The current contract is just for booking terminal capacity. GAIL would need to source feedstock gas and if it is not able to than it will need to pay a capacity charge. To mitigate the risk, GAIL would need to take more stakes in upstream shale gas projects in the US

State-owned gas transmission major GAIL India has announced booking of 2.3 mmtpa LNG terminal service with Dominion from its planned Cove Point LNG liquefaction project in the US. Dominion, which currently has an 11.7 mmtpa re-gas capacity, is planning to convert it to a liquefaction terminal. GAIL has booked 50% of the current 4.6 mmtpa capacity being marketed, as per Nomura Equity Research.

Dominion expects that construction on the terminal would begin by 2014, with liquefaction operations projected to start in 2017. GAIL has not indicated the likely liquefaction charges, but Nomura opines that these would be close to $3 per (million metric British thermal unit) mmBtu that GAIL agreed for its contract with Cheniere.

Agreement positive from long term; LNG share would increase

According to Nomura Equity Research, giving the large and increasing domestic gas demand supply gap, agreements to tie-up long-term LNG are positive. In recent years, GAIL’s focus has been to tie-up long-term gas, and it has seen significant success like tying-up contracts with Cheniere (3.5mmtpa) and Gazprom (2.5mmtpa). Share of LNG in GAIL current transmission volume is around 30%. “We think once all recently signed contracts come into operation, the share of LNG in GAIL’s domestic transmission portfolio would easily exceed 50%,” Nomura said.

Risks higher than GAIL’s other LNG contracts: likely GAIL will take more upstream capacity in the US

Unlike the Cheniere contract (where GAIL is buying Henry hub indexed LNG), the current contract is just for booking terminal capacity. GAIL would need to source feed stock gas and if it is not able to than it will need to pay a capacity charge. To mitigate the risk, it would make sense for GAIL to take more stakes in upstream shale gas projects in the US. GAIL already has a 20% stake in Carrizo’s Eagle Ford acreage, and it would look for more acreage in the Marcellus area close to Cove Point terminal.

Early non-Free Trade Agreement (FTA) country export approval by the US government would be key for the liquefaction project to move ahead. For a long period now the debate has been ongoing in the US on the merits/demerits of exporting gas from the US and its impact on the US; particularly from the point of view of the likely impact on domestic gas prices and also the likely impact on the environment.

Approval process for non-FTA export has been slow, and in recent years only Cheniere’s Sabine Pass terminal has been given the much sought after permit. There is a long list of nearly 16 project developers seeking export approval from the US Department of Energy (Dominion had made the application in October 2011 and is third on the list).

According to Nomura Equity Research, the non-FTA export approval can take time, and may not come through. In addition, there is also a risk that once the export of LNG from the US starts, and domestic gas prices start to increase (which has been a concern by those against exports), there is also some risk that the US could at a later stage stop /curtail gas exports.

Near-term concerns in each key business

In the near term, the outlook continues to remain weak for all of GAIL’s key businesses. The government is mulling over a gas price increase for all domestic gas. According to Nomura’s analysts, GAIL, as a user of gas (internal consumption as fuel/feedstock for LPG/petchem production and gas transmission), would be the worst impacted among the oil & gas companies under Nomura’s coverage. Assuming it is not able to pass on any cost increase (or reduce gas costs by increasing PMT volumes for its own consumption), it sees an impact of 15-16% to its FY14F/15F EPS estimates.

Even as GAIL continues to add pipelines, the domestic gas volumes declines continue. Domestic production volumes have been declining now for nearly three years and there is low visibility of a turnaround soon.

GAIL’s LPG business profitability has eroded due to high and ad-hoc subsidy sharing business. Nomura believes that the company’s upstream subsidy share would increase.