Stock Review: Gujarat-based city gas distribution (CGD)

 

Gujarat-based city gas distribution (CGD) company Gujarat Gas is set to enter an uncharted territory in terms of frequent price revisions as its reliance on imported LNG grows. Although the basic economics of natural gas versus liquid fuels remain favourable, the company needs to prove viability and sustainability of its new business model. The scrip is expected to face headwinds on bourses till these uncertainties subside.

Gujarat Gas, which operates India's largest CGD network in terms of gas volumes in Surat and Bharuch districts, supplies 83% of its volumes to industrial retail customers. Due to its relatively small volumes — one-sixth of the total or 0.55 million cubic meters daily — to CNG and domestic customers it gets a lower priority in the government's gas allocation policy. As a result, the company has always sourced nearly 95% of its gas at market-driven prices.

Still, till a couple of years ago, the company's gas sourcing was entirely domestic and prices were fixed for long term. However, in early 2008, the government granted GAIL marketing rights of gas produced by Panna-Mukta-Tapti fields, which have been the largest supplier for Gujarat Gas. With no gas being available in local markets, Gujarat Gas started experimenting with imported LNG in 2009. During 2010, almost 26% of its volumes — 37% if just the December 2010 quarter is considered — came from imported LNG against 13% last year. This is set to go up in future, considering that it has now tied up for three years of LNG with a parent group company. The LNG imports have no doubt given the company a volume-led growth impetus.

 

However, they are on a spot basis, where prices fluctuate widely. As LNG accords higher and higher importance in its gas sourcing mix, the company will face a tough task of passing on higher costs to its customers to maintain margins. As gas prices go up, the immediate challenge for the company will be to maintain its sales volumes since more than one fifth of its current volume competes with cheaper coal as alternate fuel. The company will have to focus mainly on replacing liquid fuels and may go for differential pricing for different consumers. This puts the company in an unprecedented situation where its ability to maintain margins or sale volumes remains uncertain. The monopolistic position and inherent benefits of natural gas usage are the two key factors in favour of Gujarat Gas, which will ensure its future growth. However, the increased uncertainty compared with other natural gas players such as Indraprastha Gas means the company is unlikely to carry on with its premium valuations.