Opportunities for long-term investors in natural gas

Low domestic production in the past three financial years has forced a change of perspective in the industry and among consumers

For the past two years, the decline in gas production at Reliance Industries Ltd's (RIL's) KG-D6 offshore block has been making headlines. Production has fallen drastically over that period and there have been lots of controversy over the gas repricing. This has forced a change in sourcing patterns for the gas industry.

In March 2010, production from KG-D6 hit 69 million standard cubic metres a day (mscmd). Projections suggested production would eventually peak at around 80 mscmd. In FY 2010-11, production averaged 56 mscmd, 45 per cent of total domestic output.

Sadly in 2011-12, production from KG D6 dipped to 43 mscmd. In 2012-13, it fell again, to 26 mscmd. By December 2013-14, production was just a little above 10 mscmd.

The fall in domestic gas production has had severe consequences downstream. Many downstream players had undertaken expansion on the basis of those optimistic projections. The gap between domestic demand and domestic supply is 60-70 mscmd and likely to grow.

There is also pricing. Downstream consumers, particularly in power and fertilisers, calculated consumption and margins, assuming prices of about $2.5 per million British thermal units (mBtu). After April 2014, that might be above $8 and imports even more expensive.

About 40,000 Mw of gas-based power capacity is stranded as a result. Domestic supply is unavailable and these plants wouldn't be financially viable on the basis of imports. That means lenders to these projects take a massive hit, to say nothing of the promoters.

This is bad news of course. But there are also some opportunities arising from the need to find alternative sources of supply. Consumers are now making plans and projections on the basis of more reasonable pricing, closer to global prices.

The city gas distribution market for instance, has bidders for long-term licences. Household consumption is bound to rise. Transport will be another key growth segment. Environmentally clean gas is the preferred fuel for public transport, including buses, auto-rickshaws and cabs.

Global gas prices vary large amounts by region. Most bulk consumers try to tie up long-term deals. Transportation is expensive and there might often be a need for liquefaction, followed by re-gasification. Liquefied natural gas (LNG) tankers and facilities are also expensive.

The only way to plug the demand-supply gap in the short term is via imports. This has interesting implications. There are two reasonable ways to import gas and consumers who buy this will have to brace to pay market prices, or close to it.

One route for import is overland, via pipelines from Central Asia, or Bangladesh. Pipelines are relatively cheap but long-gestation. This option is difficult to take seriously due to geopolitics. The Turkmenistan-Afghanistan-Pakistan-India (TAPI) pipeline is supposed to be operational by 2018 and various agreements have been signed. But Af- Pak instability and the Pakistan-India relationship implies TAPI will always be liable to disruption. The Indo-Bangladesh relationship is also difficult and a strong Bangladeshi lobby is reluctant to export gas to India.

The other mode, LNG imports by sea, is much more feasible. Petronet, for example, already has operating LNG terminals on the west coast at Dahej (Gujarat) and Kochi (Kerala). It is looking to develop an LNG terminal on the East coast at Gangavaram (Andhra Pradesh) and to increase capacity on the west coast as well. Several other ports are also looking to develop LNG facilities. Further to this, there will be investments in pipeline networks, hopefully with a national gas grid developing over time.

There has been a lot of controversy over KG-D6, with accusations that RIL deliberately cut back on production. Well, RIL gets a better price from April. Meanwhile, the low domestic production in the past three financial years has forced a change of perspective in the natural gas industry and downstream, among consumers. There will clearly be opportunities here for the long-term investor - in transportation, marketing and related areas.