A gas price of $8 is easily absorbed

Sanjeev Prasad, the co-head & senior executive director of Kotak Institutional Equities, has tracked the Indian markets as also government policies for over a decade now. Known for his candid views on corporates, Prasad is considered an authority on the oil and gas space. In the context of the debate on gas pricing, Prasad suggests an optimum price of $8-9 per mmBtu saying any price above that could pose problems for the fertiliser sector and gas-based power plants. In a conversation with Devangi Gandhi and Ashish Rukhaiyar, Prasad asserts that the government needs to make it simpler to do business in India.

Is the price of $8 per mmBtu a good level?

That seems to be a good price for both producers and consumers. Since gas-based power plants need to compete with plants that will run on imported coal, we believe that gas at somewhere around $9 per mmBtu delivered to a power plant, or about $8 at the wellhead, is a competitive price. Otherwise, if you produce power at gas priced at $12-13 per mmBtu there is no way it will be able to compete with coal-based power.

For the power sector, an increase in gas prices to $8 could result in a cost impact of about R75 billion but the increase doesn?t matter too much since it can be easily made up with an increase in the price by 7-8 paise per unit, which is quite possible.

What, in your view, would be the affordable price of gas for the fertiliser sector?

The average price of urea in 2011-12 was $400 per tonne (Middle East FOB price). If you add to that transportation costs and import charges etc, the selling price would be $450 per tonne. Now, to produce urea at home below this price, the relevant price of gas delivered to a fertiliser plant should be $10 per mmBtu and hence about $9 at the wellhead. So, a price of about $8-9 per mmBtu for gas seems to be right; we may as well shut down all urea plants and start importing urea if domestic gas prices are well above this. The impact for the industry would be somewhere around R88 billion and would actually increase the subsidy burden for the government since there is no intention of increasing urea prices to the farmer. However, that would be more than offset by additional revenues of about R94 billion that the government would earn from higher revenues and profits of ONGC and OIL.

Do you see any chances of the government doing away with subsidies for OMCs?

We are looking at under-recoveries, which could be lower by almost 30% for FY14 versus FY13 levels, and if the monthly price increase for diesel continues, for say another four to six months for a total of R2 to R3, India could save another R150-225 billion on annualised basis given that every one rupee increase in diesel price leads to a savings of R75 billion.

Thus, under-recoveries could decline to below R1 trillion on an annualised basis. That is quite a manageable number. In fiscal 2013, the government subsidy burden was R1 trillion and in two years? time we are looking at a situation where the overall under-recoveries would be R1 trillion. Further, assuming that the direct benefit scheme gets rolled out fully in the next three to four years, that could also result additional savings; there is a lot of leakage in the current PDS, at least in the case of the kerosene, and around 50-60% of kerosene does not reach the target households.

The finance minister has been pushing India?s case with investors. How do you see the policy environment?

Things are happening. We have already seen partial deregulation of non-urea fertilisers. In the case of fuels, gasoline is also more or less out of the subsidy bracket and bulk diesel has also been deregulated. Maybe in another 12 months we would see retail diesel also fully deregulated. Fiscal 2013 saw big increases in power tariffs across states and we are expecting further moderate increases in fiscal 2014. We have seen railway passenger fares being increased for the first time in 10 years. The issue is how the government can make business and investment simpler in India. For instance, how do you deregulate the labour market? How do you allocate natural resources in a more transparent manner? The other thing is to make the approval process, be it environmental approvals or other project approvals, simpler in our country. We need to reduce bureaucracy. These are the real challenges to kick-start the investment process.

How are foreign investors viewing the changes since the recent rally has been driven purely by overseas money?

The good thing is that the global macro environment is very supportive and liquidity is not an issue due to the accommodative policies of central banks. So, there is money in the system and India will get its fair share. The availability of cheap money overseas is also helping a lot of global companies increase their stakes in domestic subsidiaries. We saw Unilever and GSK Consumer doing it recently and I won?t be surprised if other companies also follow the same path. It is great because India requires FDI more than FII. While valuations are not cheap, the low cost of capital overseas is helping us. If you look at the growth markets, India will definitely stand out.

Where do you see value in the market?

There is value in a few sectors?regulated utilities such as NTPC or Powergrid, government-owned energy companies that look inexpensive assuming the reform process is taken to its logical end, which could result in lower subsidies and higher gas prices, and resource companies such as Coal India. NMDC also looks cheap but investors are concerned about the use of cash.

Apart from these, I am struggling to find value because all the standard ?India? stories such as consumer staples, pharmaceuticals, tier-1 IT and good quality retail-oriented private banks are all very expensive.

Consumer discretionary stocks?automobiles?and cement sectors are also fully valued with fiscal 2014 earnings more or less discounted. PSU banks have got value but it is hard to fully comprehend their NPAs. Global cyclical sectors?metals?face challenges of large supply-demand imbalances and domestic resource-related problems.

What is your view on Reliance Industries?

I believe that RIL is a story that will play out after a couple of years when the benefits from two of its new projects in petrochemicals?new complex?and refining-coke gasification start flowing in. In fiscal 2017, we could see a quantum jump in RIL?s earnings per share from R65 in FY13 to may be as high as R92, assuming everything else remains unchanged. This would result from the plan to increase production by developing all the satellite fields in the KG-D6 block, which will probably take another three years. The question is do you want to pay for those benefits that are three years away from now? I think the stock price will start discounting the value creation from the projects in 18 months? time. While it?s difficult to figure out the value creation from telecom, since the sector is already quite saturated, I am more positive about RIL?s likely expansion in retail businesses since it is an evergreen business and will grow for the next several decades in India. Having said that, there are two challenges, the high cost of real estate and getting the right locations. Second, retailing margins are not very substantial since an organised player has to compete with unorganised players who don?t have high overheads.