Lack of pricing power, competition to hit city gas distribution firms

The city gas distribution (CGD) sector has enjoyed favourable policies, high arbitrage versus alternative fuels, and pricing freedom in the past. However, recent cuts in administered pricing mechanism (APM) allocation and rising competition from electric vehicles are among the factors that have led to big corrections.

 

The policy vision is to have a 15 per cent share of the energy basket for gas (from 6 per cent), raising gas consumption to 500 million metric standard cubic meters per day (mmscmd) by 2030 (currently 200 mmscmd).

 

There are 307 CGDs covering almost 100 per cent of the population. Compared with 800 compressed natural gas (CNG) stations in 2014, CNG stations have increased 9 times to over 7,200 now. Domestic piped natural gas (PNG) connections are up 5 times to 13.6 million. Targets are aggressive with up to 18,000 CNG stations (2.5 times from current levels) and 126 million (8 times more) domestic PNG connections by 2032.

 

But recent large APM allocation cuts have added to stress. Nearly 6.5-7.0 mmscmd APM gas is reclassified as new well gas which is effectively priced 40 per cent higher than APM.  

 

 

CGDs are unwilling to raise prices. Compared with the required Rs 7-9/kg price hike, CGDs have taken a modest Rs 2-3/kg hike so far. In Delhi NCT (2/3rd volumes), IGL is yet to take any hike. The lower arbitrage versus petrol/diesel and EVs will also hurt the demand outlook.

 

Analysts are downgrading earnings projection and expect further cuts to APM allocations in the future. Stocks have corrected over 40 per cent over the past three months but CGDs cannot seem to raise prices and maintain volume. Following a 20-21 per cent APM allocation cut from October 16, CGDs domestic APM gas allocation was further cut by 18-20 per cent from November 16.

 

 Large cuts are driven by more APM gas (6 mmscmd) being classified by new well/well intervention gas (NWG), 3.0 mmscmd NWG allocation to OPAL (ONGC’s subsidiary) along with OPAL restructuring approval, and reduced APM availability. However, CGDs’ demand was higher by nearly 1 mmscmd Q-o-Q, increasing the shortfall.

 

Classification of part APM gas to NWG was expected. This was recommended by the Kirit Parikh Committee and implemented along with the new price formula from April 2023. NWG is being priced at a 12 per cent slope (change in gas price relative to the price of oil) and the effective price of $9/mmbtu is 40 per cent higher than APM gas.

 

For GAIL, domestic gas allocation for petchem was withdrawn years ago. In August 2022, when CGDs faced acute gas issues (high prices due to the Russia-Ukraine conflict), the government allocated domestic gas being used by OPAL (and GAIL for internal consumption) to CGD. After this decision, APM/NWG gas has been allocated back to OPAL.

 

This weakens the CGD sector’s outlook. Apart from weakening the near-term earnings, it will slow fresh investments in the CGD space. Given more expensive gas, CGD’s gas costs are up Rs 4.5-5.5/scm and required price increases are Rs 7-9/kg for most CGDs. However, the price increases have been modest at Rs 2-3/kg for most areas. Notably, for poll-bound Delhi NCT (elections likely in early 2025; accounts for over 2/3rd of IGL’s CNG volumes), IGL has not taken hikes.

 

CGDs will seek relief. While the decision to allocate NWG to OPAL is unlikely to be reversed, CGDs will likely seek more equitable allocation cuts across APM users (fertilizer, power and LPG Production). CGDs will also seek a relook at NWG prices. They are also likely to renew demand for reduction on taxes and duties and inclusion of natural gas in GST. Taxes are relatively higher by 50-60 per cent for diesel/petrol already. If at all, there is tax relief it will take time.

 

Even after sharp correction, the risk-reward equation seems unattractive.