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Petronet’s low margin overshadows the stability of its core business

The stock has been down because of lower margins in the March quarter, thanks to lower spot gas prices, but its core high-margin business is unaffected

LNG imports, which were started a few years back to secure India’s energy security, have been facing a tough time and one of the biggest beneficiaries of this scenario was Petronet LNG. But given the huge gas supply from the Reliance KG Basin, the domestic gas industry is overflowing with gas, raising the basic question of the economic feasibility of the LNG business. This is clear from the performance of Petronet LNG which has posted a subdued March quarter performance. Its sales and operating profit have declined 10% and 41% respectively in the March quarter over the year-ago period. Petronet suffered because of the absence of costly spot gas on which it earns marketing as well as re-gasification margin. Where does the business model of Petronet stand in the era of gas surplus?

The basic business of Petronet is selling long-term contracted LNG. This is a low-risk business because it is on a take-or-pay basis. But that is the bread and butter of Petronet. Its cream comes from the selling of spot LNG. Since spot LNG prices were low, it has dragged down the net re-gasification margin in the March quarter to Rs25/mmbtu, a decline of 46% from Rs48.7/mmbtu on a year-on-year (y-o-y) basis. Re-gasification margin was high in the March quarter of 2009 on account of annual rise in the re-gasification margin by 5% in January 2009 (taking it to Rs30.2/mmbtu) and high marketing margin earned on spot LNG sales. These twin benefits took the net blended re-gasification margin to Rs48.7/mmbtu. This high margin crashed in the March quarter as the company has stopped selling spot gas—from October 2009. While the re-gassified LNG volume in the March 2010 quarter increased on a y-o-y basis supported by the commissioning of the 2.5 mmtpa of gas supplies from Qatar from January 2010, it has reduced on a q-o-q basis because of the low demand for spot LNG on the back of increase in the KG Basin gas supply, which has dramatically changed the demand supply scenario of gas. While Reliance is producing 80 mmscmd of gas from the KG Basin currently, this is expected to increase to 100 mmscmd by FY2013E. Production by NEC, Gujarat State Petrochemicals and ONGC is also likely to start from the KG Basin in the near future. Will this affect Petronet’s prospects further?

Not necessarily. Because gas supply from the ONGC and GSPL-KG basin is not expected to be significant. GSPC gas volume is small and production will take time to start. ONGC’s targeted date for east coast gas finds may be delayed. Rating agency ICRA states that even if ONGC and GSPC gas starts flowing, LNG’s prospects will be good with demand coming from refineries, city gas distribution companies and industrial customers. This scenario necessitates a steady source of LNG supply. Petronet’s Dahej terminal capacity has been scaled-up to 5 mmtpa in FY2006 and to 6.5 mmtpa in FY2007 and it has been further expanded to 11.5 mmtpa at the end of the first quarter of FY2010. The gas supply has been increased to 7.5 mmtpa with the commissioning of 2.5 mmtpa of gas from the March quarter which leaves an untied capacity of 4 mmtpa.  Another terminal is being set up in Kochi with a capacity of 2.5 mmtpa and will be expanded to 5 mmtpa. Supplies for the terminal have been contracted to the tune of 1.5 mmtpa from Gorgon, Australia. Qatar has agreed to supply another 4 mmtpa of LNG to India in a recent meeting. Out of this, about 1.5 mmtpa may be received by Petronet. While untied capacity is an area of concern, the recent drop in LNG price on surplus global supply has eased up the availability of LNG at cheaper prices. The other trigger for Petronet’s volume growth would be easing of pipeline capacity, especially the expansion of the HBJ pipeline which is expected to be done by early October 2010. The near doubling of HBJ capacity would remove the current constraints on supplying gas to customers in central and northern India and would help Petronet and others to get more spot and term cargoes, by the end of FY2011, to cater to higher demand along the route. The need for a robust pipeline infrastructure can be realised from its decision of not starting receiving spot LNG until the end of 2010 by when there will be enough pipeline capacity. It has stopped receiving spot LNG from December 2009 on increased domestic gas supply.  

Petronet’s re-gasification margin was fixed at Rs23.7/mmbtu for FY2004 with a 5% annual escalation. As per ICRA this margin is very high, fetching it a return of more than 25% which is higher than the other power utilities which earn 14%. The re-gasification margin is not currently controlled by the Petroleum and Natural Gas Regulatory Board which gives Petronet scope for charging more. While the March quarter has been subdued, Petronet has the prospect of staging a better performance in the next fiscal. With the recent deregulation of gas prices and improved gas connectivity, there is expected to be more clarity in the gas demand projection. This will help Petronet to sell high-margin spot gas in larger volumes. The unutilised capacity in the Dahej terminal provides it with the opportunity to receive more spot as well as long-term LNG which will increase its operating margin.

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