High Spot LNG Prices Benefit GAIL’s Marketing Earnings, Slow Gas Consumption Growth

Fitch Ratings-Singapore-: GAIL (India) Limited's (BBB-/Negative) earnings from its natural-gas marketing segment are likely to increase thanks to the recent rise in spot liquefied natural gas (LNG) prices to levels much higher than GAIL’s contracted LNG from US, but sustained high LNG prices would slow gas consumption growth in India, Fitch Ratings says.

GAIL generally hedges most of its volume and price risk on near-term deliveries of US LNG to reduce volatility and generate a positive return. Its supply of LNG from the US is linked to Henry Hub (HH) prices, which are lower than current spot LNG prices, which are trading above USD30/ million British Thermal Units (MMBTU). However, the remaining unhedged volume affects the company's profitability, increasing earnings during periods of high spot LNG prices and leading to losses during times of low spot prices.

This was evident in the large jump in GAIL’s gas-marketing segment EBIT to INR19.6 billion in the third quarter of the financial year ending March 2022 (FY22) amid high spot LNG prices. In comparison, the same segment had a negative EBIT of INR4.3 billion in FY21, when Asian spot LNG prices touched an all-time low of less than USD2/MMBTU, due to a drop-in demand amid coronavirus pandemic-related lockdowns.

We expect GAIL’s gas-marketing segment to generate EBIT of INR40 billion in FY23 (FY22 estimate: INR43 billion, 9MFY22: INR34.4 billion), driven by our expectation of high spot LNG prices in Asia, compared to landed costs for GAIL’s HH-linked contracts, which we forecast to be USD7-9 per MMBTU, subject to transportation costs.

Depending on the spot LNG price differential between Europe and Asia, GAIL also has the option to sell some of the supplies from the US to Europe through destination swaps. Spot prices in both Europe and Asia are high, driven by efforts by the EU to reduce reliance on Russian imports and thus competing with Asian LNG importers. Fitch recently revised its title transfer facility (TTF) gas price assumptions to USD20/MMBTU for 2022 and USD10/MMBTU in 2023, reflecting the impact of geo-political risks on demand and supply of hydrocarbons.

We expect natural gas consumption in India to increase by 5% in FY23 (FY22 estimate: 6.5%), lower than our previous estimate for 7% growth, as the recent sharp increase in domestic gas prices and high LNG prices – both spot and term contracts linked to oil prices – would slow the shift towards natural gas, in our view.

GAIL's regulated gas transmission segment, which accounts for around 40% of its total EBIT, generates stable returns as it is not affected by volatility in crude oil and LNG prices. However, slower growth in gas consumption would affect the expansion of gas transmission volume and, in turn, the EBIT growth for this segment.

We expect GAIL's financial profile to remain commensurate with its Standalone Credit Profile of 'bbb' even as we expect stronger profitability in FY22 and FY23 to lead to an increase in shareholder returns. GAIL recently said it plans to buy back up to INR10.8 billion of shares in April 2022.

The Negative Outlook on GAIL’s rating reflects the Outlook on the Indian sovereign rating (BBB-/Negative).