State-owned gas utility GAIL India Ltd’s 82 per cent plunge in earnings before interest and taxes (EBIT) to Rs 480 crore in the first quarter of the financial year ending March 2021 reflects price risks under the firm’s long-term Henry Hub (HH)-linked LNG contracts from the US, Fitch Ratings said on Monday.

GAIL’s regulated gas transmission segment was the least affected by the coronavirus pandemic-related lockdowns and helped generate an overall positive EBIT margin over the quarter, it said.

India’s largest gas marketing and transportation company had a negative EBIT of Rs 610 crore in natural gas marketing segement in Q1, “largely driven by losses in HH-linked US liquefied natural gas (LNG) volumes,” Fitch said.

GAIL has contracted 5.8 million tonnes per annum of LNG from the US at prices linked to HH.

“Part of losses were also due to a sharp drop in natural gas prices, leading to inventory losses of Rs 250 crore,” Fitch said. “HH linked contracts expose GAIL to price risk, especially during a low crude-price environment such as 1QFY21, when spot LNG was cheaper than the landed cost of HH-linked US LNG.”

GAIL generally hedges most of its volume and price risk on near-term deliveries of US LNG to minimise losses and generate positive return, as reflected in its FY20 gas marketing EBIT of Rs 2,640 crore.

“However, the remaining unhedged volume risk increases during times of weak demand and low spot prices, potentially leading to losses and lower offtake, even for volume contracted with customers, as they may require gas marketers, such as GAIL, to provide some volume and price flexibility,” it said.

India’s natural gas consumption dipped by around 15 per cent in 1QFY21, driven by pandemic-related lockdowns and a drop in Asian spot LNG prices to an all-time low of below USD 2 per million British thermal units (MMBTU).

“We expect the gas-marketing segment to generate negative EBIT of Rs 1,160 crore in FY21, driven by our expectation of lower spot LNG prices, which are linked to our crude price estimates. This will make it difficult for GAIL to fully mitigate price risk on its US LNG volume,” Fitch said.

The recent increase in Asian spot LNG prices to above USD 3 per MMBTU should limit the extent of the losses, but a potentially slower demand recovery post lockdown is likely to keep the margin in the red.

India’s LNG demand will also be affected by lockdown-related delays in commissioning fertiliser plants to which GAIL aims to sell some of its US LNG volume, it said.

Fitch revised the outlook on GAIL’s long-term foreign-currency issuer default rating (IDR) to negative, from stable, in June 2020, following similar action on India’s ‘BBB-‘ sovereign rating, while affirming the long-term IDR.

“The weaker profitability in the gas-marketing segment is likely to increase GAIL’s net leverage, as measured by net debt/EBITDA, to 2.4x, against our earlier expectation of 1.7x (FY20: 0.8x).

“Still, GAIL’s financial profile should remain commensurate with its standalone credit profile of ‘bbb’ and we expect the segment’s EBIT margin to turn positive in FY22, supported by a rise in crude-linked spot LNG prices and a demand recovery,” it said.

GAIL’s natural gas transmission segment EBIT was relatively stable at Rs 720 crore, broadly in line with dip in India’s natural gas consumption.

“We expect EBIT from the gas transmission segment to increase to Rs 3,380 crore in FY21 (FY20: Rs 3,540 crore), supported by a gradual recovery in natural gas demand after the lockdowns cease and GAIL commissions new pipelines,” it added.