City Gas Distribution (CGD) networks in India are operational in around 40 cities and under construction in around 35 cities. While prior to the formation of Petroleum and Natural Gas Regulatory Board (PNGRB), the operators were approved by either the Central Government or State Government, since 2008 the operators are selected based on bidding. Till now, 8 rounds of bidding have happened with results announced for the first 6 rounds, wherein operators for 47 cities have been finalized and some of which are already operational. Though the bidding criterion has evolved over time, it has still met with fair amount of criticism from the stakeholders with regard to the fairness of selection criteria.
What have been the main drawbacks in the extant bidding mechanism? As per the latest bidding round, operators are selected based on the lowest tariff quoted for laying the network and compression infrastructure, even while a minimum work programme (MWP) is specified upfront by the regulator as regards the number of domestic connections to be given and length of the pipelines to be laid within 5 years of authorisation. However, bidding results have been disproportionate with some cities seeing elevated competition, with all bidders quoting the lowest possible tariff i.e. Rs 0.01/MMBTU for network tariff and Rs 0.01/Kg for compression charges for the entire license period of 25 years. The bidding guidelines provided for additional bank guarantee in the event of a tie in scores by the bidders, which can be encashed by the regulator in the event of slippages in meeting MWP and service levels. As a result, few bidders have quoted astronomically high bank guarantees for cities which are seen to be lucrative. Nonetheless, there have been cities which did not elicit even a single bid or received only a single bid, which are essentially cities seen to be having low market potential.
How are the industry players able to quote such near zero tariff levels when they could be hit by competition post marketing exclusivity, which is 5 years from the date of authorization? That is because the industry believes it will be nearly impossible for the third party marketers to use the incumbent network, given the multiple loopholes in the open access regulations for CGD sector. Moreover, the regulator does not have the remit to control the end product prices viz that of CNG and PNG, which are market determined, mostly based on the extent of substitution risk from alternate fuels such as MS & HSD for CNG, LPG (domestic) for PNG (domestic), LSHS/FO/commercial LPG for PNG (Industrial & Commercial). Besides, they believe the chances of encashment of BGs will be slim as they have the necessary technical expertise to lay the network and meet minimum customer service standards.
While each of the above assumptions under which bids are made can be questioned and which can hit the bid winners hard when their assumptions go awry, the end result is that bid winners have been selected primarily based on their financial strength, with their superior ability to avail BGs with limited or nil margin or charges. That apart, the bidding criterion has also encouraged non-serious players, who have not been able to achieve the financial closure within the specified period, leading, in some instances, to termination of licenses.
While there are several imperfections in the CGD bidding model, is there a perfect bidding model? In the author’s opinion there is no perfect bidding model, which will ensure that bidders always bid rationally. We have seen elevated competition in other infrastructure sub sectors as well, such as in coal mining, telecom spectrum, power (thermal, solar, wind, transmission network), roads, ports, airports and gas transmission pipelines, which have resulted in winners ending up with sub optimal returns. Ultimately market forces should ensure rational bidding such as lenders tightening funding norms and shareholders questioning aggressive biddings. Having said that, the bidding model in the CGD sector can be tightened, which will lessen the chances of irrational bids.
In this regard, the recent recommendations of a committee formed by PNGRB on new bidding norms are forward looking and worth considering. Key recommendations include changing the bidding variables to include higher weightages given for the extent of capex committed by the bidder (60%), and time period within which targets are met for PNG(domestic) connections, compression capacity and pipelines (10% each) and lesser weightage for the transportation tariff (5% each for network and compression). Other measures suggested include substantially increasing the minimum networth to Rs 75 Cr from Rs 5 Cr now and increasing the marketing exclusivity period to 10 years from 5 years now. The latter especially is crucial given the long pay-back period for CGD projects in new cities, where the market potential may not be as robust as the current cities where CGD networks are operational.
Given the Central government mission (‘Gas4India’) to increase the share of natural gas in the overall energy basket, CGD industry can play a crucial role in meeting that objective, for which a robust regulatory regime is imperative. Overhaul of the current bid selection criteria will certainly be one of them. Read More