Gujarat Gas Faces Increased Competition Risk Due To High Industrial Volume

Gujarat Gas Ltd. could see increased risks as city gas distributors lag in meeting minimum work programme targets for domestic piped natural gas and compressed natural gas.

The government has long pushed on expanding piped gas reach to curb pollution in major cities, but is dissatisfied with the slow progress. The Petroleum and Natural Gas Regulatory Board also aims to introduce competition by enforcing regulations which will end exclusivity in city gas distribution. This adds to the company's risks, as compared with larger peers like Indraprastha Gas Ltd. and Mahanagar Gas Ltd.

In India, allocation of geographical areas for city gas distribution is conducted through a bidding process supervised by the Petroleum and Natural Gas Regulatory Board.

The board regularly announces bidding rounds for CGD rights in different GAs nationwide. Gas distribution companies meeting the board's financial and technical criteria can participate in these bids. Bidders present their development plans and the PNGRB evaluates proposals, ultimately awarding CGD rights for a specific GA to the winning bidder.

Along with submitting bids for a specific GA, entities must also propose a Minimum Work Program. The MWP specifies targets for infrastructure development, which includes laying pipelines and station set-ups, among other things.

The MWP also specifies connection targets or number of households, commercial establishments, and industrial units the bidder aims to connect to the CGD network within a stipulated time frame.

Based on the regulations for rounds 1-8, CGD entities were required to achieve 15%, 50%, 70%, and 100% of their MWP targets, with respect to their domestic PNG connections by the second, third, fourth and fifth years of authorisation, respectively.

Nevertheless, the data indicates that players are significantly lagging these targets. In reaction to this, the regulator has previously attempted to enforce MWP targets through measures such as imposing penalties, revoking authorisations, and fostering competition by issuing guidelines for ending exclusivity and facilitating open access to CGD networks.

Guidelines pertaining to the end of exclusivity sparks risk of competition.

For any player looking to enter an existing market, the most attractive segments would be either CNG or industrial, Citi said. The CNG segment is attractive due to higher margin, while the industrial segment is a good bet due to higher volume.

The domestic PNG segment gets largely ruled out due to its higher capex intensity, lower volume and margin, according to the brokerage.

Indraprastha Gas, Mahanagar Gas, and Gujarat Gas have already established an extensive CNG station network in their respective geographical areas. The lack of available land in cities like Delhi and Mumbai also make it harder for a new entrant.

The PNGRB clarified in 2020 that any CNG facilities already present at existing oil marketing retail outlets cannot be used for common carrier access.

Common carrier access refers to the open access provided to other entities—in this case, new entrants—for transporting natural gas through the existing CGD network, upon end of exclusivity. This means that any authorised entity, upon request and meeting certain conditions, can use the network to transport their natural gas, and not just the company that built and owns the network.

That leaves the industrial segment as an attractive pocket for a new entrant due to higher volume. Among the three players, Gujarat Gas has the most share in the industrial segment.

On average, the company has 60% of its total volume coming from industrial customers. This compares with 10-11% for Indraprastha Gas and Mahanagar Gas.

The Morbi district in Gujarat is the ceramic capital of India. In March 2019, the National Green Tribunal ordered a ban on all coal gasifiers used by the ceramic players in the region, irrespective of whether they complied with earlier pollution control norms. This impacted the industry in Morbi and Wankaner, resulting in a sharp jump in gas demand from the region. There is potential for this demand to surge further.

The region comprises large cluster of industrial customers and accounts for two-third of Gujarat Gas' industrial segment volume.

The high concentration of volume in one area, which is supplied almost entirely by imported LNG, poses an attractive opportunity for new players, according to Citi. Therefore, if regulations permit, competition poses a larger risk for Gujarat Gas.

In recent quarters, however, the company has faced challenges from high LNG prices. It has more than 25% spot LNG dependence, Citi said. This has led to the Morbi region switching from gas to propane at a rising rate and impacted the company's volume.

A sustained decline in LNG prices or an improvement in the company’s long-term gas supply mix will be key, Citi said. In the absence of these two factors, margin upside could be capped, according to the brokerage.

Gujarat Gas' current price-to-earnings ratio stands much higher than Mahanagar Gas and Indraprastha Gas at 32.95.

Even when one looks at the one-year forward price-to-earnings ratio, the company's valuations still stand almost double that of its peers.