Vying for gas

While it is advantage RNRL in its gas-related dispute with RIL, experts believe it may not be the last we have heard about the matter.

Last Monday, the Bombay High Court announced the judgement in the dispute between Reliance Industries (RIL) and Reliance Natural Resources (RNRL) in favour of the latter. It directed RIL to sell 28 mmscmd (million metric standard cubic meters per day) of gas to RNRL at $2.34 per mmbtu, which is around 44 per cent lower than the $4.2 per mmbtu price fixed by the Indian government for gas supplies to priority sectors.

The financial implication of this judgement is huge and runs into billions for both companies. It didn’t come as a surprise that the RIL stock fell 7.5 per cent compared to its close on June 12, translating into a decline of about Rs 29,000 crore in its market capitalisation.

Market participants were assuming a favourable outcome for RIL. Nonetheless, market experts believe that this four-year battle (since the signing of the MoU in June 2005) however, is not yet over as RIL may choose to approach the Supreme Court. Should that happen, the resolution of the gas dispute could get postponed till the time the court delivers a judgement, which again, may or may not provide a different ruling.

Also, there is lack of clarity on whether RNRL will be able to gain from the gas availability in the immediate future as the Dadri-based power plant of ADAG group company, Reliance Power, is not operational.

RIL: Earnings impact
RIL is expected to produce 80 mmscmd by end of 2009-10 (current product about 30-35 mmscmd). Given the court judgement and assuming gas realisation of $2.34 per mmbtu for the first 40 mmscmd and $4.2 for the remaining 40 mmscmd, the impact for RIL is huge.

In a note, analysts at Morgan Stanley say that the quantum of revenue impact due to lower gas price would be $1 billion annually from 2011-12, assuming that gas supplies (at lower prices) to RNRL and NTPC begin after two years.

Says a consultant, “The 28 mmscmd gas supply to RNRL will not be immediate and can be ramped up in the next 3-4 years.” He thus expects that the recent judgment may not materially impact RIL for the next two years, as the prospect of RNRL trading gas to a third party is ruled out.

On the other hand, an analyst from a Mumbai-based brokerage says, “Given the court ruling, RIL’s FY10 and FY11 estimated earnings would decline 2-4 per cent if RIL supplies gas to NTPC from FY10 and to RNRL from FY13 onwards. However, in the event of supplies to RNRL from FY10 onwards, it could reduce FY10E-11E earnings by as much as 11-17 per cent.”

The other issue that needs clarification is the government’s stance on its share of profits. If it agrees to the actual sale price (thus, a blended rate of $3.27) then the earnings impact for RIL will remain at 17 per cent. But, if it demands the profit share based on $4.2 (government determined rate) for the gas sold to RNRL and NTPC, the earnings impact would work out to 20-21 per cent in the first year of full supplies to the two companies (as against the base case).

For now, the Bombay High Court decision is negative for RIL and most experts believe that a majority of the gas would be sold to RNRL at the lower rate ($2.34). Even as both the companies have a month to sign a “suitable agreement” (based on the MoU) for the gas supply for a period of 17 years, analysts have cut their share price targets for RIL by Rs 90-225 assuming the different scenarios.

ADAG: Long-term gains
For RNRL, which has been set up to procure the gas and other resources for the Anil Ambani group (ADAG) companies, it stands to gain from estimated commissions of about $0.10-0.20 per mmbtu (around $35-70 million annually). Gains would also accrue to Reliance Power (another Anil Ambani group company).

Reliance Power’s gas-based Dadri power project had got delayed due to the ongoing court case (mainly gas supply issue). With one mmscmd capable of generating around 200-250 megawatts, the 28 mmscmd of KG basin gas would be sufficient to run the over 7,000 MW Dadri’s power plant at 80-90 per cent capacity.

With the certainty of gas supplies, it would help take the project closer to achieving financial closure and increase hopes of it getting completed by 2012-13. Besides, the lower price of gas significantly improves the profitability of the project. However, Girish Solanki, analyst, Angel Broking says, “With the court verdict still fresh, it will take some time before Reliance Power and RNRL would sign up gas share price agreements for the gas supply.”

The gains for the ADAG company could come faster if it can buy sizeable gas-based power generation capacity, which could consume the gas (looks unlikely). However, for NTPC, analysts point out that the company is in a better position to take delivery (and consume) of its share (12 mmscmd) of gas.

The market’s verdict
Post the court ruling, analysts are projecting various scenarios for RIL depending on how soon RNRL and NTPC are able to take their share of gas from RIL and how the government arrives at its share of profit.

Meanwhile, reports indicate that RIL is most likely to approach the Supreme Court, which may delay the gains for the two companies. Such a move would also keep hopes alive of a reversal of the recent judgement, which if it materialises could result in a re-rating for the RIL stock.
 

PRICE IMPACT
in $ million	Base case	Scenario 1	Scenario 2
Total Gas production ^	80.0	80.0	80.0
Revenue	4,378	3,409	3,409
Average realisation	4.20	3.27	3.27
Production costs	938	938	938
Royalty charges	172	124	124
Government Share - A	327	235	332
EBITDA	2,941	2,112	2,015
Depreciation	712	712	712
Tax	265	167	155
PAT	1,964	1,233	1,149
E&P PAT impact	-	-37.2	-41.5
Assumptions: * Base case (earlier anticipated by analysts): 80 mmscmd @ $4.2/mmbtu * Scenario 1: 40 mmscmd @ $2.34/mmbtu & 40 mmscmd @ $4.2/mmbtu; govt share @ $3.27/mmbtu * Scenario 2: 40 mmscmd @ $2.34/mmbtu & 40 mmscmd @ $4.2/mmbtu; govt share @ $4.2/mmbtu * Production costs ($0.9 per mmbtu) includes development & operating expenditure, and interest costs * Royalty=5%, government share=10%, 1mmscmd=35,700 mmbtu * Taxes @ 11.9 per cent    ^ in mmscmd

In the worst case, analysts expect the impact for RIL’s earnings to be about 22 per cent, which to a large extent is also reflecting in its share price. Although RIL’s profit margins from E&P front stand reduced for RNRL’s portion of gas, further upside could come in the form of new discoveries. What also provides comfort is that even as RNRL is reportedly entitled to about 40 per cent of all future gas discoveries by RIL, the pricing would be market determined.

For now, the outlook for RIL’s refining and petrochemicals businesses does not look bright in the medium-term (FY10 at least), and will prove to be an overhang on the stock.

Analysts thus, maintain a ‘hold’ on the stock. While the court verdict has ignited positive sentiment in the RNRL stock (it jumped 25 per cent on last Monday, but gradually slipped and is currently up by a net 6 per cent), the gains could be delayed by 1-2 years.