RIL-RNRL Case Update
Event
The Supreme Court ruled in favour of Mukesh Ambani's Reliance Industries Limited (RIL) in a gas pricing dispute with Reliance Natural Resources Ltd (RNRL), controlled by Anil Ambani.
The Case
The case was regarding the sale of the KG D6 gas as well as the pricing for the same, whether RIL has to sell its first 28 mmscmd (million metric standard cubic metre per day) of gas to RNRL at US$2.34/mmbtu (million metric british thermal unit) and for a period of 17 years.
The Judgement
Upheld the production sharing agreement: The court struck down a Bombay high court order of June 2009 which had upheld a family memorandum of understanding (MoU) between the two brothers, on the basis of which Anil Ambani was seeking cheaper gas. The Supreme Court said an MoU between family members was "not legally binding" and the government had the sovereign right on fixing the price of the country's resources.
Upheld the price mechanism which the Government of India has established: As the case has dragged on through various courts, the government has tightened its control over the sector, not only approving the price but also directing the producer of the gas as to who it should sell to.
RIL-RNRL Must re-negotiate in six weeks: The court ordered the brothers to renegotiate within six weeks a private natural gas supply contract between the two. Such an agreement would have to be in consonance with government policy.
Impact on RIL
Now, RIL gets to sell the likely peak production of 80 mmscmd at the KG basin D-6 block gas at $4.2 mmBtu. This is against the claim of RNRL at $2.34 mmBtu as per the memorandum of understanding signed between the brothers at the time of split in 2005. It is a windfall for RIL that holds 56,000 square km of acreage in the KG basin, which is 42% of the total in the basin. Its most prolific block has estimated reserves of close to 35 trillion cubic feet of gas.
The refining industry is gradually seeing an uptrend globally and the company hopes to post better gross refining margin for FY11 compared to $6.5 in FY10.
This, coupled with gas profits and a mature petrochemicals business, could render it debt-free in a few years and open up more acquisition opportunities. The recently-concluded Atlas Energy stake buy for shale gas acreages in the US will contribute revenues in three years.
Further, the judgement removes the overhang on RIL stock. RIL's E&P activities are expected to accelerate, considering the deepwater rigs at its disposal as well as stakes in exploration blocks with high prospects. However, more clarity is awaited on the renegotiation option as, based on RIL's stand. We believe the company has limited leeway to supply gas to consumers yet to be allocated gas by the government and at any price significantly different than $4.2 per mmBtu,"
The judgment will have a positive impact on the company's fundamentals .However, given the prospects of renewed painstaking negotiations and the potential dip in the global economy, we believes it is a time to exit from the RIL.
Impact on RNRL
The verdict may impact the company's plans severely. Under the new policy the government apart from deciding the $4.2 per unit price for KG basin gas will also decide the priority for allocation, and the Dadri plant where even land acquisition is not complete, may be way down on the government's priority list. RNRL is unlikely to get the gas at the price it wants but there is a bigger worry as it may not get the gas at all.
Given the uncertainties involved in renegotiations, as well as global worries, we advice to stay away from ADAG group shares.
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