Tuesday, November 22, 2011

>>India Gas: Irrational tariff bidding continues – This time GAIL adopts and emerges winner

GAIL wins Surat-Paradip pipeline, with low zone-1 tariff: Very similar to ultra-low tariff strategy adopted by GSPL’s JV (GSPL 52%) last year, GAIL seems to have followed suit and has emerged a winner. As per an Economic Times article (GAIL wins rights to lay Surat-Paradip pipeline, 16 Nov 2011), GAIL bid very low (in fact the lowest allowed) tariff of 1 paisa/mmbtu in zone-1.

Bidding criteria encouraged irrational bidding: Such ultra-low zone-1 tariff may seem irrational, but perhaps was warranted as bidding criteria was somewhat irrational and too mathematical, in our view. As we highlighted in our note after GSPL won pipelines last year (Cross-country pipeline bidding – adding to the chaos, 22 October 2010) and in our anchor report (India Gas – Time to get back in), the bidding criteria were highly mathematical. It required bidders to give projections for each of the next 25 years, and gave too much weight to just zone-1 tariff.

Winners could still make decent returns: We had also highlighted (using hypothetical numbers) that despite low tariff zone-1 tariff, winners could charge high tariffs from zone -2 onwards so that average tariffs remain high and returns are reasonable. Despite low zone-1 tariffs for its three pipelines, GSPL remains confident of achieving 15%+ IRR. GAIL may also get similar returns.

With actual bid numbers now available on PNGRB website, as an example we analyse the numbers bid by GSPL JV and GAIL for Mallavaram-Bhilwara/Vijaipur pipeline last year. This shows that though GSPL’s JV bid for low tariffs in zone-1, tariffs sharply increased from zone-2 onwards. By bidding very low in criteria 1 (zone-1 tariff) and criteria 3 (zone 2 to 3 escalation), GSPL would have scored 100% score (and GAIL below 10%) for these two criteria. Thus despite getting lower score in criteria 2 and nearly same score in volume criteria 4, GSPL’s JV would have emerged winner by a wide margin.

First priority seems to corner pipeline: The strategy of bidders (at least of winners) has been seemingly (and perhaps rightly so) to take advantage of loopholes and win networks first and worry about tariffs later.

The penalties, if pipelines are not constructed (or not constructed on time) are not high. The performance bond for three pipelines awarded last year ranges from INR150mn to INR200mn, and is less than 0.5% of estimated project cost for INR120bn for three pipelines put together.
Adds to near term concerns: Even as we consider that winning a pipeline is positive (we believe pipeline would be constructed only; companies would see these as NPV positive) in near term such low bids add to concern. The serious investment in these pipelines would be forthcoming, in our view, only when companies see clear visibility on demand on the route of these pipelines, and also supply visibility via domestic gas or imported LNG.

We highlight that not much work has commenced on the three pipelines that GSPL’s JV won last year. After long delays, the actual authorization for these pipelines was issued by the regulator only in July 2011, and the six month period to achieve financial closure is valid till January 2012. In fact, not much physical progress has taken place on several pipelines that were authorised by Ministry of Petroleum and Natural Gas in 2007 (prior to formal appointment of regulator in 2008).

We do not ascribe value to these pipelines yet: With limited clarity on gas demand/ supply, tie-ups with customers and realistic timelines, we currently do not ascribe any value either for three pipelines won by GSPL’s JV or now for GAIL’s Surat-Paradip pipeline. As we say earlier, if implemented, these pipelines would be value accretive,

To read full report: GAIL