New gas price mechanism a positive for ONGC, RIL: S&P

The government's decision to increase domestic gas prices is likely to benefit Oil and Natural Gas Corp. Ltd. (ONGC) and Reliance Industries Ltd. (RIL), India's two main gas producers.

According to Standard & Poor's Ratings Services, the new gas pricing mechanism would improve the cash flows and profitability of both ONGC and RIL to varying degrees.

"We also believe that the price increase will support the companies' high capital expenditure plans. However, the new pricing guideline does not affect our ratings on ONGC (BBB-/Negative/--) and RIL (BBB+/Negative/--). The negative outlooks on the ratings reflect the negative outlook on the sovereign credit rating on India (unsolicited rating BBB-/Negative/A-3)," S&P Ratings said in a statement.

It said that the increase in gas prices will significantly improve ONGC's EBITDA by about 20 per cent, compared with 5 per cent-7 - per cent for RIL.

The impact on RIL's profitability is not likely to be as significant given the company's low gas production of about 13 million metric standard cubic meters per day.

"Our financial forecasts for RIL already considered the benefit of a potential price increase. We expect the price revision to help ONGC maintain its ratio of funds from operations to debt at more than 60 per cent over the next two to three years.

"Our view is based on the understanding that state-owned ONGC will not be required to bear any additional subsidy burden from the fertilizer or power sectors, which are likely to be adversely affected by the price increase.

The government's announcement reduces uncertainty over future gas prices, S&P said, adding, the uncertainty will continue for RIL, given a legal dispute over the government's ability to increase the gas prices for some of the company's gas blocks where production has significantly declined.

Higher gas prices would make it viable for the companies to invest in some deep water gas blocks,increasing gas production over the long term, the ratings agency noted.

Under the government's new gas pricing mechanism, gas prices are likely to almost double from the current $4.2 per million British thermal units. The mechanism is applicable for five years beginning 1 April 2014.