Natural gas as a cheaper and cleaner alternative is gaining greater acceptability. It is, therefore, imperative that a long-term investor should stay invested here

WITH crude oil prices soaring above $115 a barrel due to the political turmoil in the Middle East and the North African region, the importance of natural gas as a cheaper and cleaner alternative is gaining greater focus. As natural gas prices the world over remain at a substantial discount to that of the crude oil, consumption patterns are shifting. It is, therefore, imperative that a long-term investor should stay invested in the natural gas value chain to reap the benefits.

In the Indian context, the major concern that the natural gas industry faces today is that of availability of gas and supporting infrastructure for its transportation. Demand is constantly ahead of supply.

THE PUSH FROM THE TOP:

In recent times, the Indian government has taken a significantly flexible view in terms of natural gas pricing, which has helped boost investments in the industry. It abolished the administered pricing mechanism for natural gas in May 2010. Although the government set the price at $4.2 per million metric British thermal unit (mmbtu) for the erstwhile APM gas and RIL?s KG basin gas, it allowed a higher price of $5.25 per mmbtu to ONGC?s natural gas produced from C-series fields starting late 2010.

At the same time, Great Eastern Energy has been allowed to charge $6.7 per mmbtu for its coal-bedmethane or CBM project. The upstream regulator, the Petroleum and Natural Gas Regulatory Board (PNGRB), is also playing a key role in streamlining the investments and tariff structures in laying pipelines and city gas distribution or CGD projects.

HIGHER AVAILABILITY:

The perennial problem for domestic natural gas players has been the lack of availability rather than demand. Slowly but steadily, this is being addressed. With the development of the KG-D6 block on the east coast, and expectations of further finds and development in the Krishna-Godavari and Mahanadi basins, India?s gas production is expected to almost double within five years.

Of the major ones, the ONGC is expected to start producing from its KG basin fields during FY12 while GSPC?s east coast blocks are expected to commence production by April 2013. After doubling its regassification plant at Dahej to 10 million tonne per annum, Petronet LNG is setting up a 5-million tonne plant at Kochi to be ready by 2012. At the same time, Dabhol Power?s 5 million tonne LNG importing plant is expected to be ready later in 2011. As a cumulative impact of this, India?s import of LNG is set to jump nearly two-and-a-half times to 81 million metric standard cubic metres per day (mmscmd) by FY15.

The recent stagnation in natural gas production from KG-D6 block below 60 mmscmd has come as a surprise. However, imported LNG is making up for low domestic volumes.

INVESTMENTS PRECEDE THE GROWTH:

The domestic natural gas players are investing heavily in creating the necessary infrastructure in the form of transport pipelines to connect the demand and supply centres. Gail?s mega-capex plan envisages investments of 40,000 crore by FY13, out of which 61% will go to laying pipelines. Similarly, other companies in the industry ? Indraprastha Gas and Gujarat State Petronet ? have aggressive plans which envisage investments of 500-700 crore each annually for the next 2-3 years.

The recent tie-up between RIL and BP features a 50:50 joint venture to invest in India?s natural gas industry, including importing and transporting natural gas.

RECENT EVENTS:

The recent Japanese disaster has pushed up spot LNG prices around 20% to $11.5 per per mmbtu. However, this is still substantially cheaper to crude oil. Also, the LNG supply scenario today is much better than in 2007, when the spot LNG prices had reached $18-20 per mmbtu following a similar earthquake in Japan.

BETTER TIMES YET TO COME:

Since the investment cycle for the industry has begun only in 2010, the financial performance of the natural gas companies is still not reflecting fully the benefits from their investment efforts. However, a steady growth is clearly visible. The companies witnessed a profit growth between 16-42% in the 9-month period ended December 2010 against the year-ago period.

Over the past one year, the performance of Indian natural gas companies on the bourse has been excellent. All these companies have outperformed the benchmark BSE Sensex, especially Petronet LNG, Indraprastha Gas and Gujarat Gas which have outperformed substantially, while Gail and Gujarat State Petronet have only marginally outperformed.

VALUATIONS:

The next couple of years are going to be good for the natural gas industry in terms of extraordinary earnings growth as industry players complete their expansions and gas consumption goes up. The substantial run-up over the past one year has made Indraprastha Gas and Gujarat Gas among the most expensive scrips in the lot with a priceto-earnings multiple (P/E) around the 18-19 level.

A strong December quarter performance followed by buoyant demand for imported gas has boosted Petronet LNG to a P/E above 17. In comparison, GSPL and Gail are available at a P/E between 12 and 15, which makes them the most attractive within the group.