Indian Gas Sector

INSTITUTIONAL EQUITY RESEARCH Indian Gas Sector Towards bluer skies through storm clouds INDIA | OIL & GAS | Sector Update 2 December 2015 • Indian gas downstream will benefit from lower LNG and domestic gas prices and policy Companies triggers such as power sector revival and distribution push, aiding volumes. • With its 50% Dahej‐capacity expansion, Petronet LNG will continue to be the LNG INDRAPRASTHA GAS LTD frontrunner and see sharp growth in volume and earnings in FY18. However, stock Reco BUY price already captures most of this upside. CMP, Rs 483 Target Price, Rs 575 • Lower domestic gas prices will improve CNG/domestic PNG (DPNG) economics, benefiting Indraprastha Gas, further supported by policy triggers. • Pure gas transmission play Gujarat State Petronet would gain from higher volume flow GUJARAT STATE PETRONET LTD Reco BUY and expected tariff revision by the sector regulator. CMP, Rs 135 • We remain cautious on Gujarat Gas due to heavy industrial exposure, competition Target Price, Rs 155 from coal/grid power, and expensive valuations. LNG prices to consolidate, Qatar breakthrough to cut term LNG prices to spot levels PETRONET LNG LTD We expect LNG prices to consolidate and attain parity with liquid fuels, as demand from Reco NEUTRAL major importers such as Japan and Korea peaks, coupled with material supply additions CMP, Rs 234 from Australia and the US. Spot LNG prices have crashed by 60%+ from recent peaks and Target Price, Rs 250 currently hover at ~US$ 7/mmbtu – this is still 10‐20% expensive than comparable fuel oil (FO), so further correction is likely. Recent industry‐media reports have also indicated a GUJARAT GAS LTD possible breakthrough in the Qatar RasGas term‐LNG contract, changing the 60months Reco NEUTRAL trailing oil price average to just three months – this would reduce Indian term LNG prices to CMP, Rs 575 ~US$ 7/mmbtu, in line with spot. Lower LNG prices would boost domestic demand. Petronet Target Price, Rs 530 LNG (PLNG) will continue to be the LNG frontrunner and see sharp volume and earnings jumps in FY18, but stock upside after the recent rally is limited. Domestic gas prices to fall below US$ 4; CNG/DPNG to gain, supported by policy triggers With global benchmark prices in Henry Hub, National Balancing Point (NBP) and Alberta weakening, we estimate India’s domestic gas prices to fall to US$ 3.7/mmbtu in FY17 and possibly remain at ~US$ 4 for an extended period. With 100% domestic gas allocation, the CNG/DPNG sector would be the biggest gainer, as lower gas prices would boost competitiveness and volume growth and help sustain margins. The sector has received considerable policy thrust as the government aims to increase gas usage and distribution. With CNG Marketing Guidelines (freeing of CNG retailing) near implementation, and next leg of expansion targeted along highways, the long‐term outlook remains bright. With 80%+ exposure to CNG/DPNG, Indraprastha Gas (IGL) would benefit from these developments. Higher gas supplies and expected tariff revision to help pure‐play transporters We view pipeline players favourably due to expected tariff revision in FY17. Following Appellate Tribunal (APTEL)’s order, regulator Petroleum & Natural Gas Board (PNGRB) is relooking at assumptions and has released draft amendment revising the volume divisor by lowering capacity assumption to 75% from 100%. With its access to LNG terminals, Gujarat State Petronet (GSPL) would be a beneficiary of higher LNG imports and tariffs – it will see an earnings jump. We build a 10% tariff revision, which will have an EPS impact of Rs1.2, incorporating ~3mmscmd of power‐sector volumes. We are cautious on Gujarat Gas (GGL) due to its heavy industrial exposure and volume risk from customers such as the Morbi ceramic cluster, inclined towards cheaper coal. Valuation at 17x FY18E EPS seems expensive. Recommend Buy on IGL, and GSPL, Neutral on PLNG and Gujarat Gas Company (Rs) Rating CMP Target Price UpsideFY18E Rep. PE (x) CoreTgt. PE (x) Indraprastha Gas BUY 483 575 19% 13 14 Sabri Hazarika (+ 9122 6667 9756) Gujarat State Petronet BUY 136 155 15% 12 11 [email protected] Petronet LNG NEUTRAL 234 250 7% 11 12 Gujarat Gas NEUTRAL 575 530 ‐8% 17 16 Page | 1 | PHILLIPCAPITAL INDIA RESEARCH INDIAN GAS SECTOR UPDATE Table of Contents Key takeaways ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙ 3 Recommendations ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙ 4 Global LNG demand scenario ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙ 5 Global LNG supply scenario ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙ 8 Indian natural gas demand scenario ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙ 9 Indian natural gas supply scenario ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙ 17 LNG pricing outlook ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙ 20 Domestic gas pricing outlook ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙ 24 RasGas LNG Contract: Building expected changes ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙ 27 Urja Ganga – to boost the national grid ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙ 29 Policy focus on the gas distribution sector ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙ 30 Companies Indraprastha Gas Ltd ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙ 36 Gujarat State Petronet Ltd ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙ 48 Petronet LNG Ltd ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙ 61 Gujarat Gas Ltd ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙ 72 Page | 2 | PHILLIPCAPITAL INDIA RESEARCH INDIAN GAS SECTOR UPDATE Key takeaways • We expect a ‘loose’ LNG market. Supply growth from Australia and the US would outpace demand because of Korea and Japan seeing slowdown in consumption. • LNG pricing will remain muted and adjust to parity with oil. Currently, LNG is 10‐ 20% higher than comparable fuel oil/furnace oil (FO). We build in a recovery in oil prices to US$ 60/bbl with comparable spot LNG prices at US$ 8/mmbtu. • Oil‐linked term LNG prices would remain at reasonable levels, even though economics would be more favourable for gas at an oil price of US$ 60/bbl+, as fuel oil prices will rise. US term LNG will also follow a similar trajectory. • The expected breakthrough in negotiations between PLNG and RasGas is a significant positive development, as term LNG prices will become at par with spot LNG. RasGas is likely to waive of US$ 1.5bn on take‐or‐pay penalty. • Indian gas prices will fall below US$ 4/mmbtu in FY17, as global benchmarks remain weak. Even a recovery thereafter is likely to be muted and unlikely to cross US$5/mmbtu, unless oil prices recover to US$70‐80/bbl. • Contrary to beliefs, the current gas‐pricing formula is reflective of the market scenario. The original Rangarajan formula would have also set prices at US$ 4.5/mmbtu. However, removing the Russian component is desirable. • Domestic‐gas supplies are likely to rise from ONGC’s fields of Daman, Bassein EOR, and Vashishtha, and from smaller assets such as Cairn Rajasthan, CBM blocks, and GSPC Deen Dayal. Low prices will slow down development of larger KG blocks. • Multiple LNG terminals are planned, though in the medium term, capacity growth would come from Petronet LNG’s 5mmtpa Dahej expansion and probable expansion in Hazira and debottlenecking at Dabhol. • Indian demand will be boosted by lower LNG and domestic gas prices. Power sector will be biggest demand driver due to government’s stranded‐power plant revival policy. • Planned fertiliser capacity addition can add to gas sales, but this is likely only towards the end of the decade. City gas distribution (CGD) has seen significant policy thrust with the government allocating first priority to domestic gas for CNG/DPNG. • The government targets rapid expansion of gas distribution infrastructure with bidding for new areas, plans to double trunk pipeline network, and freeing of CNG retailing (where highway outlets can be set up by any eligible party). • Industrial gas distribution sector would need liquid fuel prices to recover. In Gujarat, more than liquid fuels, coal and grid power are serious contenders to gas. • Tariff revisions expected in the gas‐transmission sector, as the sector regulator, PNGRB initiates the process to relook at assumptions. It has already published a draft amendment that will lower the volume divisor – this would boost unit tariffs. Page | 3 | PHILLIPCAPITAL INDIA RESEARCH INDIAN GAS SECTOR UPDATE Recommendations Positive on IGL and GSPL Indraprastha Gas –With its aggressive expansion skills, sound industry experience, and disciplined capital allocation, it is best‐placed to catch incremental policy triggers in CNG/DPNG while being largely insulated to the risks of an industrial PNG (IPNG) slowdown. Gujarat State Petronet – Concentrated network in Gujarat puts it in a sweet spot to be the first beneficiary of higher spot LNG volumes and incremental power sector demand from Gujarat‐based LNG terminals. We expect tariff revision, as PNGRB initiates the revision

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