India Ratings and Research (Ind-Ra) believes the continued low domestic gas prices applicable for 1HFY22 (2HFY21: USD1.79/mmbtu) would keep benefiting the profitability of end-user industries such as fertilisers and city gas distribution (CGD). However, the profitability of upstream natural gas producers would remain subdued due to lower realisations and higher cost of production. The low domestic price is a result of subdued benchmark prices particularly the Henry Hub (HH) over the reference period 2020.

  Figure 1

Natural gas is the primary feedstock for majority of fertiliser production in India and this sector consumes the highest amount of natural gas (29% share) in India, followed by the CGD sector (20% share) and power sector (19%). While the nitrogen-phosphate-potash (NPK) fertiliser manufacturers are largely dependent on imported natural gas, urea manufacturers rely on both imported and domestic gas for their feedstock requirements, which is governed by the pooled gas pricing mechanism. 

Figure 2


  Figure 3


 Figure 4


Fertiliser Pooled Gas Prices Marginally Impacted by Domestic Gas Prices:
The affirmation of domestic gas prices at USD1.79/mmbtu would keep the increase in pooled gas prices under control, despite the increase in global LNG prices during the winter months globally. Over FY17-FY21, the pooled gas price movements were more driven by the price dynamics of LNG markets than domestic gas prices. This is because the share of cheaper domestic gas fell to 36% in 11MFY21 (FY17: 51%) while imported LNG share increased to 64% (49%). The latter was a result of low domestic gas production while demand has continued to increase (Figure 5). The pooled gas prices were around USD7.5/mmbtu during 11MFY21. Ind-Ra believes a USD1/mmbtu increase in domestic gas prices and imported LNG prices would result in a USD0.3/mmbtu and USD0.6/mmbtu increase, respectively, in pooled gas prices, assuming 35%:65% in domestic to LNG mix.

  Figure 5


Limited Impact on Fertiliser Subsidy Burden and Credit Metrics:
The affirmation of gas prices is likely to keep the subsidy burden under check, as the pooled prices are unlikely to increase. However, the driver of the subsidy burden would continue to be imported LNG prices. For every USD1/mmbtu decrease in the pooled gas prices and in the imported LNG prices, the urea subsidy burden decreases by INR1,750/tonne(t) and INR11,20/t respectively, assuming a weighted average energy consumption of 5.826Gcal/t and INR/USD of 74.5. A lower subsidy burden would lead to a corresponding decrease in the working capital requirement for manufacturers which could reduce the borrowings and supports the credit metrics. Moreover, lower domestic gas prices would not have any benefit for NPK fertiliser manufacturers, as majority of them are using imported RLNG for meeting their feedstock requirements. However, rising RLNG and other raw material prices could impact the near-term profitability, if end-product prices are not increased. The strong demand momentum because of the strong growth witnessed across rural consumption items such as tractors, fertilisers and pesticides during 9MFY21 could aid higher acceptance of price hikes by end-consumers. Even if the profitability is impacted, the profit before tax of fertiliser companies should be strong, given the likely low interest burden on account of i) a lower subsidy burden and ii) clearance of all past dues post additional allocation in the fertiliser budget. 

  Figure 6


Low Impact on Energy Efficiency Savings of Urea players:
Urea manufacturers have historically derived a healthy proportion of their EBITDA from energy efficiency savings through plant operations at lower than normative energy norms. A lower pooled gas price results in lower energy savings. Ind-Ra estimates that for every USD1/mmbtu reduction in the pooled gas price, the gross energy savings of urea players up to the re-assessed capacity (RAC) decreases by around INR1625/t, assuming a weighted average energy saving of 5.5Gcal/t at an INR/USD rate of 74.5. However, the above impact is partly neutralised by a decrease in the cost of production beyond RAC which results in a marginal improvement in the contribution margins for plants which have higher sales beyond RAC.

 

CGD Sector to Continue to benefit: The continued low domestic gas prices would keep benefiting the operating margins of CGD entities in the CNG and domestic PNG segments. CGD players did not pass on the full benefit of the natural gas price decline to end-consumers, given their absolute profitability was already under pressure due to the decline in volumes during FY21 caused by the lockdown in 1QFY21. If volumes were to take a beating, given the rise in COVID cases in select states in India, players might decide to hold on to the prices. Going into 2HFY22, if the domestic gas prices were to increase, Ind-Ra does not expect a margin contraction as CGD entities have demonstrated strong pricing power. This also stems from the increase in prices seen in alternative fuels such as petrol and diesel, making CNG competitive even at higher price points. Also, Ind-Ra does not anticipate this arbitrage to go down as the tax collected on petrol and diesel forms a significant proportion for both the central and state governments. Similarly, on domestic gas consumption, the acquired customer base is not prone to shift to alternate fuels on account of the price increase. The more price-sensitive industrial and commercial business segments under CGD are already outside the ambit of domestic natural gas pricing. 

  Figure 7

  Figure 8


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Analyst Names

  • Ashish Agrawal

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    Bhanu Patni

    Senior Analyst
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