New entrants unlikely to impact gas distrbution players till FY23

The draft regulations requires the CGD players to provide third-party access at regulated tariffs

Draft regulations by the Petroleum and Natural Gas Regulatory Board (PNGRB), for third parties, has once again put the spotlight on competition.

These norms, drafted by the oil and gas regulator, pertain to transportation tariffs for third parties that use the city gas and compressed natural gas (CNG) distribution network of existing players.

Legacy city gas distribution (CGD) players Indraprastha Gas (IGL), Mahanagar Gas (MGL), and Gujarat Gas have exclusivity in their area of operations. After expiry of the exclusivity period, pipeline infrastructure of these firms can be shared by new entrants.

These norms apply only to legacy distribution areas, and not to distribution areas awarded under auction rounds. Share prices of incumbent players took a hit on Thursday. Analysts, however, don’t see an impact till 2022-23 (FY23) and say the hit may not be as hard as feared even after that point.

PNGRB’s draft regulations require CGD players to provide third-party access at regulated tariffs, which will be computed separately for CGD and CNG to yield a post-tax return on capital employed (RoCE) of 12 per cent (on net fixed assets).

The regulator has differentiated between compressed gas — which involves higher compression charges compared to piped natural gas (PNG) — and industrial gas.

Analysts at Nomura say an assured 12 per cent post-tax RoCE would be attractive for legacy CGDs. The fact that tariffs will be based on the cost of services calculated by CGDs themselves is another key positive.

However, some impact of competition, and the resulting hit on volumes and earnings of CGD players is expected. This is despite any impact being a few years away.

Yogesh Patil, analyst at Reliance Securities, says there could be a 16-17 per cent impact on earnings of IGL, MGL, and Gujarat Gas, but only after FY23. Gujarat Gas remains Patil’s top pick, given its high exposure to industrial gas.

Notably, not all analysts anticipate such a deep impact, referring to the projection of 20 per cent fall in volumes for incumbents. Many analysts say such steep impact will not be felt, citing the international arena in which the impact on volumes has been 10 per cent after 5-7 years of the entry of new players.

Further, in India, the timeline for setting up a CNG station or other infrastructure after securing all approvals is much longer than overseas.

What’s important is that the domestic market remains under-penetrated, and there are many opportunities prevailing outside the key regions of Delhi, Mumbai, and Gujarat, where legacy firms operate. As a result, competition has multiple geographies to choose from, rather than compete with established players in their bastions.

In addition, the legacy firms are expanding to other regions and winning new bids, which will drive volumes and offset the impact of potential competition. Public sector oil-marketing companies (OMCs) like Bharat Petroleum, Hindustan Petroleum, and Indian Oil may consider entering CNG distribution, even though they are already getting a share of the profit by partnering CGDs.

OMCs also hold stakes in many of the legacy CGDs. Further, the CNG business is much smaller for OMCs, who earn significant profits from oil refining and marketing, says Probal Sen of Centrum Broking.

Therefore, Sen does not expect CGDs to feel extreme heat as anticipated by some, and says that factoring in the competition CGDs are already trading at 17-20x their forward earnings. He expects IGL and Gujarat Gas to gradually rerate to a one-year forward P/E of 20-25x.

Motilal Oswal Securities affirms Gujarat Gas as its top pick, which could receive a huge volume boost from pollution-curbing initiatives.

IGL, MGL, and Gujarat Gas, which have been subdued in recent weeks, corrected 0.8-3.7 per cent on Thursday, while the Sensex was down 2.92 per cent.