August 31, 2017 I Ratings. Executive Summary INDIAN SAW PIPE INDUSTRY OPPORTUNITIES IN PIPELINE

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1 Executive Summary August 31, 217 I Ratings INDIAN SAW PIPE INDUSTRY OPPORTUNITIES IN PIPELINE Contact: Revati Kasture Senior Director revati.kasture@careratings.com Pulkit Agarwal Associate Director pulkit.agarwal@careratings.com Ankit Shah Deputy Manager ankit.s@careratings.com Mradul Mishra (Media Contact) mradul.mishra@careratings.com Disclaimer: This report is prepared by CARE Ratings Ltd. CARE Ratings has taken utmost care to ensure accuracy and objectivity while developing this report based on information available in public domain. However, neither the accuracy nor completeness of information contained in this report is guaranteed. CARE Ratings is not responsible for any errors or omissions in analysis/inferences/views or for results obtained from the use of information contained in this report and especially states that CARE Ratings has no financial liability whatsoever to the user of this report The growth constituents of global economy have seen a dramatic shift in the past decade. i) The boom and bust of the global financial markets, ii) economic downturn in western economies, iii) increased instability in the Middle East, iv) growth and increase in the share of Asian economies excluding Japan in the global GDP and v) the unfaltering growth rate of Indian economy. The buoyant Indian economy which had risen to the forefront saw a flood of capital investments in the Indian SAW pipe industry resulting in modernisation and capacity creation. The boom in the global economy was expectedly followed by the bust which led to the slump in crude prices, recession in the global oil & gas industry, drying up of orders, low capacity utilisation and eventually over leveraged balance sheets. Nevertheless, the Rs 235 billion Indian Line Pipe industry which is among the top three manufacturing hubs for SAW pipes and one of the leading exporters was able to weather the gloom and is ready to exploit the large growth potential in waiting. With the uptick in global economy, the oil & gas industry continues to offer larger opportunity for the pipe manufacturing companies over medium to long term as close to USD 3 billion worth of pipeline projects are currently under the planning & construction stage. On the domestic front, low penetration of pipes coupled with government s thrust on setting up National Gas Grid and revamping the water and sanitation infrastructure provides domestic business opportunity of more than Rs.3, crore. CARE Ratings expects capacity utilisation levels of domestic SAW pipe players to improve gradually on back of 1) Government s initiative to increase gas pipeline network, 2) Investments planned in the Middle East and North America.

2 Product Background Submerged Arc Welded (SAW) pipes are large diameter steel pipes which find use in transportation of oil, gas and water over long distance under high pressure conditions. SAW pipes are classified as Longitudinal Submerged Arc Welded Pipes (LSAW) and Helical Submerged Arc Welded Pipes (HSAW). The differentiating factors between LSAW and HSAW are: Table 1 Product Summary Particulars LSAW HSAW Size 16" to 6" diameter 2" to 14" diameter Key Raw Material Steel Plates Steel Hot Rolled Coils Manufacturing Process Longitudinally submerged arc welding of steel plates Spirally Welding HR Coils High Pressure conditions Low Pressure conditions Key Difference Demand is directly related to Oil & Gas Sector, Demand is directly related to Oil & Gas Sector Water and Sanitation Sector Application Oil & Gas Transportation Oil & Gas/Water Transportation Key Players Welspun Corp, Jindal Saw, Man Industries PSL, Welspun Corp, Man Industries, Jindal Saw International Demand Drivers The growth constituents of global economy have seen a dramatic shift in the last decade. i) The boom and bust of the global financial markets, ii) economic downturn in western economies, iii) increased instability in the Middle East, iv) growth and increase in the share of Asian economies excluding Japan in the global GDP and v) the unfaltering growth rate of Indian economy. In recent years, there has been a gradual deceleration in global energy consumption as the huge boost experienced from globalisation and Chinese industrialisation has started subsiding. The slowdown in consumption growth is compounded by continuing weakness in the global economy. As a result, global primary energy consumption grew by just 1.3% in 216, marginally higher than the rate of growth seen in 215, but slower than the average (1.7%) seen over the past decade. Much of this weakness is driven by China, where energy consumption grew at its slowest rate in almost 17 years. Even so, China remained the world s largest market for energy for the eighth consecutive year. Oil and Natural Gas industry, however continues to offer larger opportunities for the pipe manufacturing companies. The global demand for energy is estimated to grow at a CAGR of 1.4% to reach 17,157 mtoe (million tonnes of oil equivalent) by 235. China will continue as the largest consumer of energy as its requirements are estimated to grow at a CAGR of 1.7% to reach 4,425 mtoe by 235 followed by U.S.A. (2,312 mtoe). India s energy requirement is estimated to grow the fastest in the world at a CAGR of 4.3% to reach 1,63 mtoe by 235 and is poised to be the third-largest consumer of primary energy. 2

3 Million Tonnes Limited reserves of crude oil and increase in production of natural gas, a cheap and cleaner alternative to crude has led to increase in consumption of the latter to 3,543 bcm (billion cubic metres) in 216. As more than two-thirds of oil & gas reserves are found in Middle East and Eurasia, transportation of gas to deficit regions of Asia and Europe entails huge demand for steel pipes. Oil Global oil production grew by.5% to 4,382mnt in 216 vis-à-vis 215, slower than the five year average growth of 1.8%. The decrease was primarily driven by Non-OPEC countries. Over the longer term oil production is estimated to grow at an average of.4% to reach 4,768 mnt by 235. Oil consumption in 216 grew by 1.8% over 215, outstripping the oil production and the five year average consumption growth of 1.4%. Asia Pacific (3.4%) and Europe (2.2%) were the major contributors of this growth. As per BP Energy Outlook, by 235, the consumption is estimated to touch 5,22 mnt growing at an average of.7%, outstripping the production growth. Chart 1 Global Crude Oil Production and Consumption 5,3 Oil 3.5% 4,8 4,3 3,8 3,3 2, % 2.5% 2.% 1.5% 1.%.5%.% Oil Production Oil Consumption Production Growth Consumption Growth Source: BP Statistical Review of World Energy, 217 and CARE Ratings Higher crude prices during facilitated investments in the exploration activities which led to production growing at an average of 2.1% till 215, outstripping consumption which grew at an average of 1.2% during the same period. The uncertain global environment post the financial crisis and rationalisation of manufacturing capacities by China led to surplus crude inventories during 215 for the first time in the past decade causing the crude prices to crash. Crude prices bottomed out during the start of 216 to USD3.7/bbl however prices have been making a steady recovery from the second half of

4 Billion Cubic Meters Chart 2 Crude Oil Price movement vis-à-vis Inventory Levels Oil Inventory vs Price Inventory (MnT) Brent Crude ($/bbl) Source: BP Statistical Review of World Energy, 217, EIA and CARE Ratings Natural Gas Global natural gas production grew by.6% in 216 to 3,552bcm, slower than its five year average of 1.5%. Middle East (3.6%) and Asia Pacific (3.2%) recorded the largest growth increment. As per BP Energy Outlook, 217, going ahead, natural gas production is estimated to grow at an average rate of 1.6% to reach 4,85bcm by 235. Global natural gas consumption grew by 1.8% in 216 to 3,543bcm, at par with its five year average of 1.8%. As with oil, natural gas consumption growth was driven by Asia Pacific (3.%) and Middle East (3.8%). Going ahead by 235, the consumption growth is estimated to be at par with the production and grow at an average rate of 1.6% to 4,798bcm. Chart 3 Global Natural Gas Production and Consumption 5, Natural Gas 3.% 4,5 4, 3,5 3, 2.5% 2.% 1.5% 1.%.5% 2, % Natural Gas Production Natural Gas Consumption Production Growth Consumption Growth Source: BP Statistical Review of World Energy, 217 and CARE Ratings 4

5 Rig Count $/barrel Global Pipeline Projects The investments in the oil & gas sector are directly proportional to the crude oil prices. Active rotary rig counts are one of the best indicators to gauge the ongoing exploration & production activities. Chart 4 Average Rigs Deployed 4, 3,5 3, 2,5 2, 1,5 1, Average Rig Count Brent Crude Source: Baker Hughes, EIA and CARE Ratings From the highs of 3,494 average rigs deployed during , with the peak in 214, the average rig counts slumped to 1,594 on account of falling crude prices globally during However, with the recovery in crude prices in 217 by 22.5% over 216, the average rig counts till July 217 have also increased proportionally by 24.8% to 1,99. As a corollary, the demand for steel pipes is directly proportional to the investments made in the oil & gas sector and therefore is highly vulnerable to the fluctuations in oil prices. Lower oil prices reduce the demand for pipes as many projects get postponed or cancelled. Welded tube/pipe production (ex-china) as well as planned pipeline projects has moved in tandem with the crude prices albeit with a lag effect. 5

6 kilometer $/barrel Thousand Tonnes Chart 5 Welded Tubes Production vis-à-vis Crude Oil Price 4, 35, 3, 25, 2, 15, 1, 5, Welded Tubes Production (ex-china) Brent Crude Source: World Steel Association, EIA and CARE Ratings Chart 6 Movement of planned pipeline projects vis-à-vis Crude Oil Price 2, 18, 16, , 12, 1, Planned Pipeline Brent Crude Source: Pipeline & Gas Journal, EIA and CARE Ratings 6

7 As per Pipeline & Gas Journal, more than 13,km of oil & gas pipeline is expected to be laid over the next 2-3 years, presenting an opportunity of close to USD 3bn to the steel pipe manufacturers. Of the 134,866 km, 61,783km are in engineering and design construction phase whereas 73,84km are in the construction stage. Table 2 Pipelines Planned and Under Construction Region Length (km) Tonnage (mnt) Investments (USD bn) North America 51, South/Central America 7, Africa 6, Asia Pacific 31, Former Soviet Union 2, Middle East 14, Western Europe 2, Total 134, Source: Pipeline & Gas Journal and CARE Ratings North America, one of the largest consumers of Indian pipes is expected to lay down 51,2 km of pipeline involving 1.2mnt of steel pipes over the next 2-3 years providing investment opportunities worth USD11.3 bn. Apart from the above, in USA more than 1. mn km of large diameter pipelines have been laid prior to These pipes have outlived their economic lives of 3 years and due to few accidents, there has been a pressing need to replace these pipes. The replacement pipe demand in USA is pegged at USD275 bn. With steel pipes accounting for 4% of the demand pie, it provides steel pipe manufacturers with a business opportunity of more than USD11 bn over the next 15 years. The demand arising due to replacement of old pipes in USA is also expected to increase the opportunities for Indian players. While in the Asia Pacific region, close to 32, km of pipeline is expected to be laid involving 6.4 mn tonnes of steel pipes over the next 2-3 years, representing investments worth USD 7. bn. Investments worth USD3.3 bn in the pipe industry are expected in the Middle East. Being in close proximity to the Middle East, Indian companies have a competitive edge over Japan and Europe as they are able to save on freight costs. India being one of the largest manufacturers and a leading exporter of SAW pipes, its exports are directly influenced by the price movements of international crude oil prices albeit with a lag effect. 7

8 Rs Crore $/bbl Chart 7 India s welded pipe exports 8, 7, 6, 5, , 3, 2, 1, India's Exports Brent Crude Source: Ministry of Commerce, EIA and CARE Ratings 8

9 Domestic Scenario The Indian Pipe Industry is among the top three manufacturing hubs after Japan and Europe. However, the penetration level of pipelines in oil & gas transportation is quite low at 32% in India as compared to 59% in USA and 79% globally. The low penetration of pipes in the domestic market provides a huge business opportunity. The Indian line pipe industry is pegged at Rs.235 bn. Pipelines are the most economical mode of transport as compared to roads and rail. The capital cost of laying down a pipeline is Rs.4-5 crore/km whereas the operating cost is as low as Rs..5-.6/tonne/km. The Indian government is encouraging the use of pipes as this will reduce the costs of transportation and assist the Oil Marketing Companies (OMCs) like HPCL, BPCL, IOC etc. to trim their under recoveries and the government will save in the form of lesser subsidy outgo. In India as of January 217, more than 42, km of pipeline has been laid for transporting crude, petroleum products and gas. During recent years, the constitution of Petroleum and Natural Gas Regulatory Board (PNGRB), paving way for implementation of National Gas Grid and thrust on City Gas Distribution have provided a shot in the arm to the line pipe manufacturing industry. Table 3 Existing Oil & Gas Pipeline Network Product Length (km) Unit Capacity Crude Oil 1,215 mmtpa Petroleum Product 16,8 mmtpa 14.5 Gas 16,121 mmscmd Source: MoPNG Natural Gas and Water/Sanitation sectors are expected to be the next growth drivers for domestic line pipe companies. Natural Gas In lieu of the increasing demand the government is seeking to expand its existing gas pipeline network under the National Gas Grid project from 16,121 km to almost 3, km and the transmission capacity by 2.4 times from mmscmd to mmscmd over the next couple of years. The increase in gas demand is aided by demand from user industries such as power generation, city gas distribution and industrial requirements. As per PNGRB, the gas availability from domestic sources and imports is expected to increase at an annual growth rate of 7.2% to 474 mmscmd by FY3 whereas the realistic demand for Natural Gas is expected to increase at an annual growth of 6.83% to 746. mmscmd during the same period. Even as supply is expected to increase at a faster pace, it will still lag the total realistic demand thereby further widening the demand-supply gap. In order to address the 9

10 mmscmd supply shortfall, the government will have to 1) increase investments in the exploration activities and/or 2) increase imports through cross border pipelines. Both these options augur well for line pipe companies. Chart 8 Domestic Gas availability vis-à-vis demand FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY2 FY21 FY22 FY23 FY24 FY25 FY26 FY27 FY28 FY29 FY3 Deficit Realistic Demand Gas Availability Source: MoPNG and CARE Ratings Many domestic players such as GAIL, GSPC and IOC among others have undertaken expansion plans to increase their pipeline network. At present 12 projects with total length of 13,821km are under the planning stage, providing an opportunity to the Indian steel pipe manufacturers to supply more than 1.8 mnt of steel pipes worth more than Rs.11,5 crore. Table 4 Planned domestic pipeline projects Entity Length (km) Capacity (mmscmd) Tonnes Value (Rs Cr) GAIL (India) Ltd 1, , GAIL (India) Ltd , GAIL (India) Ltd 2, ,2 2,231 GAIL (India) Ltd 2, ,9 1,65 GSPC India Transco Ltd 2, ,588 2,24 GSPC India Gasnet Ltd 2, ,563 1,876 GSPC India Gasnet Ltd , AP Gas Distribution Co , Reliance Gas Pipelines Ltd ,2 23 Gas Transmission India Pvt. Ltd , Indian Oil Corporation Limited 1, ,813 1,13 H Energy Pvt. Ltd , Total 13, ,85,434 11,735 Source: MoPNG and CARE Ratings 1

11 Apart from the announced projects of 13,821 km, the government s Hydrocarbon Vision 23 for North East India entails setting up another 6,894 km of pipeline network, which is currently under the feasibility phase, with an investment of over Rs.8, crore. The government s total capital outlay for the midstream segment in North East India is pegged at Rs.2, crore, to be invested by 23. Water/Sanitation Sector With the government s increased thrust on improved water supply & sanitation infrastructure, the line pipe demand in India is expected to remain robust in the coming 3-5 years. The projects funded by the World Bank and Asian Development Banks are scheduled to be completed by 22. Table 5 Water/Sanitation projects World Bank Projects USD (mn) Shimla Water Supply and Sewerage Project 12 Assam Inland Water Transport Project 15 Uttarakhand Water Supply Program for Peri Urban Areas 15 Tamil Nadu Irrigated Agriculture Modernization Project 454 Rural Water Supply and Sanitation Project for Low Income States 5 Maharashtra Rural Water Supply and Sanitation Program 1,44 Water Sector Improvement Project 989 Total 3,785 Asian Development Bank Projects USD (mn) Orissa Integrated Irrigated Agriculture and Water Management Investment Program 66 Sustainable Coastal Protection and Management Investment Program 63 Assam Integrated Flood and River-bank Erosion Risk Management Investment Program 12 Integrated and Sustainable Water Resources Management Investment Program 48 Total 297 Source: World Bank, Asian Development Bank and CARE Ratings These projects are beneficial to the HSAW pipe players as these pipes are used in water distribution. 11

12 Thousand Tonnes Domestic Trends and Outlook Indian steel pipe production has grown at an average rate of 2.1% over the past five years to 2.6mnt in Declining investments in the oil & gas industry globally and increasing opportunities in the domestic sector led to increase in domestic consumption at a faster pace of 11.% over the same period to 2.1mnt. Chart 9 Production vis-à-vis Domestic Consumption 6, Steel Pipes 5, 4, 3, 2, 1, Production Domestic Consumption Source: CMIE and CARE Ratings CARE Ratings expects challenges to continue in the medium term on account of subdued order inflows and excess capacities by the domestic manufacturers. However, over the long term, the outlook of the industry is expected to remain stable as capacity utilisation levels of domestic SAW pipe players are expected to improve gradually driven by 1) Government s initiative to increase gas pipeline network, 2) Hydrocarbon Vision 23 for North East India and 3) Investments planned in the Middle East and North America. Furthermore, realisations are expected to improve in FY18 on the back of increase in steel prices during FY17. CORPORATE OFFICE: CARE Ratings Limited (Formerly known as Credit Analysis & Research Ltd) Corporate Office: 4th Floor, Godrej Coliseum, Somaiya Hospital Road, Off Eastern Express Highway, Sion (East), Mumbai ; CIN: L6719MH1993PLC71691 Tel: I Fax: care@careratings.com I Website: Follow us on /company/care Ratings /company/care Ratings 12