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Rangarajan Committee formula implies gas pricing at ~USD8/mmbtu in FY15

Motilal Oswal | 04 Jan, 2013  | Follow Author | Add to my Favourites 
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Recommends scrapping cost recovery in PSCs; implementation hinges on government

- The long-awaited Rangarajan Committee report on production sharing contract (PSC) (for E&P blocks) mechanism and gas pricing was submitted in December 2012 and made public yesterday.

- PSC related recommendations suggest moving to revenue sharing (prospectively) from current cost recovery, thus reducing continuous cost monitoring by the government. Other recommendations (applicable to current PSCs) suggest setting up of inter-ministerial committee for fast decision making.

- On gas pricing, the committee-suggested formula implies gas price at ~USD8/mmbtu. While the government would take a final decision on gas pricing, if applicable to all gas producers, will be most positive for ONGC followed by Oil India and RIL.

The key Rangarajan Committee recommendations are:
- To do away with the current cost recovery mechanism and government to share overall revenues of the contractor without setting off costs

- Extend income tax holiday from 7 to 10 years

- Extend exploration time period for frontier/deepwater blocks from 8 to 10 years

- Perform audit by CAG/CAG-empanelled auditors on the basis of financial materiality of a block

- On domestic natural gas pricing, committee noted that though the PSC provides for arms-length pricing, it is not possible in India to adopt this route for several years and hence recommended an unbiased arm's length pricing based on international prices. Committee suggests to take trailing 12-month average of (a) volume-weighted net-back pricing at well head for gas producers and (b) volume-weighted price of US's Henry Hub, UK's NBP and Japan's JCC linked price. The gas pricing will be uniformly applicable to all sectors and domestic gas allocation will be based on government's gas utilization policy.

Motilal Oswal's view:
It is to be noted that historically the government has never implemented any expert committee's recommendations in totality.

- Since the PSC-related key financial recommendations are on prospective basis, they would not impact current PSCs and hence would not impact the profitability/NAV of current producing blocks of RIL/Cairn India.

- However, the proposed gas pricing formula will have a meaningful impact on the domestic gas producers (RIL, ONGC, Oil India) as RIL's KG-D6 gas price revision is due in March 2014 and would also influence prices for other gas producers like ONGC.

- Committee's recommendation to determine gas price through arms-length is a very positive one. However, views/affordability of the key consuming sectors like power and fertilizer would also weigh heavily on the final gas price decision in March 2014. The higher input price for fertilizer will have implications for the government through higher subsidy, unless commensurate end-product prices are increased.

Sensitivity of gas price change on domestic producers:
While the government would take a final decision on the recommendations, Motilal Oswal's sensitivity analysis indicates that domestic producers shall meaningfully benefit from the proposed gas price formula. If the gas pricing formula were to be uniformly applied to all domestic gas producers, ONGC will be the largest beneficiary, and at USD8/mmbtu of gas price, its FY15E EPS would increase by 30%. While EPS sensitivity for RIL is lower at 6%, it shall benefit from increased commercial viability of other discoveries, thus increasing its reserves/production in the future.

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About Motilal Oswal

Motilal Oswal was founded in 1987 as a small sub-broking unit, with just two people running the show. Today it has a 2000 member team with a networth of Rs7 bn and market capitalization as of March 31, 2008 at Rs19 bn.


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Disclaimer: The author has taken due care and caution to compile and analyse the data. The opinions expressed above are only the views of the author, and not a recommendation to buy or sell. Neither the author nor accept any liability whatsoever arising from the use of any of the above contents.

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