The city gas distribution (CGD) business is characterised by high initial costs followed by comparatively lower working capital requirements. The initial high fixed cost is a result of a number of factors including the cost of acquiring the licence and the land, getting the necessary clearances, statutory levies by municipalities and corporations, laying pipelines and installing equipment, etc. Capital expenditure (capex) varies widely across CGD operators and is generally a factor of their sales volume. For example, Gujarat Gas Limited (GGL) which has sales of about 5.41 million metric standard cubic metres per day (mmscmd), has a high capex of more than
Rs 50 billion per annum. In comparison, Sabarmati Gas Limited, which has sales of about 0.7 mmscmd, has a much lower capex of about Rs 5 billion.
A part of the capex is generally recovered by the CGD operator as a one-time refundable security deposit. For example, Indraprastha Gas Limited (IGL) spends between Rs 17,000 and Rs 22,000 for providing a piped natural gas (PNG) connection. Of this, IGL recovers Rs 5,000 as a refundable security deposit from the customer while the rest it bears on its own. Going forward, with the proposed expansion of geographical areas (GAs) to cover entire districts instead of just cities, capex for the CGD business could increase further as operators will need to lay pipelines across the entire district. Thus, only players that have high capacity utilisation and adequate volumes will be able to maintain appreciable profit margins.
The working capital or the operating expenditure (opex) of a CGD business consists of employee costs, power and fuel costs, renovation and modernisation costs, insurance costs, etc. The opex generally varies according to the consumer mix, that is, the number of compressed natural gas (CNG) and PNG consumers that the operator services and the type of CNG stations being commissioned (online versus others). Opex for major players varies from Re 1 to Rs 5 per cubic metre and depends on the marketing strategy employed by the operator.
The tariffs charged by CGD operators have been an important deciding factor in the allocation of blocks in the previous bidding rounds conducted by the Petroleum and Natural Gas Regulatory Board (PNGRB). Bidders quoted bids as low as 1 paisa per unit. These low bids made projects practically impossible to develop and would have rendered them unfeasible after the end of the marketing exclusivity period. Thus, the PNGRB decided to revise the bidding criteria and include a number of other factors such as the size of the bidder, associated infrastructure development (length of pipelines to be developed, number of CNG stations to be set up), etc.). The revised bidding criteria are expected to result in more reasonable bids in the upcoming bidding rounds.
The CGD business is highly capital intensive. Thus operators who are able to maintain high capacity utilisation and have adequate sales volumes should be able to maintain reasonable profits. Margins in the CGD business have been more or less constant over the past six years. Aggregate contribution margins for major players – GGL, IGL, Maharashtra Gas Limited, GAIL Gas Limited, Adani Gas, Sabarmati Gas Limited, Central UP Gas Limited and Tripura Natural Gas Company Limited – increased from Rs 5.30 per standard cubic metre (scm) in 2011-12 to Rs 7.40 per scm in 2016-17. However, with an increase in global natural gas prices in 2014, there was a downward pressure on margins. The contribution margin percentage, which generally remains at 25 to 30 per cent of aggregate realisations, declined to 20 per cent in 2014. Nevertheless, with prices stabilising in 2015, the industry recovered, leading to consistently increasing margins for the CGD players since then. A similar trend has been observed in the earnings before interest, taxes, depreciation, and amortisation (EBITDA). The aggregate EBITDA for the above-mentioned players increased from Rs 3.70 per scm in 2011-12 to Rs 4.60 per scm in 2016-17.
Achieving and maintaining profit margins in the CGD business depends on a number of factors such the sales mix, the strategy employed, the number of connections served, etc. It is also affected by threats such as a lack of control over fuel economics, availability of cost-competitive gas, currency fluctuations, consumer resistance to price hikes, lack of land availability for setting up CNG stations, difficulty in getting statutory approvals, lack of requisite support from states, etc. Considering the cooperation extended by the PNGRB in devising favourable policies (such as increasing the marketing exclusivity period from five years to eight years) CGD players could find the upcoming bidding rounds more attractive. However, with the probable allocation of entire districts in the upcoming bidding rounds (which would significantly increase capex), the operators must maintain high capacity utilisation and adequate volumes to ensure profit margins in the business.
Based on a presentation by
K. Ravichandran, Senior Vice-President and Co-Head, Corporate Ratings, ICRA Limited, at a recent India Infrastructure conference