GAIL's margins set for a boost

Cut in prices from Qatar-based RasGas to boost the company's profitability going ahead

Lower oil and gas prices may have been a boon for downstream companies, but it has been a dampener for the upstream and gas transmitter, GAIL. With spot prices of gas coming down, there were few takers for the higher-priced imported gas, thereby impacting the company’s transmission volumes as well as margins.

Using the same higher-priced imported LNG as a feedstock for the production of petrochemicals meant that GAIL’s profitability from the segment, too, took a hit. Thus, in a weak operating environment, the stock continued to underperform.

However, the buzz of lower imported gas prices has led to the stock gaining momentum. The government has sought a cut in gas price from Qatar-based RasGas to match the near 60 per cent slump in global gas rates in the last one year. Qatar is the country’s largest liquefied natural gas (LNG) supplier and India has a 25-year LNG supply agreement with it.

The price of imported gas based on an average of last few years came substantially higher to $13 per mBtu (million British thermal unit), whereas the spot prices have fallen to close to $7 per mBtu. This has been a major concern for GAIL, buyers and end-users. But, with new prices to be announced soon, GAIL’s transmission volumes, margins and petchem segments’ profitability will get a boost. The stock, which had declined sharply from Rs 530 levels in October last year to lows of Rs 260 in August 2015, has gained momentum and is trading at Rs 362 levels.

Sachin Mehta at Centrum Broking says, “The positive outcome on renegotiation of long-term RasGas contract with a reset in RLNG pricing mechanism would result in near reduction in gas prices by $5-6 per mBtu. This would immensely benefit GAIL’s petchem business and hence the positive stance and it also abates concerns on take-or-pay liability from RasGas contract.”

The take-or-pay liability has been one of the major concerns of the Street since the off-take of contract gas has been lower. Analysts at Nomura had observed that near-term investor focus will remain on RasGas take-or-pay issue.

Now, with the prices negotiated and looking at sharp declines in gas prices, the risks have been lowered. The analysts, who were already bullish on the stock, see low-risk of take-or-pay being implemented and believe that the impact would be lower even if take-or-pay is implemented. That’s because, GAIL has back-to-back contracts with its downstream customers and can recover the bulk of penalties/payments, if these are implemented.