Gas stocks can make you rich!

Volatile oil prices made stock markets nervous in 2004. When crude hit $50 per barrel in October last year, it sent shivers across equity and bond markets.

But this time around, despite crude prices edging past $55 and analysts warning that prices could surge to $70-80, the markets do not seem to be unduly perturbed. Why? One could attribute this nonchalance to the 'irrational' exuberance of bull stock markets.

Or conclude that the markets have already factored in or reconciled themselves to the new reality. This new reality, however, may not just be about rising oil prices but the emergence of gas as an alternative fuel.

Despite being a cleaner fuel and economical, too, natural gas has not really replaced petroleum-based fuel due to inadequate supplies and poor distribution infrastructure. Now, that may well be set to change.

First, domestic supplies will start kicking in about two years' time with Reliance gas set to go on stream, and increased imports through Petronet and Shell.

Over the past decade, the complexion of the liquefied natural gas market has changed dramatically with both capital and logistics costs reducing dramatically to make gas available at half the price.

Besides, the use of CNG (compressed natural gas) as an alternative auto fuel and PNG (piped natural gas) as a substitute for LPG can only grow as sheer economics combines with changing government regulations to force the change.

While supplies are getting tied up, the distribution infrastructure, which has prevented the change so far, is all set to be beefed up with the government's directive to set up the national gas grid.

It is obvious that companies which have anything to do with gas - right from gas exploration and production, to transmission and distribution to gas pipeline makers - will be major beneficiaries of this large-scale demand shift. Stocks of gas companies do not seem to have factored in this optimism yet, but analysts are bullish about the sector in the long-term.

Gas is cleaner and cheaper

Gas demand is set to grow because of sheer economic compulsions. Of the three key feedstock fuels for industrial users (naphtha, coal and natural gas), coal is the cheapest.

Coal is also more polluting, and the high transportation cost makes it an expensive option for industries located in the western and northern parts of India.

Analysts believe that demand for natural gas will arise mainly from this region. On an average, the delivered price of LNG is about a third of naphtha's price.

Besides, natural gas prices are as fickle as naphtha prices, which depend on crude prices. The simple reason is that the commodity is not traded, unlike crude. Prices are negotiated for long-term contracts. In some ways, natural gas prices are benchmarked against crude prices but international LNG contracts are at varying discounts to crude prices.

At present, most contracts limit the variation within a price band of $16-$24/bbl. Petronet's purchase agreement with Ras Laffan is at a price of $2.53/million British thermal unit (mmbtu), which is pegged to an international crude price of $20/bbl for five years. The company sells LNG at around $3.2/mmbtu, not inclusive of distribution costs and taxes.

Currently, gas pricing in India is not uniform all across. The price of gas sold by ONGC and OIL is subsidised and regulated by the government and the going price is $1.8/mmbtu.

Private players, however, sell natural gas at market-determined rates but are still cheaper than LNG. Petronet LNG's prices are linked to a Japanese Crude Cocktail (which determines the 15 per cent variable component in its prices).

Government has been talking about de-regulation of gas prices but nothing concrete has emerged yet. In any case, new gas will come in at market-determined rates which are still substantially cheaper than alternate sources.

Users may be forced to switch

The main consumers -- or user industries -- of natural gas are fertiliser, power, steel, ceramics and glass. Besides, natural gas is an alternative fuel for automobiles and cooking gas/LPG. It is well known that environmental laws across the world, including China and India, favour using gas as fuel for public transport.

The conversion of buses to CNG in New Delhi has dramatically reduced air pollution. However, gas consumption in the automotive/transport sector is small and may not make any significant difference to total gas sales.

So the big push for the gas sector will materialise only when industrial users - especially power and fertiliser companies - decide to switch to the fuel. Chances are that this will happen sooner than later.

For instance, the operating cost of power will be around Rs 1.2 per kilowatt hour (kwh) if the power plant uses LNG (based on Petronet's current selling price of $4.1/mmbtu) as feedstock while the cost will be Rs 3.5 per kwh if it uses naphtha instead. The current natural gas price is even lower but insufficient supply is a major constraint. Several captive power generation plants being set up in the western and northern parts of the country are likely to be gas-based. The country's largest power generation company, NTPC, is planning its latest 2,600 mw power plants in Gujarat through gas-based power plants. Reliance has been the successful bidder with an extremely competitive offer price of $2.97 per mmbtu, better than even coal-parity prices.

Analysts expect about three-quarters of Reliance's gas produce will be consumed by NTPC and its own power subsidiary Reliance Energy. Which means most other companies will rely on LNG which will be slightly more expensive than natural gas and coal but far cheaper than naphtha.

Also, according to the new fertiliser policy, all fertiliser plants in India are expected to shift to natural gas/LNG by 2006. Currently, nearly a quarter of fertiliser plants in the country use naphtha/furnace oil instead of natural gas/LNG.

This means there will be a huge demand for gas as these plants decide to make the switch. Since fertiliser production is subsidised by the government, companies do not really have too much incentive to reduce costs. But that could change as the government may now insist on fertiliser companies becoming more competitive.

Supply won't be a problem anymore

Till some time ago, gas availability itself was a problem with domestic production being very small. With no significant new discoveries, ONGC's gas supplies have also been modest.

Moreover, international supplies were unviable due to prohibitive transportation costs. This is changing. Over the next four years, gas supply is likely to grow at a CAGR of at least 15 per cent (See table). And all of it is waiting to be consumed, say industry sources.

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