Shares of Indraprastha Gas Ltd (IGL), Mahanagar Gas Ltd (MGL), and Gujarat Gas Ltd (GGL) have recovered 21%, 11%, and 12%, respectively, from their November lows following the latest round of administered price mechanism (APM) gas de-allocations. Bringing natural gas under GST regime would enable CGDs to claim input tax credits for GST paid to vendors, potentially improving profitability amid rising input costs.

Nuvama Research estimates a 9-11% upside potential to FY26 Ebitda for CGDs if GST is implemented on natural gas. However, there's no clarity yet on whether tax rationalization for natural gas will be addressed at the GST Council meeting scheduled for 21 December. Additionally, a large part of potential GST benefits will have to be passed on to consumers considering the anti profiteering rules. So, investors need to focus on the problem at hand—margin compression.

"Following the surprise twin APM de-allocation for CGDs, gas costs shall increase by Rs1–3.5/scm for our coverage CGDs assuming the gas shortfall is covered equally by New Well Gas and spot LNG," said the Nuvama report dated 17 December. This could result in a 17-44% sequential decline in their estimated Q3FY25 Ebitda margins, it added.

Pricing challenges and market saturation

Hiking retail prices for compressed natural gas (CNG) is a tough choice for CGDs, as higher prices could discourage consumers from switching away from diesel or petrol, thereby reducing CNG volumes.

Read this | Indraprastha Gas and Mahanagar Gas face perils of policy controls

"We knew that the listed companies would not be able to sustain their high margins and abnormally high profits for long, even before the de-allocation began," Vivekanand Subbaraman, lead oil and gas analyst at Ambit Capital told Mint. "They operate in saturated markets and will not be able to increase their volumes (of CNG produced) as they have not bid for newer geographical areas for expanding their distribution network, unlike the unlisted companies," he said.

Among the listed firms, IGL and MGL are likely to bear the brunt of APM de-allocations due to their heavy reliance on government-supplied gas for CNG production. GGL, with its focus on piped natural gas (PNG) and relatively lower exposure to the CNG market, is better positioned.

To promote cleaner alternatives to petrol and diesel, the government has prioritized the CNG sector, supplying natural gas to these companies at subsidized prices. This helped companies like IGL and MGL to enjoy high profitability. However, their heydays are likely over, as the government has decided to re-allocate a large chunk of its APM gas to the power sector to meet India's rapidly rising energy demand.

Natural gas, a non-renewable resource, is facing supply constraints as reserves from older fields continue to deplete. This has made it increasingly challenging for the government to allocate these limited resources, and consequently, it has been encouraging CGD companies to source natural gas from new wells operated by upstream companies like Oil and Natural Gas Corp. Ltd, albeit at higher prices.

Also read | Oil marketing companies eye a strong Q3, but LPG could be a dealbreaker

Currently, APM gas is priced at $6.5/mmbtu, while new-well domestic gas costs $9/mmbtu, and international spot liquefied natural gas (LNG) $15.8/mmbtu. Essentially, CGD companies will need to rely on a mix of domestic premium-priced gas, US Henry Hub (HH) benchmark-linked LNG, term LNG, and spot LNG to meet their sourcing requirements.

While international LNG price has fallen significantly from the peak of $46/mmbtu during the start of the Russia-Ukrain war, analysts do not see any immediate respite in spot LNG prices.

"A lot of new liquification capacity will be added globally. So, spot LNG prices are expected to fall in the next three years. But it will play out gradually depending on the pace of capacity additions," Varatharajan Sivasankaran, senior vice president at Antique Stock Broking told Mint.