Gas discos in limbo

With their decision to reduce the approved level of asset additions for gas firms this fiscal year, the governments intention to limit its investment in gas distribution network seems quite evident. Fixed assets addition target of Sui Southern Gas Companys (SSGC) has been restricted to Rs 5.5 billion against the firms demand of Rs 9.2 billion.
The target is about 38 percent less than Rs 8.9 billion approved last year. Perhaps the Oil and gas Regulatory Authority (OGRA) feared the high financial charges which could exceed the Return on Net Operating Assets on expansion. While these fears may be warranted; but this also means a very limited expansion in gas distribution network, if not grinding it to a halt.
Sui Northern Gas Pipeline Company (SNGPL) has been no exception either. They have been asked to keep their capital expenditure (capex) down to Rs 11.4 billion for FY10 as against the requested amount of Rs 18.5 billion. The reason cited for their reduction, however, is different from that for SSGC. OGRA believes that SNGPL is not capable enough to lay down such extensive distribution network.
But it is pertinent to note that capex incurred by SNGPL in FY09 was in fact 40 percent higher than the approved amount for FY10 and it makes one wonder what was OGRA thinking last year. And as if slashing capex was not enough, the government also did away with the deferred credit to gas distribution companies (discos), a measure which has historically served as a major source of liquidity for gas companies.
This amount would now be maintained in governments special projects account instead of lying with the discos. The step is likely to deprive them of the interest income on huge cash deposits, which contribute a great deal to their bottom-line profits - nearly 28 percent of their pre-tax profits in FY08.
And considering the likely hurdles in getting approvals to transfer deferred credit amount to discos account from the government account, the move would also limit discos ability to speed up their expansion process as they would have to use their own liquidity to finance new expansions.
The situation therefore calls for the decade-old plea of discos to revise their return formula. However, disagreements within ministries and bureaucratic hurdles have effectively derailed the process repeatedly, despite World Banks recommendations to switch from asset-based return of 17 percent to a 21 percent return on equity.
Since the current formula is on a pre-tax and pre-interest basis, hefty financial charges due to large capex, constrain the companies bottom line. Adjusting discos return rate with a floating rate, therefore makes more sense as it would cover the cost of debt as well. Therefore, it is high time that government acts in this regard to offer some respite to discos profitability.
Besides it will be to the benefit of public at large as well, given that the governments helping hand to discos helps them finance a significant portion of network expansions, which are mainly targeted towards small towns and villages in the form of deferred credit. In the absence of government support, these network expansions would be deemed unviable for distribution business.