Shares of GAIL have increased by over 25 per cent in the past five months on hopes that the country’s largest gas transmission company will report better earnings in the future following an increase in pipeline tariffs.
While this is true, investors also need to consider the possible loss that the company will bear on its US gas contracts if the current sharp mismatch between the contract price and the spot price of gas persists in the future.
GAIL had signed two long-term contracts to procure total 5.8 million metric tonnes per annum (MMTPA) of gas with supply starting 2018. At the current level of Henry Hub price, a benchmark for the US gas price, the landed cost of the gas will be at 75 per cent premium to the spot gas rate.
If this difference persists when the gas is delivered two years later, it will be difficult for GAIL to sell costlier gas to domestic clients because they may prefer to source cheaper gas from other suppliers. The final gas pricing will be a function of several factors including the difference between the benchmark price and spot rate as well as trend in crude oil price. However, the risk is high since GAIL has not secured customer tie-ups for US contracts.
This is unlike its long-term contract with Qatar-based RasGas Company which is under back-to-back arrangement. The event may also offset the benefit of higher tariffs for the company’s five gas pipelines. In addition, Bloomberg reported that NTPC is seeking to terminate the long-term gas supply contract with GAIL due to higher price. It means there is a potential risk to GAIL’s earnings due to supply of high-priced gas contracts amid a glut in global LNG market.
Analysts believe that Asia may become a major market for the oversupplied global LNG as the economics of selling to Europe does not work due to steep competition from Russian gas supplier Gazprom. Credit Suisse estimates that GAIL may have to take a haircut of $1/mmbtu to sell US LNG into Asia, resulting in a $300 million (about Rs 2,000 crore) annual loss.
At Tuesday’s closing of Rs 379.5, the stock traded at 13.4 times FY18 earnings, which is higher than the longterm average and therefore, reflecting that the market is under-pricing the risk from the US gas contracts. John Miller JerseyShare This