Is oil & gas industry undergoing dynamic changes?
The upstream crude oil producers would have a direct bearing if disruptions lead to fall in demand or muted demand growth along with pressure on crude oil prices. Considering this long-term threat, most E&P companies have been keen to expand presence of natural gas and renewables in their portfolio.
The crude oil era is set for a structural slowdown leading to significant implications for different stakeholders in the oil & gas industry, according to recent study by ICRA. Crude oil, since its emergence in early 1900s, showed a secular increase in its share of global energy consumption to ~45% by mid-1970s. While its share has decreased over the last four decades to ~30% now due to the emergence of other energy sources notably natural gas, it continues to be a fuel to reckon with among policy makers.
Environmental concerns with target temperature increase to below 2˚C as per recent Paris climate change accord, car-pooling, electric cars, solar power, LNG based commercial vehicles and advent of e-rickshaws, e-bikes and driver-less cars have long-term disruptive potential for oil consumption levels. K Ravichandran, Sr VP and Group Head, Corporate Sector Ratings, ICRA, says,“Electric / battery-driven vehicles are a key threat for demand of auto-fuels. The battery cost of an EV, accounting for almost one-third of the total cost of an EV will remain a key determinant in the rate of acceptance of electric vehicles.With anticipated material fall in battery costs, the break-even crude price for electric cars is expected to decrease from ~US$185/bbl to ~US$75/bbl as per ICRA’s estimates.”
Another major disruption in automotive sector could be LNG based trucks and buses, which could help in reducing pollution from diesel through use of cleaner LNG leading to lower operating expenses offsetting higher capital costs. “As per ICRA estimates, break-even period for a truck would range 1-2.5 years depending upon taxation on LNG. However, developing an LNG-based transport fuel market shall have its own challenges, especially in building a network of fuelling stations to ensure the supply of LNG, when most of the trucks and buses on the road are powered by diesel or petrol engines.” said Mr. Ravichandran
Furthermore, consistent fall in solar module prices leading to material fall in solar power tariffs have led to material increase in competitiveness against power plants based on liquid fuels, and the trend is likely to continue. Besides, replacement of diesel, FO, LSHS and naphtha by natural gas / LNG primarily for back-up power generation would also impact the demand of petroleum products.
The Upstream crude oil producers would have a direct bearing if disruptions lead to fall in demand or muted demand growth along with pressure on crude oil prices. Considering this long-term threat, most E&P companies have been keen to expand presence of natural gas and renewables in their portfolio.” As regards the downstream sector, auto-fuels (diesel and petrol) form around ~50% of total product volumes derived from every tonne of crude oil processed by a refinery and form a much higher share (~65%) in terms of value derived from crude oil. Thus, any impact on demand of auto-fuels could have a significant bearing on the demand growth of crude oil and gross refining margins (GRMs) of refineries. Due to the depreciated asset base, existing refineries may be relatively better placed to deal with oil demand disruptions. However, future refining capacity expansions, especially greenfield projects, could find the task of achieving meaningful returns a daunting challenge owing to high capital intensity of refining companies, unless they get significant fiscal incentives to prop up the returns. Gas utilities could gain from increasing use of natural gas a cleaner fuel.
Outlook for gas utilities seems positive
The capacity utilisation levels of some gas transmission pipelines would remain sub-optimal in the near to medium term due to shortage of gas supplies but would show an increasing trend with rising LNG consumption. Further, with incentives being offered for challenging fields, domestic gas production is expected to improve over the long term, which along with the rise in re-gasification capacity, could lead to an increase in pipeline utilisation. Besides, soft LNG prices result in an increase in RLNG consumption and hence increase in pipelines’ capacity utilisation levels. On the transmission tariff front, the recent PNGRB tariff orders led to a moderate increase in tariffs for some under-utilised pipelines thereby leading to marginally improved returns for gas transmission segment. Notwithstanding modest increase in spot LNG prices, the latter continue to be competitive due to rise in crude oil prices post OPEC deal resulting in to favourable economics of spot LNG vis-à-vis liquid fuels, which is a positive for consumption growth and margins for LNG marketing. The outlook for the existing operations of players in CGD sector remains favourable with domestic gas allocation in place for the CNG and PNG (domestic) segments, both of which could see 8-10% growth in volumes. The PNG (industrial and commercial) segment would, however, continue to face stiff competition from alternative liquid fuels.
Domestic gas production to increase over long term following recent reforms for challenging fields:
Domestic gas prices have seen consistent downward revisions in April 2015, October 2015, April 2016 and October 2016 following which the prices have halved to US$2.50/mmbtu (GCV basis) in H2 FY2017 from US$5.05/mmbtu during November 2014-March 2015. The prices are expected to increase marginally from April 2017 in line with the rise in globalgas benchmarks. The fall in domestic gas prices had made future development of many gas fields unviable. However, the GoI provided marketing and pricing freedom (subject to a price ceiling) to players operating in deepwater, ultra-deepwater and high pressure-high temperature areas that were yet to commence commercial production as on January 1, 2016. Natural gas price ceiling for the challenging areas are US$5.3/mmbtu as of now, but this may keep varying in line with the prices of substitute fuel (fuel oil, naphtha prices may increase as crude oil prices rise). The pricing formula along with the marketing freedom could improve the viability of gas discoveries in challenging fields and could lead to higher domestic gasproduction over the longer term. ICRA expects domestic natural gas production to increase to ~110 MMSCMD by FY2021 and to ~125 MMSCMD by FY2027 from the current level of ~88 MMSCMD. Apart from marketing and pricing freedom forgas discoveries (not yet commenced production), the GoI also announced various reforms like implementation of the revenue-sharing model, a uniform licence framework and an open acreage policy under the new Hydrocarbon Exploration Licensing Policy (HELP) and reduction in royalty rates for the deepwater and ultra-deepwater areas, which could aid in incremental domestic gas production over the long term.
Domestic demand potential for natural gas to increase over long term; price sensitivity to keep actual consumption at lower level
Despite the significantly high potential across several sectors, the realisable demand for natural gas will be a function of several factors: gas supplies in the market; price competitiveness of gas as compared with alternative fuels; timely commissioning of the proposed transmission pipeline infrastructure; and regulatory initiatives in the power sector like implementation of time-ofday tariff. Overall, gas demand is expected to rise to ~250 MMSCMD by FY2020 and to ~280 MMSCMD by FY2027 from the current demand potential of ~230 MMSCMD. Significantly, the peak levels of actual consumption in the past were 170 MMSCMD in FY2012 and 177 MMSCMD in FY2011, the figures drawing on the improvedgas availability in those two years. However, actual consumption has been much lower at around 140-145 MMSCMD over last three years (FY2015, FY2016 and FY2017-till date). Going forward as well, actual consumption could be materially lower at ~150-180 MMSCMD due to limited supply and sensitivity of prices for sectors like power, industrial, refineries etc.
Significant rise in re-gasification capacity to reduce demand-supply gap, lead to higher competition :
The total natural gas supply potential is expected to increase significantly over the next five to six years with higher domestic gas production and commissioning of firm re-gasification capacity during FY2018-22. With the increase in supplies, the difference between the projected demand and supply potential is expected to narrow down FY2020 onwards. Further, the Following recent reforms, domestic gas production expected to increase from ~88 MMSCMD in FY2016 to ~110 MMSCMD by FY2021 Domestic gas demand expected to rise to ~270 MMSCMD by FY2025 from the current demand potential of ~230 MMSCMD ICRA Limited P a g e | 4 demand for R-LNG could be affected because of significant competition from liquid fuels, and as a result the actual consumption of R-LNG could be lower, leading to significant competitive pressures in the re-gasification segment over the medium term. Thus, upcoming LNG capacities may operate at relatively lower utilisation than the current utilisation of regasification capacities in the country. The price sensitivity of R-LNG demand would be critical in this regard. ICRA believes that if many re-gasification terminals, as planned, come on stream over the next four to five years, the new entrants would face significant pressure on volumes and margins as they will have to compete with the existing terminals and brownfield expansion, which are more cost efficient because of lower capital intensity. Sub-optimal capacity utilisation and lower regasification margins could put significant pressure on the returns and credit profiles of new entrants, especially in the initial years of operations.