“There will be renewed interest for investment in gas, there will be substitution of coal and fuel oil in the production of power.”

– Paolo Rocca, CEO of Tenaris, the world’s largest producer of seamless pipes

It’s a statement that pretty much sums up the mood of Indian pipe manufacturers. Almost all the big players have shrugged off the dark days of the last part of 2008 when crude slumped to $38 a barrel. Now the buzzword for spinning profits is ‘gas’. While oil exploration activity stayed in the back seat in the first half of this year, gas took control at the wheel, driving growth. The situation is expected to stay that way for some time to come, despite crude prices steadying at current prices and signs of life are showing up in previously stalled exploration activities.

But is every pipe maker benefitting? Not exactly. We separate the ones facing a boom from those facing gloom.

Meet the pipe makers

Contrary to what most people think, all pipes are not created equal. That is, pipes are not made and sold in one way, like cement or other commodities. Pipes can be made in different ways and sold to different industries, depending on the kind they need (See chart: The pipe pipers) In other words, one size does not fit all companies. For instance, a pipe used in offshore drilling is very different from the one that transports water or what is used in industrial boilers. The outlook for pipe makers depends, therefore, on the outlook of the industries they service. Overall, the oil and gas industry is the biggest user of pipes, followed by engineering, water and sewage companies. Because oil and gas companies account for such a large proportion of sales – about 80 per cent – it’s no exaggeration to say that the fortunes of Indian pipe makers turn on how the energy industry moves.

In oil and gas, there are two broad sub-categories: exploration (pipes used in oil exploration activities) and gas transportation and distribution. An example of a pipe user for the latter would be Gail, which is rolling out gas pipelines across the country.

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The pipe pipers

Types of pipes manufactured in India and major producers

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The big pipe makers in India are Welspun Gujarat, Man Industries, and Jindal SAW, all of which cater primarily to gas distribution and transport companies, while Maharashtra Seamless, as the name suggests, focuses on making seamless pipes. Some of the pipe makers who cater to gas also make seamless pipes. Twenty per cent of Jindal SAW’s output, for instance, is seamless pipes.

To understand the state of affairs in the pipe industry, it’s important to be up to speed with all the action in the oil sector. When crude plunged to $38 a barrel in December 2008, exploration activities went into slow motion. After all, why bother prospecting for oil when you can get fuel cheap?

Oil exploration companies typically maintain stocks of pipes, mainly the seamless kind, so when exploration hit the ‘stop’ button, demand for seamless pipes, literally piped down. It’s what Tenaris’ Rocca referred to when describing the seamless pipe maker’s situation: “Demand for our pipes from the global energy industry has been affected by the decline in oil and gas drilling activity and the actions taken by customers to adjust to reduced cash flows and a less favorable market outlook, including procurement delays and cancellations and the postponement of new project activity”. But the other energy alternative — gas — saw increased spending both internationally and in India with more project announcements.

Gas is the future of the energy industry and with insufficient transport systems, it presents a big opportunity for the next 15-20 yearsJ C Mansukhani , Vice-chairman and MD, Man Industries

Not surprising then, that the gas business has become the next big thing for Indian players, with the outlook remaining robust for the next five years. “Gas is the future of the energy industry and with insufficient transport systems in place, gas presents a huge opportunity for the next 15-20 years,” declares J C Mansukhani, vice-chairman and managing director of Man Industries. To underline his point, he adds that the company’s LSAW (pipes used in gas transportation) plants are busy until August 2010. It’s not an isolated case: Welspun Gujarat saw LSAW business expand volumes to 86,068 tonnes in the quarter ended June from 40,077 tonnes in the corresponding quarter a year earlier.

To meet exploding demand, Indian companies are charting out expansion plans. Is there a supply glut in the making? Not likely, reckon analysts, who say that with companies offering their wares to local and overseas buyers, the possibility of excess capacity or a negative impact on realisations is low. “Looking at the order book of a few Indian companies, exports account for more than 70 per cent in some cases,” points out Raghvendra Kumar, analyst with ICICI Securities. “The higher demand will keep prices high.”

The party spreads

Of course, gas distribution pipe makers are not the only ones rejoicing. Crude prices are now relatively stable at $70 a barrel and are making exploration activity viable once again, lifting hopes of seamless pipe makers. Nevertheless, despite the recent uptick in exploration work, the international rig count (an indicator of exploration activities) of active rigs in the first half of the year, at about 1004, is lower by 6 per cent from a year ago. The US saw a bigger decline in rig count which fell 56 per cent from its September 2008 high and was 38 and 42 per cent lower than the first and second half of last year respectively. Exacerbating the situation was the fact that US oil exploration companies have enough stocks to last them until the end of the year and then some. “We believe that in about six months from now, inventory levels should get depleted and we should see some pick-up in demand,” says Anil Jain, chief financial officer at Maharashtra Seamless, India’s largest seamless pipe maker.

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Priming the pipeline

Planned network expansion, especially by GAIL, offers Indian manufacturers a big opportunity in the next 2-3 years

Gail	Length (km)		RGTIL	Length (km)
Jagdishpur-Haldia	2,050		Kakinada-Basudevpur-Howrah (Haldia)	1,100
Dabhol-Bangalore	1,480		Vijaywada-Nellore-Chennai	445
Dadri- Bawana-Nangal	640		Chennai-Tuticorin	670
Chainsa-Jhajjar-Hissar	450		Chennai-Bangalore-Mangalore	660
Kochi-Mangalore/Bangalore	840		GSPL/GSPC	2,200
Kochi-Kayamkulam	110		Total expected pipelines	11,245
Jhabua-Kailaras (MP)	600

Source: Industry, media reports

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But a kick to growth could come from a recent development. Early this month, the US Commerce Department slapped preliminary duties from 10.9 per cent to 30.7 per cent on steel pipes used to transport oil which are imported from China. Out of the 20 million tonnes of seamless pipes produced in China last year, about four million were shipped to the US. This directive affects seamless pipes and not those used to transport gas. Anil Jain of Maharashtra Seamless says this is a positive development for his company. “We will definitely be more competitive and cheaper with this development coming into force,” he says. A sentiment echoed by other seamless pipe makers. “We were competing against China with a 10 per cent price disadvantage earlier,” says Indresh Batra, MD, Jindal SAW. “This move will benefit Indian and other companies in East Asia.”

Kick back and relax

So everybody’s happy then. For the gas distribution pipe companies business is booming and for oil pipe companies things are looking up as well.

Given that gas projects are the way to go, what exactly are the projects that gas distribution pipe makers are salivating over? In India, the big one is the Rs 35,000 crore National Grid project, expected to add about 8,000 km of pipelines to the existing network. India’s gas pipeline network currently totals only about 10,600 km — a tiny figure compared with Pakistan’s 56,400 km and the 18,30,000 km laid out in the US. “The next three years could see pipeline related investments worth more than $3.1 billion in India,” says Ashutosh Tiwari, analyst with brokerage K R Choksey.

Gail, India’s biggest gas pipeline company, has also marked out Rs 8,000 crore for setting up the Haldia (in West Bengal)-Jagdishpur (in UP) pipeline covering 2,050 km. This mega-project has two phases. In the first phase, set to be completed by March 2012, 1,410 km of pipelines will be laid between Haldia and Phulpur, along with spur and feeder lines of 450 km to be laid out until the city gate stations at Kolkata, Ranchi, Jamshedpur, Varanasi, Allahabad and Sagardighi (in West Bengal). The second phase, to be completed a year later, involves installing a compressor at Haldia and laying out 190 km of feeder lines to Haldia, WBPDC Bandel and Katwa, DPL Durgapur and SAIL’s plants at Durgapur and Bokaro, and the petrochemical plant at Barauni. This project has just won approval from the Gail board and comes on the heels of the go-ahead given for the Dabhol-Bangalore gas pipeline at an investment of Rs 2,500 crore. This project is expected to turn operational between 2011 and 2012.

The next three years could see pipeline related investments worth more than $3.1 billion in India

And there are other projects. Reliance Gas Transportation and Infrastructure, a privately owned Mukesh Ambani company set up to carry Reliance Industries’ D6 gas has laid out 1,400 km of pipelines from Kakinada to Bharuch passing through Andhra Pradesh, Karnataka, Maharashtra and Gujarat. The company is in the middle of adding four pipelines to interconnect with the east-west pipeline. These include a 1,100 km Kakinada-Haldia pipeline, a 445 km Vijaywada-Chennai pipeline, a 670 km Chennai-Tuticorin pipeline and a 660 km Chennai-Bangalore-Mangalore pipeline. These pipelines are scheduled to be commissioned by September 2012.

Reliance Industries has also signed a statewide gas distribution deal with Andhra Pradesh, a project that is estimated to require an investment of Rs 1 lakh crore. RIL will hold 67 per cent stake in Krishna-Godavari Gas Network while the remaining will be held equally by the Investment Corporation of Andhra Pradesh (InCAP), Gujarat State Petroleum Corporation and IDFC Private Equity Fund (11 per cent each). Distributing gas to Hyderabad is also estimated to require an investment of Rs 3,500 crore.

Then there is the Rs 4,500 crore Gujarat State Petronet (GSPL) Project, which is a subsidiary of Gujarat State Petroleum Corporation (GSPC). It aims to lay out a 960 km pipeline between Mehsana (Gujarat) and Bhatinda (Punjab) and later extend that pipeline from Bhatinda to Srinagar (J&K). The company is waiting for government approvals. Currently, GSPC has 1,400 km of pipelines passing via Hazira-Vadodara-Ahmedabad-Kalol-Himmatnagar-Mehsana-Rajkot-Morbi-Vapi. It plans to add 800 km to the existing network. The expansion, under different stages of planning and implementation, will lift the total network’s length to 2,200 km.

We believe that in about six months from now, inventory levels should get depleted and we should see some pick-up in demandAnil Jain, Chief financial officer, Maharashtra Seamless

Internationally, some analysts believe that strong demand for pipes could also emanate from the US, where major pipe laying activity was last seen in the 1970s. “With pipes having an effective life of about 30 years, 60,000-70,000 km of pipelines could be up for replacement starting next year,” says K R Choksey’s Tiwari. Worldwide, about 3 lakh km of pipelines are expected to come up globally, according to US consultancy Simdex.

“International demand for pipes over the next five years is estimated to be worth $84 billion,” says Raghvendra Kumar, analyst with ICICI Securities. “In Asia and North America, demand for pipes is estimated at $25 billion and $18 billion respectively over the next five years.” So big bucks to be made here!

Place your orders

That brings us to the order books. Indian pipe makers have orders going up to 9-12 months on their books. “That’s a comfortable position to be in,” says K G Mantri, senior vice-president of corporate affairs at Man Industries. “We have fixed-price contracts in this industry and with commodity prices fluctuating constantly, no one wants to keep a longer book position.” Man Industries’ carries a Rs 2,500 crore order book. Besides the order book, pipe companies also carry a larger bid (that can be converted into orders) book. Man Industries’ Mantri says their bid book is worth Rs 4,500 crore, about 25 per cent of which is likely to be converted into firm orders.

Jindal SAW’s order book totals Rs 3,360 crore while its bid book is close to Rs 4,800 crore. The conversion rate of its bid book is about 60 per cent.

However, the size of the order books of both Jindal and Man, like many others, is far smaller than what they used to be. For instance, a year ago, Jindal SAW had an order book of $1 billion while Maharashtra Seamless had an Rs 823 crore order book by the end of December 2008 (now it’s Rs 425 crore). Welspun Gujarat’s order book was worth Rs 7,200 crore in the June quarter a year ago; this time, it’s about Rs 6,800 crore.

Two factors are responsible for this. The first is that between October 2008 and March 2009, crude prices fell off the roof, badly affecting exploration activity and forcing some projects to be put on hold or slow down. “There was a decline in the order backlog last year because of the deferment in investments by oil and gas companies,” says Raghvendra of ICICI Securities. The second was the depressing sentiment shrouding the global economy following the convulsions in financial markets, which kept potential investments at bay.

The multi-billion dollar fiscal and monetary rescue packages by governments worldwide did help to get things moving again for pipe companies, points out Indresh Batra of Jindal SAW. He says such measures have been particularly helpful in the Middle East. Take Saudi Arabia for instance. It announced a whopping $47 billion investment plan to build what will be three of the largest petrochemical projects in the world, employing up to 1,50,000 engineers and technicians. State-owned oil company Aramco is also expected to announce the start of the Manifa gas development programme and the Shaybah natural gas liquid project, estimated to be worth about $7 billion. Both projects are expected to start operations by 2014.

You can see it in the numbers. Revenues for Welspun Gujarat vaulted by 72 per cent to Rs 1,879 crore in the June-ended quarter, while net profit surged by 94 per cent to Rs 138 crore. Jindal SAW’s revenues gained 47 per cent from a year earlier to touch Rs 1,501 crore while net profit leaped up by 94 per cent to Rs 136 crore.

We were competing against China with a 10 per cent price disadvantage earlier. So the recent hike in duties will hugely benefit usIndresh Batra, Managing director, Jindal SAW

Working to the industry’s advantage also are rising steel prices. Steel is a key raw material used in making pipes for oil and gas companies. “We are seeing a pick-up in projects being executed,” says Akhil Jindal, corporate affairs director at Welspun Gujarat. “With steel prices going up, we are seeing a rush to book orders.”

In the June quarter, Jindal SAW reported a blended Ebitda of Rs 12,517 per tonne, up by 43 per cent from the December quarter and 44 per cent from the year-ago period. Jindal SAW’s Batra forecasts blended margins to be in the range of Rs 11,000 per tonne in the coming quarter. Welspun’s Jindal predicts Ebitda margins will be around Rs 10,000 per tonne, close to the Rs 10,790 per tonne reported in the June quarter. Seamless pipe makers, however, are not so optimistic. Maharashtra Seamless’ Jain, for instance, expects margins to slip to Rs 12,000-15,000 per tonne from the Rs 18,000 reported in the June quarter in the absence of any significant pickup in demand. (As Jain mentioned earlier, demand is expected to improve only after December.)

Best bets

To sum up, the outlook for companies servicing the gas distribution business appears a better bet than those servicing oil exploration companies. Seamless pipe manufacturers will need to wait until de-stocking is complete and that is expected to happen only next year.

In view of the stronger Ebitda margins per tonne forecast for Jindal SAW compared with peers, the Jindal SAW stock appears to be a good investment bet. In June this year, it received orders worth about Rs 1,000 crore to supply large diameter pipes and ductile iron pipes in both the local and overseas markets. Locally, the pipes will be supplied to Gail and HPCL while overseas, the pipes will primarily be shipped to the Middle East. These orders will lift the size of the order book to Rs 3,360 crore. Jindal SAW shares trade at 7.5 times EV/Ebitda for FY11.

Welspun Gujarat has the biggest order book – Rs 6,800 crore – among pipe companies and offers strong revenue visibility. In June, it had orders worth Rs 8,800 crore, of which close to Rs 2,000 crore have been executed, leaving the unexecuted portion at Rs 6,800 crore. Jindal says company should close this financial year with an order book of Rs 7,200 crore. Plans are also afoot to set up a new 300,000 tonne HSAW mill and expand its existing 3,50,000 HSAW plant in the US. Welspun Gujarat shares quote at 6.28 times EV/Ebitda for FY11.

Pipe stocks recently witnessed a small rally as news came in of the US duty imposition on Chinese firms. Since September 7, the four big pipe stocks have rallied an average 9 per cent till date, as compared to the Sensex which has moved up 4 per cent. Inspite of the recent run-up in prices, we feel that the slew of projects announced — both abroad and at home — indicates that the gas story is not one that has run its course yet. And with the world still in search of cheaper energy sources, the long term potential of gas is yet to be fully realised. In the meantime, companies that provide products and services in the gas sector should continue to do well.