City gas distribution is in evolution stage

The policy makers, regulator and CGD companies must come together and work towards bringing about positive changes in the sector to maintain its attractiveness, writes Samrat Chauhan.

The city gas distribution (CGD) segment saw a lot of interest from the investors in the first, second and third bidding rounds (2009-2011) with more than 35 different entities participating for different cities. However, the sector is currently facing challenges related to availability and pricing of natural gas supplies-close to 40 per cent of the supplies of natural gas are being met through high priced LNG, out of a total consumption of ~14 mmscmd. Apart from gas allocation from APM, PMT and other Pre-NELP fields, 5 mmscmd of gas was allocated to the CGD sector from KG-D6 field as per the gas utilisation policy, 2008 of eGOM. However, due to decline in production of natural gas from the KG-D6 field, only a negligible amount of gas is being supplied to the sector from the field currently. In the gas utilisation policy, CGD is accorded fourth priority, after fertiliser, power and LPG sectors, as domestic gas supplies to these sectors help in reducing the direct subsidy burden of the government. Any further decline in domestic production may result in further cuts from the CGD sector and allocation to priority sectors like fertiliser and power.

In such a scenario, the sector is expected to depend increasingly on the high priced imported gas for its supplies and thereby increasing the landed price of gas to the consumers. The landed price of gas is capped by the price of alternative fuels (such as LPG, petrol, diesel, naphtha, etc) used in different consumer segments. Many of these fuels are currently subsidised by the government, resulting in low end use price and, as a consequence, limiting the possibility of these fuels being replaced by natural gas. This results in limiting the penetration levels as well as increasing the pressure on the margins for CGD supplies. The combined effect of low volumes and squeezed margins may raise questions around viability of such projects.

On the contrary, projects awarded in pre-bidding era to the companies like IGL and MGL have made good returns and continue to show good profitability. This is primarily attributed to availability of low priced domestic gas, favourable consumer mix and assured returns on infrastructure investments. However, such returns may not be available in the post-bidding scenario, owing to significant increase in the input gas price and reduced returns from the infrastructure investment. Above factors coupled with high degree of business, regulatory and project risks may impact the investment attractiveness of the sector.

Currently, CGD sector is faced by a challenging business and regulatory environment in multiple dimensions. There are challenges related to timely connectivity of demand centres through trunk/spur pipeline infrastructure. Regulatory uncertainties in terms of bidding mechanism, adequacy of marketing exclusivity period, and clarity in roles and responsibilities of PNGRB are certain other factors affecting the sector. In addition, some of the states have unfavourable taxation policy, resulting in higher landed prices of natural gas to various consumer segments, thereby limiting attractiveness in terms of shifting to natural gas from alternative fuels. Also, increased share of imported LNG supplies have resulted in high currency risk for the CGD entities.

At operational level, CGD sector faces difficulties in terms of risks associated with GSPAs and GTAs with the suppliers/transmission companies including terms like take or pay and ship or pay (risk because of falling domestic supplies). Risks associated in such contracts could be passed on to the customer only in a limited manner. Also, during the expansion phase CGD projects are faced with a host of challenges related to clearances and approvals for laying the infrastructure. In some cases, CGD entities have to take more than 15 clearances from Central/State/Local bodies including Railways, CCOE, Defense, NHAI, municipal corporations, public works departments, and pollution control boards. In the absence of single-window clearances, long time taken for such clearances may affect the profitability of such projects, a result of time and cost overruns.

Financing risks

The above mentioned risks and challenges affect the attractiveness of the sector and may in turn result in financing issues. As per the RBI guidelines, CGD projects lending has been termed under infrastructure lending. Funding options such as term loans, ECBs (though of shorter tenure), Bonds, etc are available for CGD projects. However, certain equity funding options like PE investors are generally not interested as the ticket size of investment is small. Typically financers look at the following factors before taking investment/financing decision:-

• Having right mix of supplies including domestic gas, long term LNG, short term LNG and spot LNG with GSPAs signed
• Customer mix inclusive of high profitable customers like commercial and transport; volume providers like industrial
• Tie-ups with key/anchor customers for minimum off-take as demand build up takes 3-5 years
• Connectivity with the trunk pipelines; GTAs signed
• Strength and capability of executing companies in terms of execution capabilities, team, financial strength, equity brought in by the entity
• Strength of the parent companies in terms of experience in the allied sectors, vertically integrated operations of the parent company
• Required clearances including PNGRB autho¡rization, ROW/ ROU clearances, state government support, etc.
• Standalone project or multiple cities licence

In context of these factors, some of the CGD projects awarded as a result of aggressive bidding may face issues in achieving the financial closure, especially because of unfavourable mix of gas supplies and customer portfolio.

While there are a host of factors that have impacted the investment environment of the CGD sector negatively, there are certain aspects that act as silver lining for the sector. First, despite the increase in the input prices, natural gas may still be competitive vis-a-vis certain alternative fuels in the long term. Due to uncertainty and long term upward trend of global crude prices, some industrial/ transportation fuels such as Naphtha, FO, petrol etc, are expected to be less competitive vis-a-vis natural gas.

Additionally, subsidised fuels such as diesel, LPG, kerosene are expected to be decontrolled in the long term, owing to the rising subsidy burden of the government and under recoveries of OMCs. Also, the power tariffs throughout the country are expected to go upin future due to deteriorating financial health of Discoms and limited availability of domestic fuel, resulting in higher cost of generation. All these factors may result in increased competitiveness of CGD supplies vis-a-vis alternative fuel. Secondly, climate change related initiatives and tightening environmental laws and awareness may result in further promotion of Natural gas as a cleaner alternative. Thirdly, gas supplies and related infrastructure is expected to improve in terms of transnational pipelines, trunk pipelines, LNG terminals and long term LNG contracts, resulting in a stable gas supply related environment in the country with better visibility of future.

At this juncture it is important for the policy makers, regulator and CGD companies to come together and work towards bringing about positive changes in the sector to maintain its attractiveness. Some steps that could be taken are in terms of statutory push for using cleaner natural gas as auto and industrial fuel, favourable taxes and duties, facilitation of fast paced infrastructure development (such as trunk/spur pipelines, transnational pipelines, LNG terminals, etc) and clarity in regulatory environment in terms of bidding mechanism and roles and responsibilities of the regulator. Additionally, providing transparent and single-window clearance and assisting in allotment of land for CNG stations could help mitigate project execution risks associated with the sector. Also, aspects such as marketing exclusivity period could be looked into to promote the sector. City gas distribution sector is in evolution stage in the country and is currently at a point of inflexion. However, certain constructive steps from the government, regulator and companies could help in maintaining its attractiveness.