Is natural gas the next big Asian opportunity?

Countries such as India, China, Japan and South Korea are aiming to attract private capital to the midstream and downstream space. But, challenges remain in some markets.

Can Asia become the next big market for midstream and downstream gas assets? With rising energy consumption across the region and a continuous push to move away from coal, investors have started to hunt for opportunities in the space.

Conversations with experts from the region, however, paint a mixed picture, with glowing opportunities in key geographies and hurdles that might prove difficult to overcome for investors in others.

In April, New York-based I Squared Capital announced its interest in the region’s rising consumption of natural gas. “The Asian energy story has largely been dominated by coal,” Gautam Bhandari, co-founder of I Squared, told Infrastructure Investor at the time. “For instance, China and India primarily used coal to generate [power]. As coal has been rapidly replaced by renewable energy, I think the right intermittent power source you now need will be gas-based.”

The comments followed I Squared’s sale of Singapore-based solar company Amplus Energy Solutions. Bhandari said the firm decided to shift towards a “slightly different, but complementary investment thesis” for deploying its $7 billion ISQ Global Infrastructure Fund II, as Asian renewables markets became “more competitive”.

A month earlier, Brookfield had indicated its interest in Asian transmission assets. The Canadian manager completed its largest ever deal in India, with the $1.9 billion acquisition of the East West Pipeline. The pipeline, previously owned by Indian conglomerate Reliance Industries, connects the natural gas reserves of the Krishna Godavari Basin, off India’s east coast, with several urban centres in the western part of the country.

According to a final placement memorandum by the India Infrastructure Trust – through which Brookfield acquired the asset – the pipeline “acts as a vital link in India’s developing natural gas grid”. The trust says the asset is well-positioned for growth thanks to its “ability to access future gas production from new exploration in the KG Basin” and its connection with other gas terminals.

“We believe that it also has potential connectivity to other major gas pipeline networks in India,” the trust added.

Environmental concerns
Interest in transmission and distribution assets is driven by political and macroeconomic trends that can be found across the region.

Firstly, Asian countries are increasing their natural gas consumption as their economies grow. According to a 2018 International Energy Agency report, China will become the world’s leading importer next year, and reach 171 billion cubic metres by 2023, most of which will comprise liquefied natural gas. India is expected to expand its consumption by 25.7 billion cubic metres between 2017 and 2023. According to IEA estimates, the region, led by China, will account for more than half of the growth in global natural gas consumption until 2023.

“There is a rising energy demand in countries like China, Indonesia and Myanmar, where you see a combination of rapid economic growth, rapid industrialisation and intensive urbanisation,” says Norman Bissett, a foreign legal consultant in the finance and projects group of HHP Law Firm, a member firm of Baker McKenzie in Indonesia.

This growing demand has been met with falling prices in the natural gas market, thanks to the US shale gas revolution.

“Shale gas has been a global phenomenon that, combined with the emergence of LNG, has revolutionised the global natural gas market,” Steve Bickerton, senior managing director at energy infrastructure-focused Prostar Capital, explains. “The rapid increase in gas production and export capacity in the US, Qatar, Australia, Russia and other producing markets has driven down gas prices for importers, particularly in Asia.”

Concerns regarding the environmental impact of coal burning are also pushing countries to look for alternative energy sources. China in recent years has cracked down on polluting industries and coal-based energy plants, and thus improved the air quality of some of its biggest cities. India is expected to take similar steps soon, as toxic smog has become an endemic problem in cities such as Delhi.

Bissett expects Asian countries to turn to natural gas in order to curb pollution and achieve their commitments under the 2016 Paris Agreement on climate change: “All the countries in the region are aware of their obligation to reduce their carbon footprint, and everyone understands that natural gas is the readiest alternative to coal at the moment.”

Partner for renewables
The energy source is also a perfect complement to the growth of renewables. “Natural gas is a critical part of the Asian demand story, particularly as grid stability becomes increasingly important, as renewables account for an increasing share of power supply,” Bickerton adds.

So, where does the opportunity lie? Bickerton says Prostar is focused on “major global trading and logistic hubs”, including the greater Singapore area and key ports in North Asia: “[They] represent the gateways, and often chokepoints, through which the vast majority of the world’s energy trade passes. As such, they offer robust demand with low correlation to global or regional macroeconomics and stable regulatory and geopolitical frameworks.”

In 2017, the fund manager invested in Kyungnam Energy, a South Korean city gas distribution company with a pipeline network spanning 1,995 kilometres. The GP also stresses that there are opportunities coming from “oil traders” and “strategic investors” that are divesting from operational assets in the space, as well as from yet-to-be-built projects. “Large numbers of greenfield projects, particularly in the APAC region, are looking for experienced and patient capital from private equity sponsors such as Prostar,” says Dave Noakes, senior managing director at the firm.

Bickerton says Japan and South Korea are opening up the sector. “As deregulation gathers pace, operating and cost efficiency will become increasingly critical, and we see significant opportunities to create diversified portfolios around common asset classes, such as a Pan-Asian gas distribution platform.”

China is also in the midst of a turnaround of its oil and gas industry, traditionally dominated by three oil giants: PetroChina, Sinopec and CNOOC. Last March, the National Development and Reform Commission announced plans to transfer gas and oil midstream assets currently held by the three state-owned firms to a newly created operator. According to Bloomberg, the carve-out could involve assets valued at around 500 billion yuan ($72.4 billion; €64.7 billion).

Xiao Yong, a partner at law firm Dechert, focused on cross-border transactions of Chinese energy companies, says: “The set-up of the company will involve three stages: the injection of existing assets into the firm, the issuing of shares to private investors and, finally, a possible IPO.”

Xiao believes the firm may be of interest to private equity funds with a focus on stable assets with long-term returns. He stresses that initial information does not distinguish between foreign and domestic investors when talking about attracting capital, adding: “I believe that foreign firms will be able to participate.”

He says that the government moved to further liberalise the downstream sector at the end of last year, unlocking access to “quite profitable” assets. “[It] allowed foreign investors to hold 100 percent ownership of downstream assets,” he explains, up from a previous 30 percent limit. The lawyer says the sector has attracted interest from private equity firms and Middle East companies.

India, which has become one of the major infrastructure markets in the region, is also keen to attract private capital to transmission and distribution assets. “The government has been looking at ways to increase participation of international players in the oil and gas value chain,” says Pranav Master, director of CRISIL Infrastructure Advisory. He points out that opportunities have come in the last couple of years, with developers divesting from city gas distribution projects, and international players and private equity-backed firms bidding for CGD assets: “New players – both strategic and financial – have shown interest in investing in greenfield as well as established [CGD] assets.”

K Ravichandran, senior vice-president and group head of corporate ratings for India’s ICRA credit rating agency, says investors might be “encouraged” by the regulated nature of midstream assets. This includes a 12 percent post-tax return on capital employed for transmission pipeline operators granted by the Petroleum and Natural Gas Regulatory Board.

Despite this, he warns that “the tariff philosophy” followed by the regulator has resulted in “sub-optimal returns”, triggering litigations by incumbent operators: “While the regulator has tried to make amends by changing the regulations, a lot needs to be done before the operators can breathe easy.”

Availability issues
Ravichandran believes gas availability might be another concern, as “depleting domestic gas fields and price-sensitive consumers” have affected LNG demand in the country.

“Consequently, many gas pipelines are operating at much below the normative capacity utilisation, which negatively impacts their regulated returns,” he says.

Master believes India’s efforts to build new pipelines will provide access to consumers eager to start using LNG. “Offtake is not likely to be an issue in the near term, as potential gas consumers are currently using more expensive alternative fuels,” he says.

Overall, both analysts agree that the market will attract international attention as it becomes more transparent and the regulatory framework approaches “some maturity”.

“The regulations provide a level playing field for both domestic and international investors,” Ravichandran says. “However, when international players enter the Indian gas market, tie-ups with domestic companies with deeper local knowledge could be helpful in navigating the approval processes.”

A promising landscape across the region, then.