The city gas distribution (CGD) sector has grown at a steady pace over the past few years on the back of increased sales of compressed natural gas (CNG) and piped natural gas (PNG) in the domestic segment. The industry is poised for greater growth as the regulator has overhauled the bidding criteria and the tenth round of auctions has been announced. It is expected that there will be a pan-Indian CGD network in the next four-five years opening up huge opportunities for entrants as well as existing players.
CGD sector trends
In the CGD sector, the growth in demand has been steady. The volumes of CNG and domestic PNG have increased in the past two years supported by softer gas prices. Domestic gas prices were cut multiple times between October 2014 and October 2016, and this has largely been passed on to CNG and domestic PNG consumers. Since the economics of switching to CNG are favourable, the increase in crude prices since October 2017 has not hampered the demand for CNG. Moreover, the government’s thrust on increasing domestic PNG connections has aided the volume growth of this segment. However, the demand for PNG from the industrial and commercial segments has remained stagnant. This is on account of the low competitiveness of CGD with respect to alternative liquid fuels and coal, an industrial slowdown, and issues related to the goods and services tax. Net, net, the overall CGD volumes have been on a recovery path in the past few quarters.
In October 2017, the Supreme Court banned the use of pet coke and furnace oil in the Delhi National Capital Region (NCR) to control pollution levels. The apex court also directed the Rajasthan, Haryana and Uttar Pradesh governments to notify the ban immediately. Furnace oil is cheaper than natural gas on an energy equivalent basis and the price of pet coke is a fraction of that of natural gas. Some small players, especially those using pet coke, will have to move out of the Delhi NCR due to their businesses becoming unviable. Industrial units using pet coke and furnace oil will have to switch to alternative fuels such as natural gas. Accordingly, CGD entities operating in these states will see a significant increase in industrial PNG volumes in the short to medium term. CGD entities with a wide network and substantial industrial presence in their geographical areas (GAs) will be key beneficiaries of the ban.
Cost economics of CNG in Delhi
The cost economics of CNG are good, in the sense that it is cost competitive vis-à-vis other fuels. However, this does not hold true for industrial PNG which is facing a high degree of competition from furnace oil and liquefied petroleum gas (LPG), among others. When compared to LPG, motor spirit and diesel, the break even period for a car running on CNG is close to eight months while that for a bus is less than three months. Even with more stringent fuel specifications such as BS-VI, CNG proves to be more attractive than petrol and diesel due to low running costs. This coupled with the fact that the government did not reduce the excise duty on CNG despite pressure also helped in the growth of CNG. Even in an optimistic scenario, crude prices will not fall below $60 per barrel, thus enabling the CGD industry to compete with liquid fuels.
Performance of listed CGD players
With regard to the recent performance of major players such as Indraprastha Gas Limited (IGL), Gujarat Gas Limited (GGL) and Mahanagar Gas Limited (MGL), the volume growth has been fairly good for IGL and MGL. GGL registered stagnant growth in volumes due to the higher concentration of its business in the industrial PNG segment. The earnings before the interest, taxes, depreciation and amortisation (EBITDA) margin is a function of the consumer mix. Of the three companies, MGL has the highest EBITDA margin of around Rs 8 per standard cubic metre (scm). The focus on CNG has helped IGL and MGL achieve high margins despite volatility in the prices of other fuels.
Revision of bidding criteria
One of the biggest policy developments in the sector was the revision of the bidding criteria for setting up CGD networks. The changed regulations announced by the Petroleum and Natural Gas Regulatory Board in January 2018 for granting authorisations for setting up CGD networks and CNG stations helped attract greater investor interest in the ninth bidding round. The amended regulation has addressed most of the concerns of the sector. The need for changes in the regulation emanated from the ineffectiveness of the erstwhile bidding criteria.
The bidding criteria have been revised such that 80 per cent weightage, as compared to 0 per cent earlier, is assigned to infrastructure creation so that gas network penetration is maximised. The participation of more players is incentivised with the extension of the marketing exclusivity period for authorised entities to eight years (extendable up to 10 years) as compared to five years earlier. The new regulation also provides for adequate checks by way of prescribed minimum work programme (MWP) targets for each year for all three measurable segments – steel pipeline length, CNG stations and domestic PNG connections. The provision of the option to completely exit after five years is favourable for bidders as it reduces the long-term business risk and enables capital recycling.
Update on bidding rounds
So far, nine CGD bidding rounds have concluded. Given the improved prospects, interest in bid Rounds 4-6 was high for lucrative GAs. Some GAs received one bid or failed to receive any bid on account of relatively weaker prospects. Bid Rounds 7 and 8 have had limited GAs on offer and limited interest. However, GAIL (India) Limited has received permission to develop CGD networks in seven cities along its new pipelines – Varanasi, Patna, Jamshedpur, Kolkata, Ranchi, Bhubaneswar and Cuttack.
In rounds 4-6, most bidders had bid aggressively at lowest possible network and compression charges of Re 0.01 per million British thermal units (mmBtu) and Re 0.01 per kg respectively. Low charges will result in higher business risks for the bid winners post the marketing exclusivity period. The latest Round 9 saw enthusiastic participation from the industry with 406 bids from 38 entities being received for 86 GAs. This averages 4.7 bids per GA which has been the best response so far since the launch of bid rounds in 2008. Meanwhile, the regulator has announced CGD bid Round 10 covering 50 GAs. Bids are to be submitted by February 5, 2019.
The CGD sector is expected to witness consolidation in the next four-five years as many smaller companies that are unable to cope with the MWP will be acquired by larger players. With Rounds 10 and 11 in the offing, there is significant opportunity for equipment suppliers, pipeline companies and project contractors. Having said that, a major concern is the ability of contractors to roll out CGD networks across the country’s length and breadth. Therefore, training of the workforce is required to maintain service levels. The offer of a high number of GAs in the forthcoming rounds will become the norm. Thus, players must tie up with market participants to study the potential of the proposed GAs. Going forward, companies bidding with prudence will come out to be winners while those bidding aggressively will struggle to achieve returns.
Based on a presentation by K. Ravichandran, Senior Vice President and Group Head, Corporate Ratings, ICRA, at a recent India Infrastructure conference