the domestic gas prices are expected to decrease from October 1, 2015, which would be passed on to the consumers by CNG players and would result in increase in cost advantage of gas even if crude prices were to stay at low levels. The lower domestic gas price will also support the PNG domestic segment sales which have traditionally been less competitive against subsidized LPG. Despite some increase in prices of industrial fuels in recent months, competitiveness of PNG (industrial) continues to remain weak partly due to relatively high long-term R-LNG price contracts and as a result, demand and margins of PNG (industrial) segment would remain under pressure in the near term.
Risk related to the PNGRB’s role in determining tariffs has been mitigated; aggressive bidding a key concern
The recent Supreme Court verdict which clarified that PNGRB does not have the powers to determine the network tariffs, compressions charges or in any other manner fix the prices for CGD companies with own network is also a major positive for the sector. It alleivates the regulatory risk and allows the CGD industry incumbents greater freedom to fix the final prices of CNG and PNG for consumers. ICRA also notes that with domestic gas allocation for CNG and PNG (d) segments in place, the CGD sector has seen heightened competition to win bids in the ongoing and forthcoming rounds. Most players have quoted near zero tariff in the recent rounds for key cities and the winner has been decided based on highest bid bond/performance bank guarantee quoted, the same was also high, at times, several times the net worth of the entities. Such a strategy could elevate the business risk of bid winners, if they were to slip up on meeting the minimum work programme (on pipeline laying and PNG-domestic connections) stipulated by PNGRB for each city, as the regulator can encash the bank guarantee. Moreover, competition from third party marketers can emanate over the longer term when domestic gas availability improves and regulations reach a mature stage, as the bid tariffs will be applicable for the entire license period of 25 years
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