Indraprastha gas order: why is the market in panic?

The gas pricing shock from the Petroleum and Natural Gas Regulatory Board (PNGRB) is slowly sinking into the market. Indraprastha Gas (IGL), which lost a third of its market value on Tuesday, gained a minor 2 percent on Wednesday. The market might not be punishing the stock anymore but surely is not confident in investing even at this price level.

What PNGRB has done is cut the network tariff to Rs 38.58 per mmbtu (million metric British thermal units) against Rs 104 that it charges now and compression charge to Rs 2.75 against Rs 6.66 per kg it charges now. This is almost a 60 percent slash in tariffs and will hit the company hard if it cannot get this order revised.

[caption id=“attachment_272665” align=“alignleft” width=“380” caption=“IGL has challenged the legality and constitutionality of the order in the Delhi High Court . Reuters”]  [/caption]

IGL has challenged the legality and constitutionality of the order in the Delhi High Court and the matter could come up for hearing in a couple of days. So why is the market panicking over the order?

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To begin with, the order is to be applied immediately with retrospective effect from April 2008. Approximate calculations show this would mean an impact of Rs 1,600-1,700 crore. The total market capitalisation of the company is Rs 3,260 crore now. The total net worth of the company could be wiped out as a result of this, and even on its 2013 earnings, there will be a 80-90 percent cut. The operating margins will also be down by 50 percent.

The fall in operating margins (Ebitda) can be made up, to some extent, by a rise in marketing margins. However, Citi told its investors in a note that “Even after allowing for marketing margin over and above this (the quantum of which, however, is uncertain), the order comes as a significant negative surprise, leading to a potential downside of 45-65 percent to our Ebitda (earnings before interest, tax, depreciation and amortisation).”

There is, however, not much reason to be sure of a marketing margin increase by IGL. The company has clarified that it will not tweak prices unless legal issues are sorted out. Moreover, in a letter to PNGRB in January, the government had also entrusted it with powers to determine marketing margin for gas. According to the new PNGRB Act, the Regulator shall “in respect of notified petroleum, petroleum products and natural gas … monitor prices and take corrective measures to prevent restrictive trade practices by the entities.”

Since gas supply is much lower than demand in India any flexing of price muscle could come under restrictive trade practice. PNGRB, according to the letter, could also “regulate” or “determine” marketing margins. This means it could either decide what the marketing margin needs to be for all gas players or choose to include or exclude certain companies while regulating. In both cases, IGL will not have much scope to compensate for the current order through a steep hike in marketing margins.

The retrospective effect given to PNGRB also needs attention. Though the order does not chalk out a plan on how refunds can happen, IGL has been asked to adjust the pricing to adjust for past refunds.

Along with IGL, Gail and BPCL are also likely to be hit as they jointly own 45 percent in the company. The other gas companies which might also take the hit are Gujarat Gas, Mahanagar Gas, and LNG Petronet, as it is unlikely that other gas companies will not come under similar guidelines. All gas stocks, as a result, fell almost 8 percent on Tuesday.

Nomura, Standard Chartered and Citi have Buy targets on IGL with target price of Rs 550, Rs 473 and Rs 420, respectively. Only HSBC has downgraded the stock with a target price of Rs 150.

IGL closed 0.28 percent up at Rs 230.45. Some of the high target prices could be revised after there is more clarity on the impact of the order over the next few weeks.