India’s largest gas transmission company GAIL is set to benefit from higher prices of LPG and petrochemicals while expanding its positive marketing margins on long-term gas contracts. Such benefits could result in a 6-18% earnings upgrade in the next three years for GAIL, which has fallen about 9 per cent since the beginning of the year. The stock performance could now reverse.
The profitability of the LPG and petrochemical segments is expected to improve due to higher prices of crude oil. These two segments account for a third of GAIL’s operating profit. Prices of LPG and petrochemicals are directionally linked to the trajectory of crude oil rates, although the quantum of price change depends upon the demand and supply of LPG and different petrochemical products.
According to analysts’ estimates, every five-dollar increase in crude oil rates could boost earnings by 1.5-2 per cent. Prices of LPG and polymers increased 20 per cent to Rs 40 per kg and Rs 102 per kg in the past six months. Volumes of both segments are expected to improve. LPG volumes are likely to grow due to increasing gas volumes from ONGC. LPG production rose 18 per cent in FY18.
Similarly, utilisation at the petrochemical plant is expected to rise. Higher utilisation and lower feed-cost after the renegotiation of gas prices could lower the cost of production of the petrochemical segment.
According to Nomura, the petrochemical segment’s operating profit could beRs270 crore andRs980 crore in FY19 and FY20, respectively.
Long-term US and Russian gas contracts also may become favourable. The probable loss on long-term gas contracts has weighed on the stock in the past two years when crude oil remained below $ 50 per barrel. Typically, theoretical prices of gas, depending on the energy intensity, are 12-16 per cent of the prices of crude oil.
The Street was factoring in loss from these contracts due to a sharp mismatch between contract prices and spot prices when crude oil dropped significantly, and landed prices of gas were at a 75 per cent premium to spot gas in 2016. Consequently, analysts were expecting an annual loss of Rs 2,000 crore.
GAIL had signed two long-term contracts to procure a total 5.8 million metric tonnes per annum (MMTPA) of gas from the US, and 2.8 MTPA from Russia.
If crude oil price remains at current levels, GAIL could record positive marketing margins compared with an earlier expectation of loss. This could further support an earnings upgrade. According to CLSA estimates, the gas marketing business earns $ 1 per MMBtu as trading margins: On unallocated long-term US and Russian gas, it could earn a trading profit ofRs288-1,369 crore between FY19 and FY21.