Since October 17, India’s listed City Gas Distribution (CGD) companies, specifically Mahanagar Gas (MGL), Indraprastha Gas (IGL), Gujarat Gas (GGL) and Adani Total Gas (ATGL), have shed 56.4 / 57.5 / 26.4 / 9.4 per cent respectively. The cause could be traced back to two distinct yet identical events – a cut in allocation of natural gas under the administered price mechanism (APM) route to the CGD companies, effected twice in the last two months.

How is APM significant to CGDs and how exactly does the cause and effect play out here? Read on to find out.

Administered Price Mechanism

As per directions from the Ministry of Petroleum and Natural Gas, domestically produced natural gas under the cheaper APM route is allocated to CGD companies (gas retailers) to meet the demand from priority segments – Domestic Piped Natural Gas (PNG) and Compressed Natural Gas (CNG). This supply of domestic gas to CGD entities and allocation is implemented by GAIL (India), which operates as the nodal agency of the government in this regard.

Effective from October 16, this allocation under the APM route was reduced by 20 / 21 / 16 per cent for MGL / IGL / ATGL. This was followed with another round of cut effective from November 16, which further had an impact to the tune of 18 / 20 / 13 per cent respectively. On a net basis, allocation has been effectively reduced by 34.4 per cent for MGL, 36.8 per cent in the case of IGL and 26.9 per cent for ATGL, since October 16. Data for GGL is not available as to determine the exact impact.

Cause and Effect

The cut in allocation proposed is on the back of declining production volumes from the legacy oil fields earmarked for APM natural gas. While the allocation was more than or equivalent to the demand until FY22, the increase in demand also pulled its weight from the other side, widening the gap to a range of 35-45 per cent, between demand from the priority segments and allocation under APM to meet the same.

The drop in volumes sourced through the APM route will have to be filled in by increasing the mix of imported Liquefied Natural Gas (LNG), High Pressure High Temperature (HPHT) natural gas and/ or new well gas, which are significantly expensive (~ in the range of 23-85 per cent), in that order. This invariably will increase the input costs and expose the margins to more volatility, in line with spot LNG prices amidst others.

Impact on CGDs

Based on FY24 data, IGL stands the most affected with the sale volume mix skewed towards priority segments, meaning higher dependence on the APM route for sourcing. Priority segments account for 86 per cent of the total volume sold for IGL, while MGL closely follows with 82 per cent. CNG accounts for the bulk of demand in the priority segment for both the companies.

The cost per mileage economics between CNG and Petrol / Diesel is relatively higher in Mumbai - key geographical area (GA) of MGL, than in Delhi (due to higher petrol and diesel prices in Delhi) - which is the key GA of IGL, placing MGL at a relatively better spot amidst this volatility.

GGL, which is largely dependent on industrial volumes, is not in the same field of play as MGL and IGL, and hence, will be less affected by this development, which answers why the correction in GGL was less severe in comparison with the above two players.

CNG also accounts for around 66.6 per cent of ATGL’s sales volume. But breakup of domestic PNG is not provided by the company. ATGL is diversified into EV charging and biogas. But the relatively muted reaction is surprising, despite the present hefty valuations.

While the CGDs took the hit on their books and did not pass on the price hike to its customers post the allocation cut in October, this accelerated cut in November warrants a price hike to contain the shrinkage in profitability margins.

Also, there is a possibility of slowdown in capex and expansion into new GA-s, on account of a dip in profitability affecting reinvestment, and sector turning less attractive for newer players to enter and more so, to thrive.

Outlook

For comparison, OMCs (oil retailers) have largely operated with a 10-year average net profit margins of 2-4 per cent. The same number for CGDs is in the range of 7-19 per cent, thanks to APM. Basis the current developments, CGDs could see their margins contract in the coming quarters and years, and it is more a certainty than a possibility.

And while the margins may not drop to that of OMCs, they will have to protect the volumes and hence, cannot pass on the price hikes entirely to the end users. With India’s target to increase the share of natural gas in energy mix to 15 per cent by 2030, some pushback could be expected from the government to limit the price hikes, too.

And, as this plays out in Q3 and Q4, a clear picture will emerge as to what the new normal net profit range might be.

MGL / IGL / GGL are currently trading at a trailing PE of 8.7 / 11.2 / 27.2 times which are at a decent discount of 49.6 / 52.1 / 14.8 per cent to their 10-year average TTM PE. Adani Total Gas, on the other hand, has been trading at a three-digit PE since February 2021, which is hard to justify and incomparable with historical average.

While it could be said that the bulk of the negatives have been priced in, investors could consider waiting before hitching their wagons to this sector, as overhangs exist in form of unpredictable regulatory tweaks and possibility of further cut in allocation, amidst others.

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