Analysts’ Take On Draft Tariff Regulation For City Gas Distribution

The oil and gas regulator has issued draft regulations to determine tariff a third party or new entrant would pay for using a network to supply piped and compressed natural gas as India aims to improve penetration of the cleaner alternative to kitchen and auto fuel for curbing pollution.

That, according to analysts, may hurt profit of the nation’s three listed city gas distributors — Gujarat Gas Ltd., Mahanagar Gas Ltd. and Indraprastha Gas Ltd. — as competition will increase. But they await more clarity on the regulations to assess the extent of the impact.

The Petroleum and Natural Gas Regulatory Board on Wednesday notified draft regulation for determination of transportation rate for city gas distribution network and CNG segment.

According to the rules:

• For a geographical area that has been declared open post the marketing exclusivity period, the authorised entity shall estimate the transportation rate for city gas distribution and CNG.
• The methodology shall be cost of service considering 12% post-tax return on capital employed. Cost of service = operating cost + depreciation + return on capital employed (net fixed assets and working capital)
• Volume divisor used for tariff determination would be actual volumes transported within the city gas distribution network in the corresponding period.
• Rates would be determined every year latest by Sept. 30.

The regulator has invited public comments on the draft regulations by Oct. 14 and proposes to have an open house on Oct. 16 after which the regulations would be finalised.

Here’s what analysts have to say about the draft regulations:

Motilal Oswal

• The draft notification addresses aspects of tariff determination but key issues such as determination of capacity based on an entire geographic area/region and number of third-party competitors allowed to sell in a geographic area/region remain unanswered.
• While it is early to say in what form the final notification would come, it is difficult to estimate its impact on financials.
• Assuming competition takes away 20% of current sales volumes, it would result in a 12-14% impact on profit before tax and 9-11% impact on profit after tax.
• Gujarat Gas is top buy with a target price of Rs 360; neutral on Indraprastha Gas with target price of Rs 470; also has a buy rating on Mahanagar Gas with target price of Rs 1,200.

IIFL

• Does not see introduction of competition as a huge challenge to existing players.
• Computation of earnings impact is tricky due to limited disclosure by entities on capital deployed in each geography.
• Expects a 6%, 11% and 13% cut in earnings for Gujarat Gas, Indraprastha Gas and Mahanagar Gas, respectively.
• Weakness in city gas distribution is a good entry point. Gujarat Gas is top pick.

Kotak Institutional Equities

• Draft regulations set the stage to enable competition in city gas distribution business, wherein margins have remained elevated due to regulatory oversight and generous policy support.
• Sees material risks to profitability of extant players — Indraprastha Gas, Mahanagar Gas and Gujarat Gas — primarily in their compressed natural gas and industrial piped natural gas segments
• Expects 10-20% impact on profits of city gas distributors, if they were to provide open access for 20-30% of volumes on regulated rates.

Nomura

• The proposed tariff regulations are a positive for legacy city gas distribution players
• Expect city gas distributors to propose tariff only marginally below current gross margins; likely at much higher level than Indraprastha Gas’ earlier proposal for deciding its tariffs.
• With reserve network/CNG tariffs relatively high, there will be low risk of third parties seeking open access for CNG or domestic piped natural gas network for legacy city gas distributors.
• Indraprastha Gas remains top pick in India’s gas space with a target price of Rs 575, implying a 41% upside potential.