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The new gas tariff proposal based on the cumulative transmission capacity is expected to prune GAIL (India)’s earnings by over 25%. This together with lower domestic gas demand due to economic slowdown may affect its stock in the near term. It has underperformed the Nifty Energy index by 6% in the past three months.
In the last week of June, the Petroleum and Natural Gas Regulatory Board (PNGRB) proposed a new gas tariff structure wherein the volume divisor in the tariff equation will be based on the total gas transmission capacity of a company. The volume divisor helps in ascertaining the utilisation rate of the pipeline depending upon its age.
For instance, in the case of a pipeline with a capacity of 10 million standard cubic metres per day (mmscmd), the regulator may consider 30% utilization rate in the first year, 40% in the second year and gradually increasing it from thereon. Typically, the utilization rate after the fifth year of operation is fixed at either 75% of the normative capacity or actual utilization, whichever is higher.
At present, the gas tariff of a pipeline is computed using the discounted cash flow method based on the projected volume transmission, capital expenditure incurred and operating expenses. Under the proposed unified or pooling method, the pipeline tariff will be computed by pooling capital expenditure and operating expenses of all the cross-country pipelines of a company and apportioning them over the cumulative volume in such a way that allows 12% after tax return.
In the case of GAIL, pipelines such as Jagdishpur-Haldia-Bokaro and Chainssa-Jhajjar have no source of gas so far. Therefore, the proposed method of adding all the pipeline capacities together will inflate the volume divisor thereby resulting in lower tariff and reduced return on investment.
Of the total gas transmission capacity of 235 mmscmd of GAIL, nearly one-third has no gas source. Hence, the company’s actual transmission volume may be less than 40% of the volume divisor. This would bring down the after tax return below the proposed rate of 12%. According to Nomura, if the proposed unified tariff were to be implemented, GAIL’s average transmission tariff may decline by over 20-30%.
GAIL transmitted 109 mmscmd of gas in FY20. Analysts expect around 7% volume drop at 101-102 mmscmd for the current fiscal following lower demand. This will further widen the gap between the actual utilization and the normative utilization considered by the regulator.
Given a spate of overhangs on the earnings due to unified tariff, probable loss on the US gas contracts and petrochemicals, the street may shift to the stock’s valuation based on the book value compared with the sum of parts method. At Monday’s closing price of Rs 103.7, the stock was traded at 1.1 times its trailing book value. While this looks attractive, the uncertainty over the proposed regulations may affect the stock’s near term movement. The stock lost 1% at the end of Monday’s trading session.