As per the Estimated Revenue Requirement (ERR) of the gas utility, SNGP, the Oil and Gas Regulatory Authority (OGRA) has estimated a consumer gas tariff increase of 32%, effective 1 January 2020.
These prescribed prices will be considered by the Petroleum Division, which will then forward their proposal to the ECC for final approval. It is uncertain whether the final determined gas tariff will be in line with what OGRA has determined. However, we highlight the gas price increase effective July 2019 were higher than the FY19 ERR of the gas utilities (partly because of sharp PKR depreciation in the ensuing period).
We think the proposed increased is not only due to higher well-ahead gas prices (mostly as a result of PKR depreciation), but the government trying to settle the outstanding balance of circular debt through increasing consumer tariffs. Reportedly, there is an estimated PKR181bn circular debt in the gas sector.
Given the IMF program and government’s intent to address outstanding circular debt balance, we see a high probability of a large increase in gas prices.
The gas tariff hike comes amid very weak consumer demand and industrial slowdown. We think presently very few industries enjoy high pass-on ability without compromising volume demand or attracting government attention.
If the proposed prices are implemented, fertilizer players will likely seek to increase Urea prices given they will risk deep earnings erosion otherwise. Note that the proposed increase for feedstock gas price for the industry is estimated at 136% in addition to 32% increase in fuel gas prices. We think the fertilizer producers and the government will likely find a middle ground instead of fully absorbing or fully passing-on the cost increase.
Lucky Cement is the most affected cement player given gas based captive power. In the Chemical sector, petrochemical companies like Lotte Chemical and Engro Polymer will likely bear the cost increase, given internationally determined prices and primary margins, in our view. For the Textile and other exporting sectors, however, we think the government will likely reinstate subsidized gas prices.
Large increase in gas tariffs will be positive for cash-flows of the two gas utilities and in turn will help reduce circular debt of PSO and PPL in particular.