India Ratings and Research (Ind-Ra) expects a significant increase in investments in the city gas distribution (CGD) sector over the next three to four years, pursuant to the Supreme Court of India's judgment allowing asset-owning CGD companies to freely price their products. "Given the pricing flexibility that CGD entities would now have, Ind-Ra estimates for every Rs 1/scm increase in EBITDA margin, CGD entities could see a 5%-6% increase in their return on capital employed. This would also depend on the level of operating leverage in the business."

Fresh investments would also be aided by the highest priority being accorded to the compressed natural gas (CNG) and domestic piped natural gas (PNG) categories of CGD since January 2014 in the domestic natural gas allocation.  Operators had been going slow in new investments since 2010 due to the regulatory uncertainty with respect to pricing.

The sector would be free of pricing risk which could have emerged earlier from an unfavourable regulatory stance. The major pricing risk CGD entities would now face is to pass on changes in domestic gas prices and foreign exchange risk to end consumers through price revisions and relative competitiveness of alternate fuels.

It is often believed that such pricing power could result in super-normal returns on invested capital, given that most CGD companies are usually monopolies in their respective areas of operations. However, consumer's ability to switch to alternate fuels (diesel in case of CNG and LPG in case of domestic PNG) would act as a market check on earning super-normal returns.  

The current judgment in Ind-Ra's opinion is unlikely to change existing CNG and PNG tariffs as CGD entities were charging tariffs based on alternate fuels and not on Petroleum & Natural Gas Regulatory Board’s (PNGRB) ruling. However, CGD entities might strive for somewhat  higher EBITDA margin over the long-term, given the pricing control post the ruling, leading to slightly higher consumer tariffs.

The current ruling is the final outcome of a legal process which was set in motion in 2010, when PNGRB approved a significantly lower compression charge of Rs 2.8/kg than Rs 6.7/kg proposed by a CGD entity in New Delhi and network tariff of Rs 38.6/mmbtu as against Rs 104.1/mmbtu. The Delhi High Court had ruled against the PNGRB's order stating that there were no statutory provisions that allowed PNGRB to fix retail prices for asset-owning CGD.