Technological developments are creating new product platforms and altering the delivery channels across industries. The last mile is often the toughest to achieve in the supply chain of most industries, more so for the traditional energy industry. Historically, the basic supply of fuel to homes is the cylinder-based LPG and for transportation needs, the predominant fuel supply continues to be petrol and diesel, all of these are refined petroleum products, derived from crude oil. The delivery channel is to access these products by either driving your vehicle to a fuel station or cylinder based LPG being driven to your home.

Over the next few years, India will accelerate its move to being a gas-based economy, propelled with the discovery and development of giant offshore gas fields, and the expansion of LNG terminals on the west coast of India. Natural gas, recognised as the fuel for the 21st century, is already powering gas-fired turbines for power generation and feedstock for the fertiliser industry. Its impact in the National Capital Region as a fuel for public transportation is now successfully completed.

The stage is now being set for natural gas to replace LPG as a fuel for households and for the development of CNG as a preferred fuel over petrol and diesel for city transportation requirements. Over the next five years, it is estimated that City Gas Distribution (CGD) networks could require investment of close to $50 billion (Rs 2 trillion). The ingredients needed for this make-over are slowly falling in place.

Now, with over 170 mmscmd of additional natural gas expected to flow by 2012, the supply gap is estimated to come down from the current levels of 68 mmscmd to 5 mmscmd by 2012. As per the Planning Commission, the demand of natural gas in cities is estimated to grow conservatively to 16-20 mmscmd by 2012, up from the current 12 mmscmd. The industry players have aggressive plans to increase coverage to over 200 cities, up from the current level of 20 odd cities. This will enable connectivity to over 40 million households and a large number of vehicles within the city gas networks.

The regulatory piece of the jigsaw puzzle started to come into place with the constitution of the Petroleum and Natural Gas Regulatory Board, and its plans to authorisation CGD networks players as early as March 2009. The Board has announced guidelines which encompass the technical and financial criteria, quite liberal considering most regulators would well be tempted to provide more rigid entry regulations. Effectively any entity which has laid and/or operated pipelines of a distance exceeding 300 kilometres is qualified, or if it has a shareholding of at least 11% by an entity which meets this criteria. Moreover, if the entity does not have such prior experience, it can still qualify by either appointing equally qualified contractors or personnel. Entry fees are pegged on the basis of the population of the city, and six tiers have been established, with fees ranging from Rs 8,00,000 to Rs 1.2 million. Net-worth criteria and bid bonds ranging from Rs 5-50 million have been specified to ensure that only those entrants who are serious and credible enter the fray.

To ensure timely completion of project, a performance bond ranging from Rs 10-100 million or 5% of the estimated project capex is required. This to ensure that in case the entity fails to meet any requirements the performance bond would be encashed and authorisation cancelled. In addition, a fee is levied during the construction and operation phase of CGD business. It is important to take a cognisance of these levies as this cost stack up into the overall costs and have a bearing on the resultant Return on Investment (RoI).

To attract the much needed investment, 100% FDI is automatically permitted for laying of natural gas pipelines. The policy also provides an exclusivity period to companies?25 years for the infrastructure and 5 years for marketing. This is balanced with specified service obligations within the specified geographic area of CGD networks to provide PNG connections.

In 2006, the government had framed a pipeline policy that envisages creation of additional one-third capacity of pipelines over the base capacity proposed and the same to be available on common carrier basis to third party. As regards creating additional design capacity over base capacity it is important to ensure a balance between both capacity and efficient utilisation of capacity. Inability to achieve full capacity utilisation could lead imbalances on RoI to investors.

CGD networks are an important infrastructure backbone with lengthy gestation and significant capital outlays. Hence fiscal incentives, clarity of law and stability of regime are therefore critical factors for success. The Income Tax Act provides for a 10-year tax holiday for developing and operating ?cross-country natural gas distribution network?. In order to avail of the tax holiday benefits, the act requires the additional one-third capacity to be made available for use on common carrier to persons other than assessee or any associated person.

The ambiguity of the tax incentive is its applicability for CGD as the term ?cross country? is neither explained nor articulated well in law. The economic impact of this aspect is significant and needs early and positive articulation by the Board and the legislators to mitigate needless litigation. The project entities, even if tax holiday is available, are liable to pay a Minimum Alternate Tax (MAT) at 11.33% on ?book profits? during tax holiday period.

CGD projects could be funded through equity or debt. Equity being the most common funding source, the distribution of profits emerging from the business is liable to a dividend distribution tax at the rate 16.995%. As with most infrastructure projects, access to external commercial borrowing is essential and therefore it is important for pipelines to be recognised as infrastructure by the Reserve Bank of India?and access to international debt made available even for the domestic expenditure to be incurred.

Development of CGD networks will entail import of pipes etc?imports are liable to custom duty. Pipeline projects engaged in transportation of natural gas are eligible for project import status?the scope of the term transportation should logically encompass both transmission and distribution of natural gas, and hence project import status should be available to CGD projects?clarity on this aspect would be helpful to mitigate any challenges later for the projects.

In the operation stage, CGD network will supply gas to CNG stations, domestic consumers as PNG, other industrial and commercial consumers. Compression of natural gas for supply to CNG stations is specified to be manufacture liable to excise duty, and eligible input credit should be available. PNG, however, is not considered as a manufacturing activity. This inconsistency in the fiscal treatment creates accounting and compliance challenges and abnormalities for computation of credits and taxes. Consistency of the tax treatment and rationalisation of the rates, including by classifying natural gas in the central list of declared goods, would help the scalability and efficiency to be achieved in the roll out of CGD networks across the country.

The migration of the households and the transportation sector from refined products to natural gas is an important transition?the supply chain is asset intensive and impacts millions of households. It is time for the regulatory and fiscal framework to evolve rapidly adhering to the principles which balances the interests of the investors and consumers, incentivise the much needed investment and provides a progressive and stable fiscal regime?a few simple helps from North Block would be most valued at this stage of evolution of this industry.

?The writer is a partner, BMR Advisors. The views expressed are personal