PNGRB ORDER ON INDRAPRASTHA GAS: Oil & Gas Sector Now Faces Higher Regulatory Risk, Lower Investor Interest

The petroleum and natural gas industry in the country, dominated by several large staterun companies, is becoming increasingly unattractive for retail investors. The sharp cut in tariff rates of Indraprastha Gas by the Petroleum and Natural Gas Regulatory Board or PNGRB underlines the fact that regulatory risk has risen substantially for the sector.
The PNGRB’s order on Indraprastha Gas would not only cut tariffs by nearly 60% and impact its future profitability, but will also deal a body blow to the company considering that the cut is going to be with retrospective effect.
“In case IGL has to refund the excess charges with effect from April 1, 2008, the resultant . 1,530 crore charge would wipe out the company’s FY12 net worth of around . 1,290 crore,” says Sandeep Randery of BRICS Securities. Almost all analysts have expressed surprise at the PNGRB order while downgrading Indraprastha Gas. However, most of them reckon that the company would challenge the order, which could result in a prolonged legal tussle.
The impact of this regulatory change will not be restricted to Indraprastha Gas alone. Nomura, in its report on this regulatory action, says that such a drastic reduction in tariffs of IGL also raises the prospect of likely tariff cuts for networks where tariffs are not yet determined — in particular, it notes, for Gujarat Gas and Gujarat State Petronet.
“Investor interest in gas stocks would likely wane with such decisions,” the report adds. While IGL lost over 33.6% of its value on Tuesday, Gujarat Gas and GSPL lost 15.1% and 7.5%, respectively. In the natural gas sector, while network tariffs and compression margins are regulated by PNGRB, marketing margins are not. In January this year, the government mounted an attempt to control even that. It entrusted PNGRB with the task of determining marketing margins on the basis of the costs incurred. This effectively increases the regulatory risk for the sector.
India’s petroleum sector has always remained captive to government interference, which has been detrimental to their valuations. Ad hoc decisions on retail subsidies, price increases and sharing of subsidies make it tough for the three oil retailers — Indian Oil, BPCL and HPCL — to create shareholder value.
Similarly, the uncertainty in profit forecasting for ONGC, Oil India and Gail due to the ad hoc subsidy sharing mechanism has always been the key negative factor in their fair valuation.
Even private companies are not spared. Last year, Cairn India was forced to pay royalty on its portion of Rajasthan crude oil while seeking permission for the Vedanta deal. This year, within days of share sale by ONGC, the government raised the cess on crude oil to . 4,500 per tonne in the Union Budget, which could impact all oil producers.
All this goes on to show that regulatory risk is rising for the entire sector. A company like Indraprastha Gas, which has long been praised for its stable and growing business model, is overnight being viewed as a risky investment because of a single regulatory action. Retail investors may not have the appetite to take such a high level of risk. 

KEY POINTS The PNGRB’s order on Indraprastha Gas not only cuts tariffs by nearly 60%, but also does it with retrospective effect
The drastic cut in tariffs of IGL also raises the prospect of likely tariff cuts for other similar networks
Ad hoc decisions on retail subsidies make it tough for oil retailers such as Indian Oil, BPCL and HPCL to create shareholder value
Within days of ONGC share sale, the government raised the cess on crude oil to . 4,500 per tonne