Correction Leaves Stocks Attractive As LNG Makes up for Gas Production
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EQUITY RESEARCH ANCHOR REPORT ANCHOR India gas: Time to get back in May 06, 2011 Research analysts Correction leaves stocks India Oil & Gas/Chemicals Anil Sharma attractive as LNG makes up for [email protected] +91 22 4037 4338 gas production shortfall Ravi Adukia, CFA [email protected] +91 22 4037 4232 We are raising target prices for most stocks, as we believe LNG is able to fill the breach caused by the KG-D6 production decline. Petronet LNG (TP: INR180) is the most obvious beneficiary of the LNG boom and is our top pick. BP-RIL deal underlines long-term sector outlook. BUY RIL (TP: INR1,200). We also reiterate BUY on GAIL (transmission giant, TP: INR600) and Indraprastha Gas (City Gas in Delhi, TP: INR450). Key analysis in this anchor report includes: • Deep dive into LNG dynamics • India’s readiness – terminals and pipelines • Updates on demand, supply and pricing See Appendix A-1 for analyst • We continue to watch policy carefully and include a detailed analysis certification and important disclosures. Analysts on price pooling and upcoming pipelines/CGD networks. employed by non-US affiliates are not registered or qualified as research analysts with FINRA in the US. India Gas Oil & Gas/Chemicals EQUITY RESEARCH May 6, 2011 Time to get back in Correction leaves stocks attractive as LNG makes up for domestic production shortfall Action: Time to get back into the gas story Anchor themes Despite the underperformance of most gas stocks in reaction to the Even with slowing domestic gas production decline at the KG-D6 block, we raise our target prices for most growth in the near term, we see stocks under our coverage, as we believe LNG can fill the shortfall. Spare considerable growth potential re-gas capacity is filling up fast, and we expect LNG to account for the bulk for gas in the long term. of gas supply growth in FY12F (fiscal year-end 31 March). New capacity is Meanwhile, higher LNG imports coming on line and we project LNG re-gas capacity will double by FY14F. should help to drive growth. LNG the key catalyst: Petronet LNG is our top pick Nomura vs consensus Petronet LNG is the obvious beneficiary of the LNG boom and is our top We are more bullish on oil pick, as we think the market has yet to fully value its growth potential. With prices and less hopeful of a projected EPS CAGR of 21% through FY11-FY13F, we believe our significant near-term reforms. implied target P/E of 15x FY13F earnings is undemanding. We reaffirm BUY on Indraprastha Gas (city gas in Delhi) and upgrade Gujarat Gas a Research analysts notch to NEUTRAL, despite limited market potential. We continue to like transmission giant GAIL and raise our PT to Rs600; we are confident that India Oil & Gas/Chemicals concerns on KG-D6 and rising subsidies are overdone, while the upside Anil Sharma - NFASL [email protected] potential from LNG and petrochemicals is not in the price. +91 22 4037 4338 BP-RIL deal is a reminder of the long-term outlook Ravi Adukia, CFA - NFASL [email protected] We reaffirm BUY on Reliance Industries and believe its recent partnership +91 22 4037 4232 with BP will allay concerns over near-term volume decline and delayed ramp-up. We expect the deal to restore confidence in the longer-term E&P outlook, apart from setting a benchmark valuation for the E&P business. But watch out for regulatory ups and downs We had previously highlighted that regulatory chaos would take time to be resolved and keep generating short-term noise. The latest example of this can be seen in the continued delays in network authorisation, tariff setting and formal award of three pipelines for Gujarat State Petronet. For these reasons, we cut our PT on the stock to Rs135 but maintain our BUY call. Fig. 1: India gas: stocks for action Price PT Company Ticker (INR/sh) Rating (INR/sh) Reliance Industries RIL IN 984 BUY 1,200 ↑ GAIL GAIL IN 475 BUY 600 ↑ Petronet LNG PLNG IN 132 BUY 180 ↑ Indraprastha Gas IGL IN 322 BUY 450 ↑ See Appendix A-1 for analyst Gujarat State Petronet GUJS IN 98 BUY 135 ↓ certification and important Gujarat Gas GGAS IN 367 NEUTRAL ↑ 415 ↑ disclosures. Analysts employed by non US affiliates are not Note: Prices as of 29 April, 2011; ↑ Upgrade from Reduce registered or qualified as Source: Bloomberg, Nomura estimates research analysts with FINRA in the US. Rating: See report end for details of Nomura’s rating system. Nomura | AEJ India Gas May 6, 2011 Contents 6 Executive summary 6 Domestic gas – losing steam 6 Near term – limited domestic production visibility 6 Long term – BP deal restores faith in Indian E&P potential 6 LNG likely the key source of growth in the medium term 7 Stock selection – favourable risk reward 12 Domestic gas – losing steam 12 Fizzling domestic volumes in FY11 after sharp growth in FY10 12 And confusion abounds on likely KG-D6 volume near term 13 We assume KG-D6 production at 50/55 mmscmd in FY12/13F 14 Near term – limited domestic production visibility 14 Long term – BP’s deal restores faith in Indian E&P potential 15 Long term – several potential blocks on the east coast 18 LNG to the rescue 18 LNG was a key source of gas growth prior to KG-D6 18 LNG volumes declined in 2HFY10 due to pipeline constraints... 18 ... but have gradually picked up in FY11 19 LNG likely to be key source of growth in medium term 19 Significant short-term capacity booked recently 21 Seeking to tie-up long-term LNG 21 Gap between price expectations precluded new contracts 21 Increasing willingness to pay higher prices for assured supply 21 Supply glut moderating price expectations of producers 2 Nomura | AEJ India Gas May 6, 2011 22 Post nuclear incident – Supply overhang may ease LT 24 Time for India to tie up LT LNG 24 Qatar a most likely source – Formal demand for 15mmtpa 24 Nigeria – GAIL looking to take equity in LNG projects 24 Russia – talks with Gazprom on swap basis 25 LNG re-gas capacity to double by FY14F 25 Current capacity of ~14mtpa at two operational terminals 25 Both Dahej and Hazira terminals are expanding capacity 25 New terminals at Kochi and Dabhol to be operational in 2012 26 Several other terminals at drawing board stage 28 Pipeline: easing bottlenecks; set to grow 28 Pipeline networks span more than 11,000km currently 29 Easing pipeline bottlenecks 30 Slow progress on some authorised pipelines 31 Bidding process for award of ~6000km of new pipelines 32 Demand remains, supply constrained 33 Government continues to ration domestic gas 34 More than two-thirds of gas still consumed by power/fertiliser sectors 34 Muted investment in greenfield industry 35 New LT LNG to look beyond power/fertiliser 36 Base power and fertiliser may be priced out 36 Base power – coal will have price advantage 36 Power sector will still need RLNG for peak/captive needs 37 Recent LNG swaps – AP IPPs may pay over US$14/mmbtu 3 Nomura | AEJ India Gas May 6, 2011 38 Fertiliser – RLNG unlikely to compete with direct imports 39 Most other industries would find RLNG attractive 40 RLNG would also be competitive for CGD applications 41 CGD gets priority – significant advantage over alternate fuels 41 CNG – likely to retain advantages even if RLNG is used as input 42 Residential piped gas — subsidised domestic LPG makes even US$4.2 expensive 42 Commercial piped gas — can easily afford higher priced gas 44 Gas pricing – increased but in shackles 45 Last year’s APM price increase was sharp and surprising 45 Yet, APM increase was ad-hoc – static and with no time frame 46 Only LNG price has been truly market linked, in our view 46 Government actively considering pooling of prices 47 We still believe that pooling would be a retrograde step 48 Time’s ripe to re-visit domestic gas pricing, in our view 51 Regulatory/ policy chaos continues... 51 Empowering of PNGRB with authorisation powers 51 Bidding process – near zero bidding for tariff continues 54 Inclusion of natural gas in GST regime / declared goods status 55 Seven-year income tax holiday for natural gas 55 Confusion over definition of undertaking 55 Utilisation policy takes away marketing freedom 55 Pipeline taxation benefits under section 80IA 56 Annexure 1: Long term – LNG as nuclear replacement? 56 Loss of nuclear power similar to 2007 4 Nomura | AEJ India Gas May 6, 2011 56 Nuclear power shutdown could increase near-term LNG demand 57 Long term – LNG as nuclear replacement? 58 Enough LNG to compensate drop in nuclear capacity 59 LNG market to loosen with 30% increase in supply in five years 59 IOCs and NOCs have nearly equal production capacity 60 Royal Dutch Shell and ExxonMobil have largest capacity 60 BG and Woodside – largest exposure to LNG as % of global production 61 LNG export dominated by MENA and Asia-Pacific 61 Majority of MENA production from non-troubled countries 63 Reliance Industries 83 GAIL 96 Petronet LNG 109 Indraprastha Gas 118 Gujarat State Petronet 128 Gujarat Gas 133 Appendix A-1 5 Nomura | AEJ India Gas May 6, 2011 Executive summary Domestic gas – losing steam After a decade of low growth (~1.8% CAGR) to March 2009, India’s domestic gas production grew by a sharp 45% y-y (even higher 72% y-y on exit rate) in FY10, driven by a sharp ramp-up of gas production to 60mmscmd at the KG-D6 block.