The Indian gas sector: A long-term perspective

Over the past year or so, companies operating in the natural gas space in India have been facing severe headwinds as a result of dying domestic supply, which is struggling to keep up with the robust demand from the user industries.

RIL’s gas output at its prolific KG-D6 basin in the east coast of India has been constantly plummeting ever since it peaked out at 55.9 MMSCMD in 2010-11. The latest figures suggest that the production levels have fallen to a dismal 38 MMSCMD, which is a far shot away from its projected levels of 71 MMSCMD for FY12. The major reasons cited are a drop in pressure in the wells and increased water ingress. Upstream major, ONGC, has also seen a drop in its production levels, which has only added to the supply woes.

The production glitches, in turn, have forced the gas distributors to rely heavily on imported LNG to make up for the supply shortage. Despite the price hikes undertaken, the companies continue to face margin pressures, which has been further accentuated by the sharp rupee depreciation. Companies like Petronet LNG have been operating at full capacity to keep up with the demand. Others like GGCL and Indraprastha, which are currently driven by no significant increase in volumes, have had to rely heavily on price hikes to boost realisations. GAIL is troubled by the uncertainties of a rising subsidy bill, which is bound to impact its financial performance by the year end.

Having said all this, there is a silver lining that investors in the natural gas sector can look out for. As per recent media reports, ONGC seems to have secured official approval to declare its ultra-deepwater UD-1 gas discovery commercial after submitting a revised investment and production plan to the govt. This gas field, which has the ability to produce 20 MMSCMD of natural gas at its peak for a period of 5 years, sits right next to RIL’s KG-D6 basin.

Earlier, at the time of discovery, ONGC had laid down its concerns that the gas production would not be viable at the current rate of US$ 4.2 per unit. Now, after re-modelling its plans, the company believes the price to be viable. As per the detailed development plan, ONGC plans to invest around US$ 2.9 billion dollars in UD-1 (which is the deepest gas discovery in the country), and commission it by 2016-17.

Add to this, the Oil Ministry's recent approval for RIL’s satellite gas finds, which is slated to compensate the flagging output from the KG-D6 fields. As per RIL’s development plans, with an investment of US$ 1.5 billion, the satellite fields are expected to pump out around 10 MMSCMD of natural gas by 2016. Moreover, GAIL has also tied up with Sabine Pass Liquefaction, a subsidiary of Cheniere Energy Partners, USA, for the supply of 3.5 MTPA of LNG over 20 years at very favourable prices. This is expected to start from the year 2017.

Though the benefits of most of these expected synergies would materialise over the next 4-5 years, it still presents a good opportunity for investors with a very long-term objective. One must also take note of a bounceback to normality in the KG-D6 basin over the next 2-3 years, which will prove to be a major driver for the industry as well as for RIL. Also, the strategic alliance with BP will prove beneficial.

Though in the near term, the gas space is expected to find itself in troubled waters, we believe that this space is slated to witness high growth in the future, keeping in mind the robust demand and the likely ramp up of domestic production, aided by impetus from the govt. We advise our readers to keep a close watch on companies in this space with a long-term perspective.