Petronet LNG

Petronet is a key player in the fast growing natural gas market of India and has had a decent run over the past few years.

The company is engaged in the import of liquefied natural gas (LNG) from RasGas of Qatar, which is regassified at its 11.5 million tonnes per annum (mtpa) terminal in Dahej, Gujarat. A second terminal is under construction at Kochi.

Natural gas demand is running far ahead of supply and there is tremendous scope for an established player such as Petronet to cash in on this. Yet, there are some key issues that continue to dog the industry such as the uniform gas-pricing policy which the government is studying now. The rising supply of gas from domestic sources, especially from the Krishna-Godavari (KG) Basin, at a competitive price is a critical factor that could slow down the growth of Petronet.

At its current market price of Rs 78.05, the stock discounts its trailing 12-month earnings by around 11.4 times. Shareholders can stay invested while keeping a close watch on the developing market and regulatory environment.

Well-positioned

The government is promoting natural gas as the preferred fuel due to the new domestic discoveries of gas reserves, the relatively cheaper price compared to oil and its environment-friendliness. The sector is expected to witness rapid growth in the coming years and demand is expected to exceed increased domestic supplies. The gas deficit situation bodes well for LNG importers such as Petronet which are almost assured of a ready market, provided the pricing is favourable.

The back-to-back long-term (typically 20 to 25 years) purchase and sales arrangements entered into by Petronet provide some comfort on revenues and earnings.

While long-term contracts comprise the bulk of its business, Petronet also supplies gas on a spot basis on which it enjoys marketing margin in addition to re-gasification margin. The re-gasification charge on long-term contracts is subject to a 5 per cent escalation annually.

The expansion of the Dahej facility from five mtpa to 6.5 mtpa through de-bottlenecking in 2007 and recently to 11.5 mtpa in June 2009 through capacity expansion may help Petronet increase volumes. The company has tied up additional supplies from RasGas for 2.5 mtpa from January 2010, in addition to the existing supplies of 5 mtpa.

Thus, supply linkage for 7.5 mtpa out of the 11.5 mtpa capacity has been tied up. The company has recently acquired a third LNG shipping vessel “Aseem” to transport additional LNG from Qatar to Dahej. Petronet has also tied up supplies of 1.5 mtpa LNG from the proposed Gorgon project in Australia for its 2.5 mtpa LNG terminal in Kochi, which is expected to be operational in 2013.

Besides, the company is also developing a solid cargo port at Dahej, and power plants near the Dahej and Kochi terminals.

Financial metrics

Petronet's annual growth from 2005 to 2009, both on the topline (around 45 per cent to Rs 8,428 crore) and bottomline (from losses to Rs 520 crore) has been impressive. This has been driven by increase in volumes (spot cargoes in addition to long-term contracts) and improvement in price realisation. Growth though, has been decelerating over the years due to base effect.

The company disappointed in the third quarter with sales and profits declining 9 per cent and 21 per cent respectively over previous year, primarily due to expiry of the Ratnagiri Gas Power Plant contract, and also due to significantly higher depreciation and interest cost incurred on expansion of the Dahej terminal.

However, growth could be back on track with higher spot cargo volumes, and additional supplies (2.5 mtpa) from RasGas being tied up in the current quarter.

Petronet's single-digit net margins (around 6-7 per cent) till 2009 declined this fiscal to less than 4 per cent, mainly due to increased depreciation and interest charges. Return on equity was healthy (above 25 per cent) till 2009. Margins are expected to be under pressure, going forward, given the effects of the increased capex.

Headwinds

Tying up additional LNG supplies at competitive rates to meet potential increased demand remains a key challenge. As against the increased nameplate capacity of 11.5 mtpa at the Dahej terminal, Petronet has tied-up sourcing of about 7.5 mtpa, leaving a deficit of about 4 mtpa (almost 35 per cent of capacity).

While the recent offer by Qatar to supply an additional 4 mtpa over the next few years could help tide this deficit, pricing remains a contentious issue.

Reports suggest that the asking price by Qatar for the new supplies (upwards of $10 per mmbtu) is quite steep compared with the pricing of existing LNG supplies (around $7 per mmbtu) and, more importantly, above $4.2 per mmbtu fixed by the government for Reliance's KG gas. Even at current levels, LNG is significantly more expensive than gas produced domestically.

Sourcing at higher prices could further aggravate the situation and reduce competitiveness. Also, supplies for only 1.5 mtpa of the proposed 2.5 mtpa LNG terminal at Kochi has been tied up, pricing details for which have not been disclosed. Idle capacities built at huge cost, could prove to be a drain on the company.

While the government has announced its intent to bring about a unified gas pricing policy, till such time this takes shape, LNG is expected to remain costlier than gas produced domestically.

This could lead to pricing pressures and reduction in margins, going forward. Commencement of production from the KG Basin discoveries of ONGC and GSPC could further skew the picture.

Regulatory intervention by the downstream regulator (though unlikely in the near term) to moderate re-gasification margins and returns on equity, and execution delays at the proposed Kochi terminal pose additional risks.