ICRA Rating Feature

Industry Outlook: Indian Downstream Natural Gas Sector

Contact: Summary Opinion

K. Ravichandran,
ravichandran@icraindia.com, The Indian natural gas market reported a significant increase in
+91-44-45964301 supply in 2009-10 with the KG D6 field of RIL going into production.
In fact, the actual supply could have been higher but for the capacity
Anjan Ghosh, constraints in the trunk pipelines. The large increase in supply has
aghosh@icraindia.com, been absorbed comfortably by the Indian market, reinforcing its
+91-22-30470006 significant growth potential. Going forward, ICRA expects domestic
natural gas supplies to increase to around 230 MMSCMD by 2018-
19, from the level of 145 MMSCMD in 2009-10.

May 2010
On the demand front, ICRA notes that the market is currently
well supplied with hardly any consumer (connected to the trunk
pipeline network) starved of gas. ICRA however believes that
demand will increase from new customers once the bottlenecks in
the trunk pipeline are cleared, which is expected to happen in the
near to medium term, given that the incumbents GAIL, RGTIL and
GSPL are expanding their capacities. Moreover, the regulator
PNGRB is likely to call for bids for newer trunk pipeline routes, which
should give the network an almost pan-Indian coverage in the next
five to seven years, in the process more than doubling the existing
trunk pipeline capacity.

ICRA believes the power and fertilizer sectors will remain the largest
consumers, provided natural gas prices remain competitive, since
both the sectors are highly price sensitive. Notwithstanding
competition from coal-based thermal power generation, hydroelectric
and nuclear power, the potential for gas consumption in the power
sector is so high that it can absorb the entire domestic supply
expected in the next decade from the current domestic discoveries.
As for the fertilizer sector, demand for natural gas should arise from
the conversion of existing liquid feedstock based urea plants and
from new projects. For the latter, it is imperative that the landed cost
of gas remain below US$6/MMBTU, as otherwise the project
economics would weaken, especially considering the extant subsidy
policy for new projects.
Website:
www.icra.in
ICRA Rating Feature

Refineries, industrial users and the CGD sector should account for the rest of the demand for
natural gas, with most of the demand expected to be met by R-LNG as domestic supplies of
natural gas may not be adequate in the foreseeable future. However, greater regulatory clarity
would be required if the CGD sector’s potential were to be realised, it may be mentioned that new
project activity has slowed considerably because of recent regulatory uncertainties.
Further gas price deregulation, especially measures to allow APM gas prices to move up to market
levels either in one step or gradually over a few years, could also serve the market well by
correcting the price expectations of consumers.
As for ICRA-rated companies in the Indian downstream natural gas sector, most of them are in the
process of implementing large capital expenditure (capex) programmes, given that the sector is
seen as one with good long-term demand prospects. While the large capex is a credit concern,
the’ demonstrated track record of executing projects of similar nature, comfortable capital
structure, regulated returns, and steady cash flows are the mitigating factors from the rating
perspective. As for CGD entities, access to gas at competitive rates will be critical, since the price
realised by them on CNG and PNG will be a function of the price of alternative fuels. In this regard,
companies with strong parents involved in the production and/or marketing of gas are better
placed to source gas at competitive rates.

Table 1: ICRA’s Portfolio of Rated Downstream Natural Gas Companies

Company Ratings Outstanding*
GAIL (India) Limited LAAA
Petronet LNG Limited LAA, Ir AA and A1+
Mahanagar Gas Limited LAAA
Indraprastha Gas Limited LAAA and A1+
Sabarmati Gas Limited LA+
Adani Gas Limited LBBB and A2
Siti Energy Limited LB+ and A4
*As on May 11, 2010

Despite new domestic supplies, market should be in deficit in the foreseeable

future because of increasing demand from several sectors
The Indian natural gas market saw an unprecedented 65% increase in gas supplies in 2009-10 with RIL
commencing production from its KG basin D6 block, in the process pushing up supplies from domestic
fields to around 145 MMSCMD, from 87 MMSCMD in 2008-09. With KG D6 going on stream, RIL became
the largest producer of natural gas in the country, a position held till then by ONGC for over five decades.
Going forward, ICRA expects domestic natural gas supplies to increase to around 230 MMSCMD by 2018-
19, from around 145 MMSCMD in 2009-10. Besides RIL’s KG D6 field, the other sources which will
contribute towards supply increase include: KG basin satellite fields (owned by RIL consortium); NEC field
(RIL consortium); Deen Dayal block in KG basin (GSPC consortium); KG-DWN-98/2 (ONGC); and MN-
DWN-98/3 (ONGC). Further, ONGC is expected to begin gas production from several small and marginal
fields that have been given to it on nomination by GoI. However, given that the output from the existing
fields of ONGC has been falling by 7-8% annually, ICRA does not expect significant net additions to
production by ONGC from the nominated fields.

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Chart 1: Estimates for NG Supplies from Domestic Fields

250.00

200.00

150.00
MMSCMD

100.00

50.00

0.00

ONGC—Nominated OIL—Nominated Others—Existing

RIL—KG D6/Satellite/NEC GSPC—KG Basin ONGC—KG basin/Mahanadi
Others—New

Source: ICRA’s estimates

On the demand front, despite the significantly high potential across several sectors, ICRA notes that the
realisable demand for natural gas will be a function of gas supplies in the market, the price competitiveness
of gas vis-à-vis alternative fuels, timely commissioning of the proposed transmission pipeline infrastructure,
and some regulatory initiatives in power sector. If the last two factors materialised, ICRA would expect gas
demand to rise to around 390 MMSCMD within a decade (i.e., by 2019-20) from the actual consumption of
around 170 MMSCMD in 2009-10. Refer Charts 2 and 3 for the sectoral mix of gas consumption.

Chart 2: NG Consumption by Sectors (170 Chart 3: NG Consumption by Sectors (395

MMSCMD) in 2009-10 MMSCMD) in 2019-20 (Estimated
Power Power
8 9
Fertilizers
43 Fertilizers
24
66 CGD CGD
56 185
23 Petrochem/Refinery/IC Petrochem/Refinery/IC
26
7 Industrial + Captive Industrial + Captive
Power Power
76
42 Steel Steel

Source: Industry Source: ICRA’s estimates

The factors that ICRA sees as driving the demand for natural gas in the various consuming sectors over
the medium to long term are discussed in the following sections.

Power
The cost of power from domestic natural gas being competitive (refer Chart 4), several power utilities have
been seeking gas allocation from GoI. According to market participants, gas allocation requests from State
Governments and companies planning to set up greenfield power plants and expanding existing ones add
up to a total requirement of around 250 MMSCMD. Besides, the MOP has sought allocation of around 135
MMSCMD for its projects to be commissioned during the Eleventh Plan (2007-12) and early Twelfth Plan
(2012-17) periods. While thermal power plants located at pitheads or those using imported coal and located
in the coastal regions may be able to generate power at a lower rate vis-à-vis gas-based power projects,
there are several advantages of using gas as fuel: shorter gestation (for setting up a power plant), higher
thermal efficiency, greater ability to meet peak load requirements, and minimum greenhouse gas

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emissions, among others. With the focus increasing on the environmental factors and given India’s
voluntary commitment to reduce carbon emissions by 20% over the 2005 levels by 2020, ICRA expects the
thrust on setting up gas-based power plants to increase further. The other key drivers of gas demand in the
power sector could be distributed co-generation plants (i.e. combined cooling, heating and power plants)
and peaking power plants, if the enabling regulatory support comes through.

Chart 4: Variable Cost of Generating Power from a CCGT Plant at Various Gas Prices

3.5

2.5
Rs/Kwhr

1.5

0.5

0
4 5 6 7 8 9 10
Landed cost of gas (US$/MMBTU)

Notes: (i) Heat rate assumed at 2,000 Kcal/Kwhr

(ii) Levellised fixed costs could vary from Re. 0.70 to Re. 1/Kwhr, depending on capacity and make of
machines
Source: ICRA’s estimates

Fertilizers
The fertilizer sector, particularly the urea segment, has been accorded the highest priority in the allocation
of RIL’s KG D6 gas, in view of the potential for subsidy savings. Going forward too, ICRA believes the
fertilizer sector will get the highest priority, given the country’s steadily declining self sufficiency in key
fertilizers and intermediates such as urea and ammonia, and its increased focus on augmenting food
security. The fertilizer sector is expected to require an estimated 44 MMSCMD during the period 2009-
2013, with the demand coming from: (i) conversion of naphtha-based plants (8.12 MMSCMD); (ii)
conversion of FO-based plants (3.75 MMSCMD); (iii) expansion and revamp projects (13.90 MMSCMD);
and (iv) revival of FCI and HFC’s plants (17.6 MMSCMD). ICRA however notes that while demand from the
first two sources is more or less certain, that from the latter two is contingent on some refinements in the
subsidy policy for brownfield and revival projects. This is so because the extant policy could lead to
suboptimal returns for fertilizer companies when the prices of imported urea rule at the lower end of the
price band1. Consequently, the players contemplating such projects—such as IFFCO (at Kalol, Gujarat),
KRIBHCO (at Hazira, Gujarat), Indo-Gulf (at Jagdishpur, Uttar Pradesh), RCF (at Thal, Maharashtra),
Chambal (at Kota, Rajasthan) and Tata Chemicals (at Babrala, Uttar Pradesh)—have been going slow on
their plans, pending improvements in the policy. Moreover, it is imperative that the players contemplating
brownfield or revival projects source gas at competitive rates so that they can achieve meaningful returns
on their large project investments. Given that the gas from RIL KG D6 has already been allocated up to 90
MMSCMD (including on fallback basis), the fertilizer companies will have to obtain allocation from new
domestic supplies, as R-LNG would not be competitive, especially at higher crude oil prices. For instance,
the production cost of urea would cross US$250/tonne at gas prices beyond US$6/MMBTU (refer Chart 6).
Thus, in a scenario of higher gas prices and lower IPP of urea, the economics of a brownfield project would
turn weak (refer Chart 5).

1
The price band, as suggested by the current policy, is US$250-425/tonne. According to the existing subsidy
policy for brownfield projects, the total realisation has 90% linkage to the Import Parity Price (IPP), subject to a
floor and cap of US$250/tonne and US$425/tonne respectively. The subsidy is the difference between the total
realisation and the farm gate price of urea. For total realisation, IPP is computed as the sum of the f.o.b. price
and oceanic freight, without any incidental port charges.
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Chart 5: Urea Brownfield Project IRR with Landed Chart 6: Cost of Production of Urea from a
Cost of Gas at US$6.50/MMBTU Brownfield Project at Various Gas Prices
30.00% 350 332
311

Cost of production (in US$/tonne)

25.36% 290
300 269
25.00%
248
Project IRR (Pre-Tax)

250 227
20.00%
16.24% 200
15.00%
150
10.71%
10.00% 7.88% 100

5.00% 50

-
0.00%
5 6 7 8 9 10
250 300 350 425
Landed cost of gas (US$/MMBTU)
IPP of urea (US$/tonne)

Note: The key assumptions for the above are: Project cost at Rs. 42 billion for a 3,500 tpd urea plant;
Energy consumption at 5.2 Gcal/tonne of urea; LCV of gas at 8,100 Kcal/m 3; Rs. versus US$ at 45 is to 1
Source: ICRA’s estimates

Industrial, Transport and Residential Users

Gas demand from industrial users is expected to arise primarily from the replacement of liquid fuels and
premium gaseous fuels such as naphtha, HSD, FO, LSHS, LPG and pentane for captive generation of
power and steam and for oven heating. In States such as Gujarat, which score high on both pipeline
connectivity and gas availability, a significant number of industrial users have converted to natural gas,
buying PNG from the CGD companies. ICRA expects this process to get accelerated in industrial clusters
in other States as well, given that the CGD companies are expanding their network following the
improvement in gas availability. Apart from industrial users, demand from the transport and residential
segments should drive growth for the CGD companies, with each city consuming between 0.5 and 4
MMSCMD, depending on the population, vehicle density, and extent of industrialisation (refer section on
the CGD business on page 9).

Refineries
Traditionally, refineries have been using their own fuels such as naphtha, FO and LSHS to fire their captive
power plants. They also consume significant quantities of naphtha to generate the hydrogen that is used in
various secondary processing units. In recent years, following the sharp rise in the prices of petroleum
products, substituting natural gas with these fuels/feedstock has made greater economic sense, and
refineries can make net savings post-conversion even if they were to export the replaced liquid fuels.
Besides, with stringent refinery emission norms being implemented, the refineries are under compulsion to
use cleaner fuels in their power plants and fired heaters. Some refineries have been meeting these norms
by using low sulphur crude, although this could negatively impact their GRM, low sulphur crude traditionally
being costlier than high sulphur crude. Overall, given the tangible benefits of using natural gas, ICRA
expects the demand for the same from the refinery segment—both the existing refineries and the new ones
being set up2—to increase significantly over the medium term from the currently low levels. It is expected
that consumption of natural gas would range from 3 to 12 MMSCMD per refinery, depending on its capacity
and complexity.

Petrochemicals
In the recent past, almost all gas-based petrochemical producers in India, such as RIL, GAIL, RCF, GNFC,
GSFC and Deepak Fertilizers, have experienced shortages in natural gas, which have been partly met from
the allocation made out of KG D6 gas. In addition to the existing unmet demand, incremental demand
should emanate from the expansion projects of existing players such as GAIL (gas cracker expansion at
Pata), and from new projects such as those of ONGC (C2-C3 extraction plant at Dahej, Gujarat, from
LNG), and Brahmaputra Cracker and Polymers (gas cracker in Assam).

Prospects for LNG in India appear good with domestic gas supplies likely to
fall short of demand
Given that domestic supply of natural gas would not be adequate to meet demand over the medium to long
term, the country would have to rely on either LNG or gas sourced through transnational pipelines to meet
a part of the incremental demand. Since there has not been much progress on the proposed Iran-Pakistan-
India (IPI) pipeline and the Turkmenistan-Afghanistan-Pakistan-India (TAPI) pipeline, the analysis here
focuses only on the opportunities in the LNG space in the Indian market. For over six years now, India has

2
According to ICRA’s estimates, Indian refinery capacity is expected to increase to around 250 MMTPA by the
end of 2012-13, from 178 MMTPA in 2008-09.
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been using R-LNG, with the country currently having two operational terminals at Dahej (owned by
Petronet LNG Limited, or PLL) and Hazira, Gujarat (owned by Shell Hazira LNG). Going forward, additional
LNG will be available following expansion of the existing terminals at Dahej and Hazira, completion of the
partially built terminal at Dabhol (Maharashtra), and establishment of greenfield terminals. As for greenfield
ventures, the Kochi (Kerala) terminal project by PLL is under way, while the Mundra (Gujarat terminal (by
GSPC-Adani JV) is a possibility in the next three to four years. Besides, terminals are proposed in
Mangalore, Karnataka (by ONGC) and Ennore, Tamil Nadu(by IOC), although they are still in the planning
stage.

A key issue for all these new terminals however is their ability to tie up LNG supplies through long-term
contracts at competitive prices. In the case of PLL, LNG has been tied up for 7.50 MMTPA on long-term
contract for the Dahej terminal, against the terminal’s nameplate capacity of 10 MMTPA; the company will
use the balance capacity to regassify spot LNG. For the Kochi terminal, PLL has tied up to the extent of
around 1.44 MMTPA on long-term contract, against the terminal’s capacity of 2.50 MMTPA. As for Shell, it
has been using its Hazira terminal exclusively for regassifying spot LNG as part of its global business
strategy. For the other terminals (Dabhol and Mundra), LNG is yet to be tied up on a long-term contract
basis. Overall, the total LNG contracted on long-term basis is only 31.30 MMSCMD as on date, as against
the projected cumulative capacity of 100.45 MMSCMD of these terminals.

Table 2: Projected LNG Capacity in India

(in MMTPA) 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 2018-19 2019-20
PLL Dahej 10 10 10 10 10 10 10 10 10 10
PLL Kochi 0 0 2.5 2.5 2.5 5 5 5 5 5
Shell Hazira 3.7 3.7 3.7 3.7 3.7 3.7 3.7 3.7 3.7 3.7
Dabhol 5 5 5 5 5 5 5 5 5 5
Mundra 0 0 0 5 5 5 5 5 5 5

Total capacity 18.7 18.7 21.2 26.2 26.2 28.7 28.7 28.7 28.7 28.7
Possible supplies at 100% capacity (MMSCMD) 65.45 65.45 74.2 91.7 91.7 100.45 100.45 100.45 100.45 100.45
Note: 1 MMTPA= 3.50 MMSCMD of LNG
Source: ICRA’s estimates

ICRA’s analysis indicates that there could still be fair demand for spot LNG, given that domestic supplies
and the volume of LNG on long-term contracts may not be sufficient to meet domestic demand. ICRA
however notes that, in practice, there could be a temporary glut in a few pockets, as has been observed in
the current fiscal, because of pipeline capacity constraints and the lack of a balanced developed market for
natural gas in India. ICRA believes the trunk pipeline capacity constraints will get addressed in the near to
medium term (refer section on gas transmission pipelines on page 8), given that GAIL, RGTIL and GSPL
are either expanding their capacities or setting up pipelines in the regions not served so far. Thus, the
demand for LNG should be favourable, with LNG sourced either under long-term contract or spot, in the
coming decade.
Chart 8: Potential for New Regassification
Chart 7: Estimated Demand for R-LNG Terminals
450.0 160
400.0 140
350.0 120
MMSCMD
MMSCMD

300.0 100
250.0
80
200.0
60
150.0
100.0 40
50.0 20
0.0 0

Gas Deficit Untied LNG capacity

Supplies from domestic fields LT contract R-LNG Gas Deficit

Source: ICRA’s estimates Source: ICRA’s estimates

Note: Gas Deficit =Total estimated demand for gas Supplies from domestic fields LNG
supplied through long-term contracts

ICRA notes that demand for R-LNG is price-sensitive and believes domestic gas will continue to be
cheaper than R-LNG. Hence domestic gas would be the first choice for price-sensitive consumers in the
power and fertilizer sectors. However, as domestic supplies of gas would be limited in relation to the
demand from these consumers, part of the residual demand would have to be met with the more expensive
R-LNG. Also, incremental demand from the other major consuming segments might be met primarily from
R-LNG. A key risk to this expectation is the possibility of any further large gas discovery being made in the
country. This risk would however be partly offset by: (i) the long lead time for commercialisation from the
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date of discovery, which can be anywhere

from three to eight years, depending on the Chart 9: Demand from Power and Fertilizers Sectors
nature of the field, that is, onshore, shallow vs. Gas Supplies from Domestic Fields
water, or deepwater; and (ii) the potential for 300
additional demand for domestic gas from 250
several power sector consumers to the

MMSCMD
200
extent of around 385 MMSCMD.
150

In the light of the demand-supply situation 100

anticipated, ICRA expects the prospects for 50

third-party marketers of natural gas to be 0
good in the long term. However, ICRA also
believes that marketing margins could
undergo a modest downward revision for Demand from Power+Fertilizers Total supplies from domestic fields
companies that go by the prevailing
demand-supply status of natural gas to Source: ICRA’s estimates
determine their marketing margin, given the
emerging scenario of increasing supplies.

Changed global LNG market dynamics present opportunities for Indian players
to source LNG at competitive rates
The global LNG market is expected to witness significant capacity additions over the next few years.
According to industry sources, global liquefaction capacity is expected to double to around 360 MMTPA by
2015/16 from the level of 184 MMTPA in 2008. Seven countries, viz Qatar, Russia, Iran, Yemen, Angola,
Peru and Algeria, are expected to account for around 86% of the total capacity addition envisaged. On the
regassification front also, capacity additions are reported to be robust with regassification capacity
additions being higher than the additions to liquefaction capacity.

On the demand front however, there have been significant developments in the recent past that have
changed the industry dynamics. These include lower demand for LNG because of global economic
slowdown, large shale gas discoveries in the US market, and the “wait-for-a-better-pricing” attitude adopted
by the LNG project developers. Thus, LNG demand slowed down considerably in 2009 from the CAGR of
6% reported previously. On the supply front, the US market has seen significant additions 3 via development
of unconventional gas resources, such as shale gas. The development of these reserves was hampered in
the past by technological challenges. However, with the development of the horizontal drilling technique,
the dynamics of the industry have changed, pushing up gas production in the USA and thereby lowering
demand for imported LNG. Because of these developments, gas prices, as reflected by the Henry Hub gas
prices, have not moved in line with crude oil prices. While oil prices have slightly more than doubled since
their lows in 2009, gas prices have barely moved. These developments have also impacted spot LNG
prices. Because of the weak sentiment (low price expectations from the buyers’ side), several LNG project
developers have been reluctant to sign long-term contracts. As a result, some of the developers have
preferred to either sell LNG in the spot market, or sign only short- to medium-term contracts, waiting for an
opportune moment for long-term contracts. Since several such projects are there in the market, spot LNG
prices have been ruling low, in the region of US$4-6/MMBTU in the recent past, which is lower than the
prices of competing liquid hydrocarbons derived from crude oil.

ICRA believes the changed market dynamics present attractive opportunities for Indian companies to sign
long-term contracts, given that the developers may not be in a position to wait for long because of
pressures from project financiers. Besides, Indian terminals should be in a position to contract spot LNG or
LNG with short- to medium-term contracts at competitive rates.

As for the prospects of Indian regassification terminal operators, their credit risk profile would be influenced
largely by how the key risks involved in the business, such as LNG price risk, LNG offtake risk, LNG
transportation risk, take-or-pay liabilities, and project construction risks, are addressed by their business
model. If these risks are addressed adequately, the earnings would be largely predictable as regassification
charges are worked out on a “normative cost plus return” basis.

APM gas price deregulation imminent, augurs well for market development
over the long term
Currently, the domestic gas market consists of both price-controlled gas (APM gas) and free-market gas.
Although the proportion of free-market gas has reported a large increase (to around 67% in 2009-10 from

3
Gross In Place Reserve (Shale and CBM) Estimates: 700 TCF. Recent additions to proved reserves are
approximately 30 years of annual production.
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50% in 2008-09) particularly after the commencement of sales from RIL’s KG D6, the volume under price
control remains high in absolute terms (around 58 MMSCMD). While the GoI had initiated measures to
deregulate APM gas prices in 2005, there has not been any upward price revision since then other than for
CGD companies, although significant Chart 10: Prices^ of Gas from Select Domestic Sources
background work (study by tariff 8
commission and inter-ministerial 7
6.69
consultations) had been done to justify 5.85 5.69
6 5.5 5.5

US $/MMBTU
price revision. Notwithstanding the fact 5 4.4 4.34 4.46
that the domestic market has by now got 4 3.6
2.97
used to free-market pricing, in ICRA’s 3

opinion, any further upward revision in 2

1
APM gas prices would help in the
0
development of the domestic gas market,
given that end-consumers would get
accustomed to more realistic pricing.

ICRA also notes that the domestic ^

natural gas market is marked by the Landfall point prices, which are exclusive of taxes and
presence of several pricing levels (as transmission charges
many as 22). To offer a stable pricing Source: Industry
regime, the GoI is reported to be considering adopting a uniform pooled price for either all consumers, or
for select consumers such as power and fertilizer companies. In the event of the second option being
adopted, ICRA believes concerns over marketing high-priced LNG (from RasGas, Qatar, sourced by PLL
on a long-term contract) by the marketers (GAIL, IOC and BPCL) would abate, as the pooled price would
be considerably lower than the LNG price because of weighted averaging with the cheaper domestic gas.

Table 3: New Trunk Pipelines Projects

Gas transmission pipeline capacity set to more Company Kms
than double in next five years; however, gas supply GAIL
tie-ups to be critical for achievement of regulated Dadri-Bawana-Nangal 621
margins Chainsa-Jhajjar-Hissar 443

India’s current gas transmission pipeline length is estimated at 10,500 Dahej-Vijaipur-GREP upgrade 1108

km (GAIL: 7200 km; GSPL: 1,420 km; RGTIL: 1,386 km; Oil Dabhol-Bangalore 1389
India/AGCL: 500 km), and it has a capacity of around 270 MMSCMD. Kochi-Mangalore-Bangalore 1114
Although the capacity per se appears high in relation to the current Jagdishpur-Haldia 2050
gas availability in India, there are several bottlenecks in the existing RGTIL
infrastructure that prevent some potential end-users from being able Kakinada-Basudevpur-Howrah 1100
to consume gas. Such bottlenecks include almost full capacity Kakinada-Chennai 600
utilisation of a few arterial pipelines and lack of balanced development Chennai-Tuticorin 670
of the pipeline infrastructure across India. As for capacity utilisation, Chennai-Bangalore-Mangalore 660
HVJ and DVPL of GAIL have been operating at almost full capacity GSPL
during the last one year, thereby preventing any further transmission Gujarat expansion 780
for end-users in the northern part of India. At the same time, GAIL has IOC (Dadri-Panipat) 133
a few regional pipelines in States/areas like Gujarat, Rajasthan, OIL/AGCL 300
Mumbai, the Cauvery basin and Assam, which operate at less than Under PNGRB bid/EOI submitted
optimum capacity utilisation for want of gas. Also, the pipeline network Mehsana-Bhatindia 1670
in India currently covers mainly the western, central and northern Bhatinda-Jammu-Srinagar 740
parts, with the network being limited in southern and eastern India. Surat-Paradip 1680
Even within western, central and northern India, there are several Mallavaram-Vijiapur-Bhilwara 1585
cities that are yet to be connected. As a result, the market has Durgapur-Kolkata 160
developed only in areas that are in proximity to the existing pipeline Total 16803
network. Going forward, ICRA expects this scenario to change, given Source: Public announcement of the
that the incumbents have announced large projects (estimated capex companies concerned and PNGRB
of Rs. 500 billion) to expand their coverage. Besides, the regulator
PNGRB has also called for bids for a few new pipelines in regions
hitherto not served.

As for the impact of PNGRB regulations on the profitability of new trunk pipeline projects, ICRA notes that
the extant regulations provide for a return of 12% (post tax) RoCE, on normative cost, subject to the
pipelines attaining normative capacity utilisation. Hence, the key risk factor for the new pipelines would be
the adequacy of gas tie-ups. In this regard, all the three players (viz. GAIL, RGTIL and GSPL) face some
risk, since the pipeline-wise visibility of gas tie-ups is absent at this juncture. Hence, the players may not be
in a position to achieve the normative returns in the initial few years, which may however be made up for in
the subsequent years as the volume scale-up happens.
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Prospects for CGD business appear good for the medium to long term; recent
regulatory uncertainty could however slow down momentum in the near term
As of now, CNG is available in 40 cities in India, where considerable conversion has happened from the
traditional auto fuels such as MS and HSD. The conversion has been driven primarily by the heavy users
such as buses, taxis and auto rickshaws, who have found the savings potential of CNG use attractive.
Moreover, courts/states mandated conversions have also materialised in few cities. The prices of
conversion kits have also declined by 20-25% during the last few years, making the switch to natural gas
more economical; the savings potential is encouraging private vehicles to convert as well. Importantly, even
with CNG being sold at market determined rates (Rs. 25-45/kg in most cities, other than Mumbai and
Delhi4), demand has held its ground, underscoring the improving economics of conversion. Sale of PNG
(domestic, commercial and industrial) has also gained traction because of the discounted-price strategy of
the CGD players, wherein they sell PNG at a discount to the prices of alternative fuels to attract
consumers.

ICRA expects the prospects for the CGD business to remain good in the long term, given the under-
penetration of city gas in India in the absence of adequate gas and transmission pipeline capacity.
However, ICRA hastens to add that access to cost-competitive gas will hold the key to profitability for CGD
players, as the net sale realisation on CNG and PNG will be a function of the price of alternative fuels. In
this regard, ICRA believes companies with strong parents involved in gas production and/or marketing are
better placed to source gas at competitive rates and ride out the occasional volatility associated with gas
trading margins.

The regulations governing the CGD sector, formulated by PNGRB, are also attractive for the existing CGD
players in that they propose a normative return of 21% (pre-tax) RoCE, network exclusivity for 25 years,
and marketing exclusivity for five/three years for new players/incumbents, respectively. Under the new
regulations, PNGRB had invited bids in 2009 for 13 cities in two rounds, against which licences have been
awarded for six cities5 in the first round; licences are awaited for the balance seven6. The bidding witnessed
high competition for few cities known to have good potential, with a few bidders quoting either zero or a
nominal network tariff to win bids, thereby diluting the network-investment returns available to incumbents
in the cities where CGD players already operate. ICRA believes such a strategy could expose the
aggressive bidders to competition once the exclusivity period is over; any third-party marketer could use
the network of the successful bidder free of cost and sell gas to current or new customers in the region.
ICRA understands that the players who had adopted such an aggressive bidding approach could be
banking on cross-subsidy from the gas trading margin, which is not regulated. Besides, they could be
relying on the strategy of creating entry barriers 7 for third-party marketers, the success of which appears
uncertain, given that the regulator may well disallow such practices. Moreover, the ability to achieve
sufficient marketing margin is also uncertain, in view of the lack of control over the prices of gas and
alternative fuels and the slow scale-up of volumes. Given these considerations, ICRA expects the recent
entrants, who have come in through the bidding route, to face significant business challenges, even as the
long-term profit outlook for the incumbents appears good.

With the gas transmission pipeline capacity poised for growth in future, the regulator has also laid a
roadmap for increasing the penetration of city gas to 335 cities, the bids for which are expected to be
announced in the near to medium term. However, in this regard, the recent Delhi High Court interim and
final orders8 stating that without notification of Section 16 under the Petroleum and Natural Gas Regulatory
Act, 2006, the regulator PNGRB is not legally entitled to grant authorisation to CGD entities, has come as a
setback for the sector and slowed down investments. Unless this issue is expeditiously resolved, the
process of authorising entities for the new cities could get delayed, and offtake of natural gas by the CGD
entities could be lower than what the potential suggests.

4
CNG prices are lower in Mumbai and Delhi because of APM gas allocation and certain tax concessions given
by the State Governments concerned.
5
Kota (Rajasthan), Dewas (Madhya Pradesh), Sonepat (Haryana), Meerut (Uttar Pradesh), Mathura (Uttar
Pradesh) and Kakinada (Andhra Pradesh)
6
Ghaziabad (Uttar Pradesh), Allahabad (Uttar Pradesh), Jhansi (Uttar Pradesh), Rajahmundry (Andhra
Pradesh), Yanam (Pondicherry), Shahdol (Madhya Pradesh), and Chandigarh (Punjab).
7
Such as denying access at vantage points in the network and allowing access only in un remunerative areas
8
In the context of the cases filed by IGL and an NGO.
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ICRA Rating Feature

ANNEXURE

LIST OF KEY ABBREVIATIONS USED IN THE REPORT

AGCL Assam Gas Company Limited

APM Administered Pricing Mechanism
BPCL Bharat Petroleum Corporation Limited
CBM Coal Bed Methane
CGD City Gas Distribution
CNG Compressed Natural Gas
FCI Fertilizer Corporation of India Limited
FO Fuel Oil
Gcal Giga Calories
GNFC Gujarat Narmada Valley Fertilisers Corporation Limited
GoI Government of India
GRM Gross Refining Margin
GSFC Gujarat State Fertilisers and Chemicals Limited
GSPC Gujarat State Petroleum Corporation Limited
GSPL Gujarat State Petronet Limited
HFC Hindustan Fertilizer Corporation Limited
HSD High Speed Diesel
IFFCO Indian Farmers Fertilisers Co-operative
IC Internal Consumption
IGL Indraprastha Gas Limited
IOC Indian Oil Corporation Limited
KG Krishna Godavari Basin
KRIBHCO Krishak Bharti Co-operative
LCV Lower Calorific Value
LDO Light Diesel Oil
LNG Liquefied Natural Gas
LPG Liquefied Petroleum Gas
LSHS Low Sulphur Heavy Stock
MMBTU Million Metric British Thermal Unit
MMSCMD Million Metric Standard Cubic Metres Per Day
MN-DWN Mahanadi deepwater basin
MOP Ministry of Power, GoI
MoPNG Ministry of Petroleum and Natural Gas, GoI
MS Motor Spirit
NEC North Eastern Coast
NG Natural Gas
NGO Non Government Organisation
OIL Oil India Limited
ONGC Oil and Natural Gas Corporation Limited
PNG Piped Natural Gas
PNGRB Petroleum and Natural Gas Regulatory Board
RCF Rashtriya Chemicals and Fertilisers Limited
RGTIL Reliance Gas Transportation Infrastructure Limited
RIL Reliance Industries Limited
R-LNG Regasified Liquefied Natural Gas
RoCE Return on Capital Employed
RoE Return on Equity
tpd Tonnes per day

May 2010

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ICRA Rating Feature

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