MANAGEMENT DISCUSSION AND ANALYSIS Global LNG Market Overview The LNG Industry has come a long way since the first LNG Ship called the Methane Princess commissioned in June, 1964, delivered the LNG industry's first commercial LNG cargo to Canvey Island, U.K. from Algeria for a 15 year long term LNG contract, on October 12, 1964. The year 2014 marked 50 years of the LNG industry. Today the LNG industry stands at 246 MMTPA of LNG production capacity which is 5 mmtpa more than 241 mmtpa in 2013. LNG trade hit a record high in 2014, with 243.6 mmtpa traded last year, up 4.5 mmtpa from 2013. LNG Trade as a total of global gas trade is approximately 30% and accounts for approximately 10% of the total gas consumed globally. The global LNG industry is facing structural changes as the US Shale gas revolution has lead to a surplus market in North America and it posed to export this surplus gas in the form of LNG to the rest of the world. Other challenges of a debrssed global economy with reduced power and industrial demand, as well as a new wave of LNG projects mainly from Australia and US are going to hit the market from 2015-16, are putting further brssure on LNG prices, making it into a Buyer's market. Additionally oil prices dropping sharply coupled with sharp decline in spot prices, has put more brssure on new project development and existing long term LNG contracts which locked by buyers at a higher oil indexed price. 2014 saw LNG projects offering supply from diverse sources like US, Canada, East Africa and Russia. There was intense competition between various LNG projects to lock in Buyers in long term sale agreements. There was a conflict between buyers and sellers on the pricing of LNG and which one would be better, Gas Hub or Oil indexed LNG pricing due to US LNG exports which are linked to Henry Hub prices in the US. Supply Side 2014 On the supply side in 2014 total global LNG production was approximately 246 MMTPA. Two new LNG facilities were commissioned, one is the PNG LNG in May 2014 in Papua New Guinea and the other being the QC LNG project in December 2014 in Australia. QC LNG also held the distinction of being the first Coal Seam Gas project to come on line in the world. The start of QC LNG also marks the beginning of a new wave of LNG supply that will emerge from the Pacific Basin and culminate in Australia overtaking Qatar as the world's largest exporter of LNG most probably by 2020. At the same time as new capacity entered the market, some was reduced with the Angola LNG project closer which had been facing a slew of technical problems. The LNG plant is expected to restart in mid 2015. On the Financial Investment Decision (FID) front, 2014 achieved FID in 30 mmtpa of LNG projects, the same as 2013. Total 4 projects achieved FIDs and three of them were from the US accounting for 28.5 mmtpa. The other was in Malaysia of 1.5 mmtpa. US is, due to the shale gas revolution, fast emerging as a major player in the LNG industry and a source for LNG supplies in the long term. The factors that will determine how much gas is exported from the US as LNG will be the domestic gas prices (Henry Hub), international oil prices and how expensive will LNG from alternate buyers be. For the Asia Pacific Region supply sources are going to diversify in the near future as US and additional Australian LNG enter the market and in the long term more supply is expected from countries like Russia and East Africa. Additionally as international cross border trade in gas through pipeline also has a direct impact on LNG supply as LNG is a substitute for piped gas if the economics of piped gas are not working out for certain long distance trade routes, specially those which have to cross over the sea. A major piped gas deal has been signed between Russia and China for sale of piped gas of about 38 BCM equivalent to 28 mmtpa by 2020. This will limit LNG demand in northern part of China, but the southern part of China will not receive any gas from this gas deal and LNG will have to be imported to bridge the gas supply deficit in that region Demand Side 2014 On the demand side the story is the same as it was in 2013. Japan and Korea dominated the LNG import with each importing 36% and 15% respectively of the total LNG imports. China imported 8% and India almost 6% and is in the top 5 importers in the world. Existing LNG importers commissioned new LNG import Terminals, while only one new Buyer entered the market with commissioning of a LNG import Terminal in 2014 which was Lithuania. Japan due to the nuclear capacity shut down has witnessed a sharp increase in its imports since 2011. In 2014/15 it is expected to import a record high of 88.7 mmt vs the 87.5 mmt it had imported in 2013/14. Now that the nuclear safety authority in 2015 is likely to give permission to nuclear power plants to restart, it has been estimated that imports will start to decline from 2015 onwards with 85 mmt of LNG imports in 2015 itself. As more power plants restart over the years the LNG imports will decline in response. This in the short run is expected to put more brssure on the already debrssed LNG market. In the case of South Korea they also faced a issue of nuclear plant safety, but not as severe as that of Japan's. Due to reduced nuclear plant power regeneration Korea that to import more LNG but in 2014 as some of the nuclear power plants restarted and this lead to lower demand. It is forecasted that in the short term the LNG demand will decline as additional nuclear plants are restarted. But in the long run as the Korean government wants to diversify power generation sources from nuclear, it is planning to invest in additional gas based power plants, which will lead to a rise in LNG imports. Other countries are also poised to enter the LNG market to met their natural gas needs, such as Pakistan and Philippines in Asia. It is expected that in 2015 both these countries will have operational LNG importing facilities. In Latin America Countries like Chile, Uruguay, Columbia and Panama are also planning or have facilities under construction to enable them to import LNG for the first time. In the Middle East and Africa Jordan and Egypt will be joining the LNG imports club in 2015, while other Middle Eastern countries like Bahrain, Kuwait and Lebanon are planning on setting up a LNG Import Terminal in the near future. LNG Trade In 2014 on the LNG export side approximately 243.6 mmtpa was traded and out of that Qatar had the lion's share of the LNG exports. Qatar's share was more than 30% followed by Malaysia and Australia at approximately 10% each. Qatar will continue to play a dominant role in the LNG industry with its 77 mmtpa LNG production capacity in the medium term till 2018/19 when the Australian LNG industry is expected to catch up and overtake the Qatar. Asian region is the biggest importer of LNG in the world with 70% of the LNG traded going to the Asia Pacific region. The biggest consumers like Japan and Korea are highly industrialized economies, but have very limited reserves of natural resources and domestic gas is not available in meaningful quantities. They are the leaders in LNG import in the Asian region but rapidly industrializing countries like India and China are also increasing their LNG consumption. In 2014, Asian demand increase was limited, in spite Japan showing a marginal increase in LNG imports which broke last year's record, as other buyers like Korea the second largest LNG buyer, reduced imports on the back of mild winter, high LNG inventory and more power generation from coal and nuclear. Lower Chinese economic growth also lead to a lower than expected increase in LNG imports. In the Atlantic Basin, Europe showed a marginal decline, but two countries Turkey and UK had strong LNG imports to offset some of the decline in the rest of Europe. Additionally Spain sold many reloaded LNG cargoes and in 2014 the quantity of LNG that was reloaded and exported was 4 MMT vs the 2.1 MMT in 2013. LNG Price LNG price for long term contracts is linked to crude oil prices as LNG is used as a replacement for liquid fuels. In order to make LNG a viable replacement in comparison to crude oils it has to be priced cheaper because it is in effect a substitute. LNG prices due to their oil linkage will be impacted by oil price movements, but it will take time for oil price changes to impact LNG prices, as LNG is linked to oil price average of the brceding 6 to 9 months. Therefore in the current scenario the sharp decline in oil prices from about $100/bbl in June of 2014 to less than $60/bbl in February 2015, which is more that a 40% decline in about 9 months. Long Term LNG prices will take up to 6 months to readjust to the drastic fall in oil prices and Buyers will start to benefit in the middle of 2015 from lower LNG prices. Even though LNG long term prices will take time to adjust due a inbuilt lag in their pricing with relation to oil, LNG spot prices react to current market conditions more quickly. In February 2014, they reached a peak of $20/mmbtu and by February 2015 they fell below $7/mmbtu. This was because winter last year was colder than usual and in 2014/15 it was very mild reducing demand for heating. Weather coupled with weak economic growth from Japan, Korea and China reduced demand for LNG for power generation and industrial use. Weak LNG demand with robust supply put great downward brssure on the LNG spot market making it touch record lows. Due to a slump in the spot market resulting from lower crude oil price and a supply surplus, LNG spot prices have been lower than LNG long term prices. This incentivises buyers to reduce their off-take of LNG under long term contracts and by from the spot market cheaper LNG to replace the long term quantity. Outlook for LNG Industry The story of LNG will be based on the story of oil as most of the LNG sold in the world is linked to oil prices. The US Shale revolution in oil and gas has altered the landscape of not only the intentional oil market, but is having a deep impact on the basic structure of the LNG industry. On the oil front, US has overtaken Saudi Arabia as the world's largest oil producer. Shale oil production pushed US oil output above 9 million bbl/d in 2014. This massive increase in supply coupled with slow global economic growth has managed to push oil prices down to 6 year lows. US is also now the largest producer of gas in the world and this boom in shale gas led to the development of LNG export projects. International Energy Agency (IEA) has forecast that in 2015 Brent oil prices will be around $55/bbl and 2016 it will be about $60/mmbtu and till 2020 it expected to remain below $80/mmbtu. There has been a structural shift in the oil market from a high price oil environment to a more low to moderate price environment. The entry of US in LNG industry via LNG exports a few years ago, due to the surplus of shale gas, has challenged the long standing commercial structure of the LNG industry. The US gas hub linking of the price of LNG export, the tolling model of LNG sale and purchase and destination flexibility for long term LNG contracts has created a conflict between buyers and other non US sellers. Buyers due to US offering LNG gas hub price linkage have been clamouring for the last few years for non-US LNG contract prices to be linked to gas hub based index also. Non US sellers want to stay with the established oil based index for pricing LNG, for they fear that gas hub will indexation will give lower LNG export prices as compared to oil, coupled with increased volatility of gas prices, resulting is lower rate of return on their LNG project investments. Eventually most in the LNG industry feel buyers and sellers will find a middle ground in terms of pricing by going for hybrid structure of Gas Hub and Oil index LNG pricing for some Non US LNG projects. Additionally with the current low crude oil prices, the demand from buyers for gas hub as a LNG price indexation will lessen, as if they perceive that oil lower prices are here to stay for the long term and are not just a temporary phenomena. Looking at the current oil pricing environment it is felt that Buyers may agree with Non US LNG Sellers to go for oil indexed LNG contracts with a higher index to oil than Buyers had wanted brviously, with a cap on oil prices, which give a floor and a ceiling price. Therefore in LNG industry jargon Non US LNG may have a S-Curve protection for Sellers as well as Buyers. LNG Scenario in India Economic Growth Outlook The International Monetary Fund (IMF) in an update to its World Economic Outlook has forecast that India's economy will overtake China in terms of its annual growth rate by 2016. The IMF brdicts that India's economy will grow at 6.3 and 6.5 percent respectively over the next two years. This puts India's projected growth in 2016 ahead of the organization's estimates for China, which stand at 6.8 and 6.3 percent for 2015 and 2016, respectively, leaving India the fastest growing major emerging economy in the world. The IMF's projections rebrsent a substantial increase from the actual growth rates of the Indian economy in 2013 and 2014, when the economy grew by 5 and 5.8 percent respectively. The IMF's World Economic Outlook projects global economic growth at 3.5 and 3.7 percent in 2015 and 2016 respectively. Additionally India's actual potential for growth is far more and as the global economy recovers over the long term India's growth rate can reach higher levels as it has much catching up to do in terms of per capital income in comparison to the industrialized world. All this indicates that India will require increasing amounts of energy to fuel its growth and in the long run a balance will have to be maintained between the environment and economic growth. That is where Natural gas comes into the picture as a greener alternative of the other more polluting fuels and as a bridge before transitioning to a renewable energy system. Depending on how the pricing and affordability of the end users of gas in the main consuming sectors works out through government policy, gas has a huge potential demand and LNG will play the role of filling the gap between the demand supply deficit. Gas Supply & Demand Currently, India is the 15th largest natural gas consumer in the world, down from being the 13th due to declining gas supply from the KG D6 Basin and the 4th largest LNG importer globally. In 2013/14 total gas production in the country was 97 MMSCMD as compared to gas production in 2010/11 of 143 MMSCMD. In 2013/14 gas consumption was 93 MMSCMD and out of this total consumption, 64% is consumed by the fertilizer and power sector. The remaining is consumed by industry, petrochemicals, CGD/CNG etc. The KG Basin D6 gas field has not been able to produced to its maximum capacity due to technical problems which have lead to a sharp decline in production. Additional gas production will also take time in coming online and some of the remaining demand has been met with LNG imports. In 2014 total LNG imports into India are about 14 MMT which is approximately 54 MMSCMD. Therefore out of the total gas supply of 151 MMSCMD, 37% is LNG imports. LNG plays a vital role in bridging the supply deficit in the country. Petronet LNG Ltd. is a dominant force in the LNG import business as more than 60% of the LNG is imported by Petronet into India. Gas Pricing Indian gas industry as of now has a myriad of gas prices for gas supply. These gas prices can be divided into two categories Administered Pricing Mechanism (APM) and Non Administered Pricing Mechanism. In 2013-14, 59% was sold under the APM, while 11 % was sold under Non-APM mechanism, 12% was sold under Pre NELP, under NELP (RIL KG D6) 17% and under CBM pricing only 0.42% was sold. On 18th October 2014, the newly elected government announced a new methodology for determining the wellhead price for domestic gas produced in India and notified a price of $5.05/ MMBTU, on a gross calorific value (GCV) basis, effective for the six-month period commencing 1st November 2014. This new methodology has resulted in a much lower price than that of the brvious government which was above $8.40/mmbtu. The new lower price will not be able to incentivize domestic E&P activities in a meaningful manner and significantly higher gas prices are required to increase supply of gas to reduce the demand supply deficit. On the LNG front India has befitted greatly from the drop in oil prices as it will gradually work it's into the long-term LNG contracts as well as spot cargoes have become cheaper, encouraging more imports. Government Policy Apart from gas pricing issues they are various policies the government is mulling over which have the potential to significantly impact the gas industry in the long run. In 2012 under the chairmanship of Dr C. Rangarajan, Chairman, Economic Advisory Council to the Prime Minister a Report of the Committee on the Production Sharing Contract Mechanism in Petroleum Industry was issued. This report dealt with two issues. Firstly it reviewed the PSC model currently in use in India which PSC followed a cost recovery mechanism for the oil and gas contractor, allowing the contractor to recover all investment made in the field before sharing revenue with government. The main purpose of the PSC model is that it would encourage investors to take higher exploration risks, and in the event of success, the costs could be recovered first. This model according to the Rangarajan Report also has its drawbacks as it would necessitate a close scrutiny of costs by the Government to verify the actual investment incurred by the contractor since there is an inventive to engage in gold plating of costs to increase the contractors recovery of costs over and above what it actually invested. The Rangarajan Report recommended the Revenue Sharing Contract as an alternative. In this the advantage will be that the contract of the oil and gas field will have to share the revue it earns with the government at different slaps of output and prices. This will make auditing of costs by government unnecessary and the contractor will now have an incentive to keep E&P costs low as possible to maximize its profits. The second issue dealt with in the Rangarajan Report was on gas pricing. It had recommended a formula for pricing of domestic gas at the well head by basing it on a number for gas and LNG prices internationally and can be reviewed after five years when the possibility of pricing based on direct gas-on-gas competition may be assessed, which meant that by 2017 it was envisaged that gas prices will be free to be determined by the market based of supply and demand fundamentals in the country. This suggestion was a radical departure from the existing gas pricing system followed in the country and was looking at deregulation of the gas market in India with market based pricing of gas being established in 5 years. This system of gas pricing and PSC would lead to more incentive for high E&P activity in India with a long term aim for increasing oil and gas supply resulting in lower import dependence. The report issued by the Kelkar Committee dated September 2014, dealt with these two issues of PSC and gas pricing and suggested amendments to the gas pricing formula formulated by the Rangarajan Report. The Kelkar Committee removed the LNG component in the Rangarajan gas pricing formula, which will result in a lower domestic gas price. The reasoning for that was that LNG price should not be used in the price calculation of domestic gas as in most other countries with liquid and well developed hubs domestic gas produced is not linked to LNG price. As far as the issue of market determined pricing bases on gas to gas competition is concerned the Kelkar Report stated that anytime between 2017 to 2019 gas pricing can transition to full gas on gas competition. The Kelkar Committee also advised the government to stay with the current PSC model of cost recovery contrary to the Rangarajan Report recommendation for switching to a revenue sharing model. On the PSC it was against the Revenue sharing model on the grounds that India is not geologically endowed with significant hydrocarbon reserves and any contractor investing in E&P activities in India will face high risk of failure. Therefore as a risk mitigation measure the contractor has to be allowed to recover all its costs of E&P activities and in the revenue sharing PSC recommended by Rangarajan Report, cost recovery is not allowed, which reduces incentive to search for hydrocarbon deposits in India. For the gas allocation policy, the new government is likely to take a decision soon on revising the gas allocation priority. The current gas utilization policy by order of priority is Urea manufacturing Fertilizer plants, second is LPG plants, third gas based power plants and the last being CGD. The new priority will be firstly CGD, followed by strategic sector (nuclear plants), third being Petrochemical and LPG plants, fourth is Urea plants and the last will be power plants. This revision is because the current government wants to rationalise the current gas utilization policy and wants to give a boost to CGD projects across the country and aims to reduce domestic household dependence and consumption of subsidised LPG and also reduce subsidized diesel consumption in automobiles by encouraging more CNG use in cities. In addition the government has initiated a new policy for increase utilization of power plants which need gas as a feedstock. In order to revive these stranded gas based plants, the mechanism envisages importing Regasified Liquified Natural Gas (RLNG) for supply to these plants so that they can generate power. The mechanism also envisages sacrifices to be made collectively by all stakeholders, including the Central and state governments by way of exemptions from certain applicable taxes and levies on the incremental RLNG being imported for the purpose. The government also proposed to provide support to discoms from the Power System Development Fund (PSDF) through a transparent reverse e-bidding process. This will make the cost of power affordable and increase demand for LNG from the power sector. The government is also pooling domestic gas and RLNG for the fertilizer sector so as to rationalize the cost of gas delivered to each urea plant. The plan is to pool or average out prices of domestic natural gas and imported LNG used by fertiliser plants to make the cost of fuel uniform and affordable. Fertiliser plants consume about 42.25 million standard cubic meters per day of gas for manufacture of subsidised urea. Out of this, 26.50 mmscmd comes from domestic fields and the rest 15.75 mmscmd is imported liquefied natural gas (LNG). The USD 5.18/mmbtu of domestic gas is about half the cost of LNG. The cost of gas, which is the most important component for production of urea, varies from plant to plant owing to differential rates at which imported LNG is contracted as well as cost of transportation. The government has become more proactive in dealing with the issues faced by the end users of gas like fertilizer and power which are the largest consumer of gas in the country. This is a positive for LNG industry in India as LNG combined with domestic gas will make is more affordable to the price sensitive users. Natural Gas Outlook for India Over time more interest in the LNG industry in India has developed as it holds great potential for expansion and is considered as new area of growth in the energy sector. Additionally due to lack-lustre performance by the domestic gas industry (mainly due to the KG Basin D6 underperforming due to technical issues) LNG is vital to meet the unmet gas demand in the country, even though the price of LNG is many times that of domestic gas. This enthusiasm for the LNG industry in India will mean more development of LNG import terminals and new long term contracts of supply to the Indian gas market. Also the shale oil and gas production in the US has an overreaching impact of the oil and gas global industry and has shifted the industry structurally to a moderate price environment below $100/bbl and a long term price range of $60 to $80/bbl. This make LNG linked to crude oil prices more affordable to the end user in India who are generally very price sensitive. The next few years will witness of competition as pipelines are completed, improving interconnections and the ability of Companies to penetrate new demand bases. India is projected to have healthy medium to long term growth with the current governments emphasis on boosting the manufacturing sector. This means that overall gas and LNG demand will in the future will be high and coupled with moderate oil prices LNG will continue to play and significant role in India's growth story. Threat from Competition All the major players in the Indian hydrocarbon business have plans to enter the natural gas business. The expected competition in the future scenario will not only be from Indian players, but also from several multinational Companies that will extend their brsence in the Indian market. As a result, the competition is expected across the gas value chain. PLL is brpared to face the competition from Indian as well as overseas players in the market through long term tie-up of LNG/ Regas capacity. In India, gas competes primarily with Coal (in Power sector) and with liquid fuels (in Industrial and Fertilizer sectors). As a result, gas demand is fairly price- sensitive for the Power sector, with low elasticity for the Fertilizer sector due to the existing Fertilizer policy. The city gas distribution segment, where the competition is mainly with high- priced petroleum fuels (HSD, Petrol, LPG, etc.) faces challenges in terms of infrastructure and conversion costs. Segment wise or Product wise Performance Presently, PLL primarily deals only in one segment, i.e. Import and Re-gasification of Liquefied Natural Gas (LNG). During the year 2014-15, 533.08 TBTUs of re-gasified LNG was delivered to off-takers and customers. Risk and Concerns PLL considers good corporate governance to be a brrequisite to meet the needs and aspirations of shareholders and other stake shareholders alike. As part of the Company's efforts to strengthen corporate governance, the Board of Directors has formulated a Risk Management Policy. This policy puts a risk management structure in place that clearly defines roles and responsibilities. It also provides a risk portfolio that involves a continuous process of risk identification, assessment, control assessment and monitoring, review and communication. The Company aims to: • Identify, assess and manage existing and new risks in a planned manner. • Increase the effectiveness of PLL's internal and external reporting structure. • Develop and foster a 'risk' culture within the organization to encourages all employees to identify risk and associated opportunities and respond to them with appropriate actions. Risk of Competition LNG competes with naphtha, coal, fuel oil and similar hydrocarbons. These alternate fuels are currently widely used by end-user industries like fertilizers and power. In addition to the above- mentioned fuels, LNG alsocompetes with the domestic natural gas. LNG offers several advantages over the above-mentioned fuels. PLL LNG sourced under long-term contract, is currently priced higher against these alternate fuels. A reduction in prices of the alternate fuels and increase in long-term prices of LNG is putting pricing brssure on LNG. This may have an impact in the near growth of PLL. Currently, the Company does not produce or market any products other than LNG/R-LNG. The sole activity is the import and re-gasification of LNG. PLL has sourced LNG under long-term contract from RasGas of Qatar and has sold re-gasified LNG mainly to three intermediate off-takers, namely, GAIL (India) Ltd., Bharat Petroleum Corporation Ltd., and Indian Oil Corporation Ltd. PLL has had long-term gas sale and purchase agreements with these reputed Companies. Even though this assures market for the entire product, there are risks involved in limited customers. In addition to the existing contract with RasGas, PLL has also executed another long-term contract with the Australian entity of Exxon Mobil for supply of around 1.44 MMTPA of LNG from its Gorgon project. This will meet the requirement of the new LNG Terminal in Kochi. PLL also provide regas services to third parties who import LNG directly. PLL has executed 7.25 MMTPA equivalent contracts to provide long- term regas services to GAIL, IOCL, BPCL and GSPC/GSPL for existing and expansion plan of Dahej. Internal Control Systems and their Adequacy The Company has developed adequate internal control systems to commensurate to size and business. PLL has appointed Ernst & Young as Internal Auditors, who conduct audits for various activities. The reports of the Internal Auditors are submitted to the Management and the Board's Audit Committee. There is a thorough review of the adequacy of internal control system. Financial Performance The turnover during the financial year ended 31st March, 2015, was Rs. 39,656 Crore including other income as against Rs. 37,832 Crore in Financial Year 2013-14. The net profit during the financial year ended 31st March, 2015, wasRs. 883 Crore as against Rs. 712 Crore in 2013-14. Human Resources The Company maintained harmonious and cordial industrial relations. No mandays were lost due to strike or lock-out. As on 31st March, 2015, there were 461 employees excluding three Whole-time Directors. Disclosure by Senior Management Personnel, i.e. One Level below the Board including all HODs: None of the senior management personnel has financial and/ or commercial transactions with the Company. They do not have any personal interest that would have a potential conflict with the interest of PLL at large. |