The city gas distribution (CGD) segment has been growing steadily over the past two-three years. The launch of new bidding rounds, policy and regulatory amendments to increase private interest, and initiatives to build an adequate pipeline network in the eastern and north-eastern states have provided a major push to the CGD segment. However, there are some concerns such as low domestic gas availability, delays in pipeline and network implementation, shortage of skilled manpower, narrow profit margins and slow demand build-up that need to be addressed in a time-bound manner for ensuring a smooth growth path for the segment.
In the past few years, the volume of compressed natural gas (CNG) and domestic piped natural gas (PNG) sales has increased, supported by softer global gas prices. Domestic gas prices were reduced multiple times between October 2014 and October 2016, and this reduction was largely passed on to CNG and domestic PNG consumers. However, prices were increased in the revisions between October 2017 and October 2018 due to higher crude prices. The demand for PNG from the industrial and commercial segments is being met through spot/ long-term sourcing of imported regasified liquefied natural gas.
Since February 2014, the CNG and domestic PNG segments have been accorded first priority in the allocation of domestic gas. Thus, any adverse change in the current policy on domestic gas allocation will pose a risk to the industry’s profitability.
In a major regulatory move, the Supreme Court, in October 2017, banned the use of pet coke and furnace oil in the Delhi National Capital Region (NCR) to control pollution levels. The court had also directed the Rajasthan, Haryana and Uttar Pradesh governments to notify the ban immediately. Industrial units using pet coke and furnace oil will now have to switch to alternative fuels such as natural gas. However, since furnace oil is cheaper than natural gas on an energy equivalent basis, some small players, especially those using pet coke, might shift out of the NCR due to their businesses becoming unviable. At the same time, CGD entities operating in these states could see a significant increase in their industrial PNG volumes over the short to medium term. These entities therefore need to extend their pipeline networks to uncovered areas to meet the growing demand. Also, providing last-mile connectivity in the areas which have already been covered by the network is critical.
The development of transmission pipelines in the eastern and north-eastern states is expected to provide a further impetus to the CGD business. The central government has nominated GAIL (India) Limited for implementing the ambitious Urja Ganga pipeline project. Urja Ganga, also known as the Jagdishpur-Haldia and Bokaro-Dhamra pipeline project, spanning 2,655 km, will provide connectivity to the eastern states of Uttar Pradesh, Bihar, Jharkhand, Odisha and West Bengal. While Phase I of the project has already been commissioned, Phase II is expected to be completed by December 2021. The pipeline project is being extended to Guwahati in Assam and will later be extended to all state capitals in the Northeast. This is expected to be achieved within five years.
Further, the government has chalked out plans to implement green energy corridors on which green fuels such as CNG and PNG will be available. These corridors will extend the availability of CNG beyond city limits, thereby, allowing the use of clean fuels for long-distance and intercity travel. At present, six such corridors have been identified: Delhi-Meerut-Roorkee-Haridwar, Chandigarh-Panipat-Sonepat-Delhi-Neemrana-Jaipur, Agra-Firozabad-Kanpur-Lucknow-Allahabad-Varanasi, Ahmedabad-Mumbai, Bengaluru-Tumkur and Hubbali-Belagavi-Goa.
Till date, nine CGD bidding rounds have concluded while Round X is still in progress. For Rounds IV-VI, bidder interest was high only for lucrative GAs. Bid Rounds VII and VIII had limited geographical areas (GAs) on offer, with some GAs having connectivity issues. Therefore, bidders exhibited limited interest in these two rounds.
In January 2018, the Petroleum and Natural Gas Regulatory Board (PNGRB) revised the bidding criteria for setting up CGD networks to attract greater investor interest. The ninth CGD bidding round, which was launched in April 2018, received an overwhelming response with a total of 406 bids received for the 89 GAs on offer. This translates to 4.7 bids per GA. The tenth round received an equally enthusiastic response with 225 bids received for the 50 GAs offered. However, as per industry experts, the issue of irrational bidding has continued even after the introduction of new bidding regulations. As a result, there is a huge possibility that CGD players will end up paying the penalties that the PNGRB has set for not meeting the targets for infrastructure development stipulated under the minimum works programme (MWP).
Challenges on the way
Given the huge number of CGD licences on offer under Rounds IX and X, CGD entities have faced difficulties in evaluating so many GAs at the same time. This problem was further aggravated in the GAs where three or more districts were clubbed, making the size of the GAs very large. The sketchy market assessment data available has also made evaluation of market potential of the GAs difficult. While there are penalties for underachievement of the MWP, the quantum of penalties and performance guarantee cap of Rs 500 million for default seems low.
Further, the CGD segment faces some inherent challenges such as the long construction period, need for approvals from multiple agencies, low profit margins, and competition from alternative fuels. Though the state pollution control boards have laid guidelines mandating that industries switch from polluting fuels such as coal to natural gas and the regional transport authorities have mandated the conversion of public transport vehicles to CNG, these require political will and administrative machinery for implementation. If these steps are not taken in a time-bound manner, the returns from CGD projects could be delayed.
Another major challenge faced by the segment is the long payback period of CGD projects. A CGD company usually takes two to three years to develop the infrastructure, including the pipeline network, a city gas station, and CNG stations before commencing operations. Moreover, the sales scale-up is typically slow and it takes three to four years to reach break-even point. The slow scale-up of sales coupled with the large upfront capital outlay mean a payback period of a CGD project is as much as seven to eight years. After the marketing exclusivity period is over, there is a risk that customers could migrate to a different gas provider. Therefore, the eight-year marketing exclusivity for new entrants may not be adequate.
Currently, the competitiveness of CNG and PNG against substitute fuels comes from the supportive taxation structure that these fuels enjoy in most states. However, as these fuels gain popularity, state governments could see this as an opportunity to earn additional revenues. Further, the lack of a balanced consumer mix, inadequate market potential, slow scale-up in domestic demand and the long-term disruptive risk from electric vehicles are some of the other challenges facing the CGD segment.
The anticipated pickup in domestic gas production, development of transmission pipelines in states in the east and Northeast, and development of green corridors and new CGD infrastructure under the ninth and tenth bidding rounds are expected to offer huge opportunities to all stakeholders in the segment. With favourable conversion economics for CNG, the margins for CGD players are expected to remain healthy. However, industrial PNG margins will continue to fluctuate depending on parity with alternative liquid and solid fuel prices. Domestic PNG will continue to be only marginally profitable, although the industry will benefit from the volume push from the central government. Also, commercial PNG margins will remain robust although volumes will be low.
While recent changes in the PNGRB bidding criteria are forward-looking and have been successful in attracting greater investor interest, there is scope for refinement. As the government is doing its bit with the launch of new bidding rounds and facilitative policy and regulatory amendments to increase private interest, initiatives have to be taken to build an adequate pipeline network in the north-eastern and eastern states. Further, the state governments need to create a more conducive business environment while financiers need to introduce innovative methods of financing.
Based on a presentation by K. Ravichandran, Senior Vice President and Group Head, Corporate Ratings, ICRA, at a recent India Infrastructure conference