Indraprastha Gas Profitability Under Strain Post PNGRB Directive

According to a directive from the Petroleum and Natural Gas Regulatory Board (PNGRB) of India, the network tariff and additional compression charges levied by state-owned PSU Indraprastha Gas (IGL) in Delhi-NCR on the sale of gas has been pegged at Rs 38.58 per million metric British thermal unit (mmBtu) and Rs 2.75 per kg respectively as against the company’s calculation of Rs 104.05 per mmBtu and Rs 6.66 per kg. Moreover, the company has also been ordered to reduce its selling prices to the extent of the difference between the board’s figures and company’s estimates. The order also states that IGL would have to refund all excess charges retrospectively since 1st April 2008 however the modalities of the same would be decided later.  

This development has come as a major setback to the GAIL and BPCL co-promoted company whose shares tanked massively by 40 per cent at the opening bell and closed the day at Rs 229 a share, down 34 per cent.

While unconfirmed sources have told us that the state PSU has approached the Delhi High Court (HC) over this issue citing that the PNGRB has made a one sided calculation and that the company has a strong case in its hands to oppose the order, we at DSIJ have factored in a worst case scenario for the sake of our readers and the investor community at large to help them understand the current situation in a comprehensive manner.

However, before we present our case scenario, investors must understand that the network tariff would be applicable on both CNG and PNG, while compression charge would be levied only on CNG. Overall there are three margins that are charged by city gas distribution companies (CGD) – network margin, compression margin and marketing margin. While the previous two are under regulation by the PNGRB the marketing margin is not regulated. It is believed that the market forces of competition would take care of it in future.

Now according to our case scenario, if the order comes into effect it would mean that IGL would have to cut down its consumer prices by Rs 5.58 per standard cubic meters (scm). This when compared to the company’s FY11 EBIT earning of Rs 4.12 per scm, would translate into a loss of Rs 1.46 per scm. In short the passage of this rule will prove to be very detrimental to the company’s financial health. The only cushion that can be provided is in the form of IGL’s ability to self regulate its marketing margins. However, given the fact that the company has lost its monopoly in Delhi w.e.f Jan 2012, it could offer other city gas distributers the opportunity to enter the markets which would restrict IGL from raising its marketing margin significantly. Hence one will have wait and watch out for the company’s approach on the marketing margin front as this will provide a fair view of the final impact.

Moving on, as mentioned earlier the order has also stated the IGL would have to refund the excess charges with retrospective effect since April 2008. While the modalities for this are yet to be decided, our case scenario suggests that company may have to shell out a total of Rs 1550 crore, which would completely wipe off its FY11 networth of Rs 1004 crore. However, given its government owned status it is highly unlikely in our view that the govt. would let such a thing happen.

In conclusion, despite the detrimental effects of the PNGRB order and the resultant correction seen in IGL’s stock prices we recommend investors to not exit the counter in a haphazard manner until there is further clarity from the management on this issue.

From a macroeconomic perspective, we at DSIJ believe that this move will not materialize in totality sans any changes as it is completely against the government’s envisaged plan to encourage use of natural gas as a chief source of energy over other variants like petrol diesel and coal. The advent of this order would put-off all future capex plans in the city gas distribution space as companies will no longer find it a viable venture.

Finally, one important question that awaits a reply from the management as well as company auditors is that why weren’t any disclosures made earlier to unaware investors’ about such contingent liabilities, which would prove so fatal to companies future. Until we get clarity on all this we advice investors to hold the counter.