Mandiri Sekuritas PGAS - Supply cut : prelude to price hike and lobby to obtain new supply

In a continuing momentum, the story on domestic gas shortage moved to the next level with PGAS planning to cut 20% of its supply to industries in West Java as a result of contract termination with Pertamina ONWJ. Our channel check indicates a willingness on the part of the buyers for a price hike provided PGAS can guarantee the supply. As it’s becoming the main headline in business newspapers today, the story is also in our view a campaign to pressure BPMIGAS to! decide t he use of Subhan III, Conoco Phillips, which currently is uncertain due to indecision of its usage (for Singapore or domestic). Both bode well for PGAS to reason with its customers for a price increase. Our 2010 assumptions have incorporated a 5% p.a. increase in price starting from 2010, with input price increase of 9% and 11% for 2011 and 2012, respectively and flat for the following years. We remain a Buyer on PGAS with Rp4,350 target price. At our TP, PGAS will be trading at 18.4x PER 2010F and 19.0x PER 2011F.

Supply cut. PGAS announced to its clients a 20% cut in supply and an increase in surcharge for additional gas from agreed amount from 50% to 100% starting April 2010. The supply cut is needed as PGAS terminated its 30-MMSCFD supply contract with Pertamina ONWJ priced around US$4/MMBTU. Today, BP Migas official hinted that 50 MMSCFD new supplies from Medco (priced around US$4.5/MMBTU) will fill in the gap. Our channel checked indicated buyers willingness to pay higher tariff as the alternative is much higher (PLN mentioned it costs them US$16/MMBTU for diesel fuel). We believe this will! help cre ate a better acceptance for a tariff hike.

A pressure for government. PGAS is currently eyeing 200 MMSCFD supply from Conoco Phillips Suban III. Government through BPMIGAS is still undecided whether to sell the gas to Singapore or to the domestic market. As Singapore price is indexed to crude oil (and currently could achieve US$7/MMBTU), the Government could obtain better revenue than selling it domestically, albeit there are multiplier effects worth consider! ing. We believe the decision could be achieved half way, meaning for PGAS to buy it, it has to raise the selling price. At US$7/MMBTU well-head price, price in Java could reach US$9-10/MMBTU, higher than average US$5.5/MMBTU today. Again another reason to have a tariff hike.

What promise PGAS will bring to the negotiation table. It would be much elegant if PGAS can have a government assurance for additional supply before PGAS could exercise its tariff increase. However, without that, we can still expect an increase. PLN, judging from comments by its CEO, seems to accept a possibility of gas price up to US$9/MMBTU.