Mukesh Ambani is a grand master in strategy. So when something happens at flagship Reliance Industries Ltd (RIL), it’s time to sit up and take notice. It is also a good time to ask: what’s his gambit this time?
In recent weeks, RIL has done its best to confuse everyone about what is really going on at its Krishna-Godavari (KG-D6) offshore gasfield. Is it a gusher, or it is about to go phut for a while, with output declining in the short-term, due to “technical problems”?
A probe by the petroleum regulator, Directorate General of Hydrocarbons (DGH), squarely blames Reliance for the output drop. An independent analysis by consultant P Gopalakrishnan on the output performance of Dhirubhai-1 and 3 gasfields in the KG-D6 block confirms that the “shortfall of gas production is due to non-drilling of adequate number of wells”. Reliance disagrees with this conclusion.
In the Ambani Book the gas belongs to Mukesh (he wouldn't even sell gas cheap to his brother Anil (R) and Reliance), and the fewer the list of people sharing in the gains the better. Reuters
Our best guess: Reliance is hoarding its gas in the expectation that prices will be raised in the not-too-distant future. Reason: the present government-administered price of $4.2 per million British thermal units (mmBtu) is too low, given the global price scenario. When Panna-Mukta gas fetches $5.73 per mmBtu, when imported liquefied national gas (LNG) costs $12-14 per mmBtu when it gets here, when global demand is set to soar with higher Chinese and Japanese demand for LNG, is Mukesh Ambani going to sell his gas at $4.2 per mmBtu? Think again.
Remember, Ambani wouldn’t sell gas cheap even to his own brother. Okay, we know they aren’t the best examples of brotherly conduct, but to thwart his brother from getting KG gas at $2.34 per mmBtu, he was willing to go all the way to the Supreme Court. In the bargain, he got a Supreme Court verdict that effectively said the government had the right to fix gas prices, because gas is a “national asset.”
That’s where Ambani would probably inwardly disagree. In the Ambani Book the gas belongs to him and Reliance, and the fewer the list of people sharing in the gains the better. If the Supreme Court verdict took the cake away from brother Anil, Mukesh is not going to let the government and gas consumers take a huge bite from it either. In short, it suits his purpose to reduce gas flows from KG and hold on till the prices get better.
This is probably the main reason why the media has been flooded with reports that KG gas output is set to decline from an average of 50-52 mmscmd (million metric standard cubic metres a day) to around 38 mmscmd due to unforeseen problems. The markets have taken note, and the share price has tanked. Many equity researchers have put Reliance on their watch list, the latest being Kotak Securities.
On 19 May, Kotak downgraded Reliance shares to a “reduce” rating (meaning “sell”, but no broker really likes to put a “sell” on Reliance for fear of angering the management) in view of “downside risks to our volume and valuation estimates of the E&P (exploration and production) segment.” Translated, it means the broker doesn’t know whether the KG gasfield can deliver on its promise.
HSBC says it is neutral on Reliance. Why? “We believe RIL is unlikely to ramp-up its natural gas production from current levels of c.52-53 mmscmd near term in the absence of relevant regulatory approvals for new development, technical limitations with existing wells and long lead time for critical deepwater equipment.”
But typical of the usual confusion over what is really happening in the gasfield, another brokerage has upgraded Reliance to a “buy”. UBS says it sees “little downside on gas volumes” as the bad news has already been discounted.
Reliance itself has not exactly been forthcoming on the real state of affairs. The company has waxed eloquent at some times, and remained extremely tongue-tied and obfuscatory at others. Net result: neither equity analysts nor the markets have any clue about what is going on.
There’s been a sea change between last year and now. Consider RIL’s 2009-10 annual report. It proudly painted a picture of a bounteous gasfield on the threshold of making history. “KG-D6 completed 365 days of 100 percent uptime and zero-incident production. Gas production from KG-D6 has ramped up to 60 mmscmd in a short span of nine months….Current production of about 60 mmscmd is from 16 wells…The design capacity of the KG-D6 deepwater gas production facilities were assessed and achieved a flow rate of 80 mmscmd….”. It then goes on and on about extensive quality assurance checks at the oil and gas facilities, and fatigue tests on the pipeline infrastructure to ensure that it supports the “25-year lifespan of the field.”
The 2010-11 annual report all but maintains radio silence on the gasfield’s prospects. Plans and programmes are conspicuous by their absence. “In the oil and gas business, deep-water exploration and development operations present technological challenges and operating risks,” says the report. “An integrated development plan for all gas discoveries in KG-D6 is being conceptualised.” One is a motherhood statement, and the second is something we already knew from previous years.
What has changed between May 2010 and May 2011? One answer could be what Reliance has been saying: that there are technical problems in keeping gas output up. It needs technical help from a global expert. BP, which has bought a 30 percent stake in the KG offshore gasfield, could be the answer to the problem.
But the more plausible explanation is that Mukesh has hatched a new strategy to collar more of the gas gains in the wake of the changed scenario. In May 2010, Mukesh was fighting brother Anil to deny the latter cheap gas at $2.34 per mmBtu in line with the separation agreement they signed to divvy up the group in 2005. To deny Anil his due, Mukesh got the government to weigh in on his side, claiming gas a national asset whose pricing could not be decided by a family agreement. The Supreme Court duly agreed, and Anil was left twiddling his thumbs. In due course, he settled for peace and the brothers are not anymore in open conflict.
The second thing that has changed is the medium-term outlook for natural gas prices. With the Middle East in turmoil, with Japan paring down its nuclear energy, oil and gas prices have been ruling firm (despite some recent declines, that’s the larger reality). In India, a gas shortage is developing and consumers in the fertiliser and power sectors are feeling the pinch. A report in DNA (Daily News & Analysis) quotes Anish De, CEO of a gas consultancy firm, as saying that the demand for gas is 50 percent higher than supply at 225 mmscmd against supply of 150 mmscmd.
A Reuters report, quoting Gas Authority of Inida Ltd (GAIL) estimates, says India’s total gas demand will surge to as much as 500 million mmcmd in the next 10 years from 225 mmcmd. Petronet LNG, India’s biggest liquefied natural gas importer, thinks demand may touch 380-400 mmcmd in five years, while Ernst & Young says the shortfall in gas supplies could be 130-140 mmcmd by 2020.
BC Tripathi, chairman of GAIL, told Reuters that the bulk of Indian gas is sold at a base price of $4.2 per mmBtu, when the price needs to rise to at least $8-$10 mmBtu.
Net-net: Ambani gains the more he delays output.
The third reason why Ambani won’t be too keen to produce to capacity is that he is battling the Directorate General of Hydrocarbon (DGH), the oil and gas regulator, to get his investment plans approved. It makes good sense for him to refuse to invest further till the DGH sanctions higher project costs. Under the profit-sharing contract with the government, the government gets a profit share from the KG fields only after Ambani recovers his investment. As long as his investments are high, the government’s profit share will be low. It is worth recalling that at the height of his pow-wow with brother Anil, the latter accused Mukesh of gold-plating his KG investments and called for a government audit of his investments. We haven’t heard from the Comptroller and Auditor General on this aspect: whether he has indeed gold-plated his capital investments in KG.
But it stands to reason that by holding back output and delaying its ramp-up – either deliberately or due to technical constraints – Ambani effectively piles the pressure on the DGH and the government to increase his investment outlays, or raise gas prices, or both. With fertiliser and power plants already feeling the pressure of gas shortage, Ambani is sitting pretty. He can wait.
Any bets then on what the real reason could be behind the programmed fall in Reliance’s KG gas output? The chances are that Mukesh Ambani is hoarding his gas in the expectation that GAIL will do his work by lobbying for higher prices, and soaring imports will make the current low controlled prices unrealistic. Ambani is not one to allow consumers to walk away with the gains when he can have it all.
Fair disclosure: The author and/or his family hold 200 shares of Reliance
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