>INDIA: ENERGY: GAS (GOLDMAN SACH)

Strategic impact of adverse court verdict makes it sensitive for RIL

Unfavourable verdict for RIL; but pricing dispute could linger on
The Bombay High Court has ruled that Reliance Natural Resources (RNRL, RENR.BO, Not Covered) is entitled to receive 28mmscmd of gas supplies from Reliance Industries (RIL, RELI.BO) operated KG D-6 block at US$2.34/mmBtu for a period of 17 years. This is against our floor price assumption of US$4.2/mmBtu – per government guidelines. While market has reacted sharply on this news, we believe the dispute could linger for a while as RIL can appeal against the ruling in
Supreme Court in absence of reconciliation with RNRL within a month (as per court order). In such a scenario, the Supreme Court, typically having a broader perspective of cases, could consider the national significance of D-6 gas project, rather than focusing only on the terms of the RIL-RNRL gas sales agreement.

D-6 valuation could reduce by Rs140/sh - already in the price
Assuming that the government would extract its share of D-6 revenues at its directed gas price of US$4.2/mmBtu, the valuation of D-6 block could reduce by Rs140/sh, which we think is already reflected in the share price. Our calculation also assumes that RNRL can only source gas when Reliance Power’s plants start getting commissioned in FY12E, since D-6 gas cannot be used for trading. This implies that RIL’s FY10E/11E EPS of Rs138.6 / Rs203.44 are unlikely to be affected.
We have not assumed any negative read-across for RIL’s gas supply to other consumers.

But the long term impact of the verdict makes the issue sensitive
Apart from affecting RIL’s EPS from FY12E, low gas prices and high govt share could turn RIL’s cash income from D-6 negative starting from FY20E. We believe RIL could either stop D-6 operations then or, by corollary, could go slow on D-6 capex. Moreover, RNRL could impact RIL’s future gas projects as it would have the option to source all or 40% of RIL’s gas beyond 53 mmscmd of production from all blocks auctioned until 18 June 2005, though at market prices. We keep our Buy on RIL with 12-m SOTP-based TP of Rs 2430 (upside of 13%). Key risk: delay in D-6 ramp-up. We await further clarity on the dispute.

Inability to trade in gas implies RNRL cannot benefit from verdict
Currently, RNRL stock is implying marketing margin of US$1.54/mmBtu (17 years, 28mmscmd gas) vs prevalent margin of US$0.12/mmBtu. But since the gas agreement mentions D-6 gas cannot be traded, we believe RNRL is unlikely to be able to charge these margins as of now, which otherwise imply upside risk for the industry’s margins.

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