Privatization: Who will run Istanbul’s gas grid?

The coming tender to privatize the distribution of Istanbul’s gas to its 5.1 million customers should not be seen as a simple commercial transaction of “whoever pays the most in the bidding round will win the contract.”

It is rather strategic for many reasons affecting Turkey’s energy security, investment climate, environmental quality and trading ties.

Most of all, it is strategic due to the magnitude of Istanbul, one of the world’s largest cities. Any breakdown in the gas supply, infrastructure, distribution or operation would cause potentially immense consequences for the entire country.

Indeed, the Istanbul Gas Distribution Company (İGDAŞ) is currently the largest natural gas distribution company in Turkey. It sold 5 billion cubic meters of natural gas, had revenue of 4.6 billion Turkish Liras (about 1.65 billion euros) and posted a net income of 279 million liras in 2013.

İGDAŞ is undoubtedly a prestigious and strategic asset both nationally and globally. Thus, it is expected to generate high interest from major local and international investors, despite the fact it comes at a time when investment levels are declining globally and geopolitical tension in gas producing countries and regions is on the rise. 

According to media reports, expressions of interest have already been received from Gazprom and Marubani Corp, as well as Turkish companies including EgeGaz, Enerya and Aygaz. There may also be other bidders stepping in once the tender specifications are published.

An uninterrupted and reasonably priced gas supply is a prerequisite for the success of İGDAŞ’s future owner because it currently consumes more than 12 percent of Turkey’s total gas demand. The significance of consumption rates will attract those upstream suppliers who aspire to be part of this attractive downstream business.

Gazprom’s chances to win the tender may not be so high, given Turkey’s already excessive dependence on Russia’s gas, nuclear, oil and coal supply. SOCAR, another major gas supplier, announced that it would not bid for this tender, but it might change its mind in the course of how things evolve.

As for local partners, they will be hungry for financial back-up. Considering the immediate cash generation prospects of a mature and expanding business involving 14.2 million people, I would not be surprised if strategic financial investors, such as pension funds and sovereign wealth funds, take a keen interest in this tender.

Turks have a more or less good track-record in privatizing their city gas distribution assets, the latest one being Başkent Gas in Ankara, which served 1.3 million customers in 2013. The Ankara privatization tender attracted China’s ENN Group, which controls gas distribution in more than a hundred Chinese cities, a Saudi Arabian-based investment fund and local groups such as Akfen, Aksa, Kolin-Cengiz-Limak, Aygaz, STFA, Torunlar and Global Yatırım. The Torunlar Group ultimately won the tender for $1.1 billion.

Although a similar path may be pursued, Istanbul could also be different in some respects. It is the largest city in Turkey, serving as the business and cultural heart of the country. It is also one of the largest agglomerations in Europe and the fifth-largest city in the world in terms of population within its city limits. It is growing bigger every passing year and gas demand will be accordingly on the rise during the coming decades.

Normally, green field city gas distribution projects are exposed to high execution risks because of the long construction period involved, the extensive approvals required and the state support needed in terms of land allocation and scaling up of sales. However, İGDAŞ offers a mature, completed and functioning asset ready to generate cash from day one.  

On top of that, the privatization process may not take too long and can be speedily completed for two reasons. First, the government needs fresh cash to be injected into its Treasury coffers for relief before the parliamentary elections due in May 2015. Second, there are sufficient benchmarks of privatization to learn from. İGDAŞ was slated for privatization back in 2012 and lots of work has already been done to pave the way for a smooth process.

Citigroup and Burgan Yatırım have been retained to advise on the privatization of the gas grid. Together with the Privatization Administration, they are finalizing preparations for İGDAŞ’s tender announcement soon. Separating the Asian and European distribution activities is also an option under consideration. The price has not yet been announced, but if Başkent Gas’ final value is any guidance, İGDAŞ’s price tag could be above the $5 billion mark.

Furthermore, the draft of the Natural Gas Market Law, still under review by a parliamentary commission, includes provisions and exemptions intended to increase bidders’ appetites. Accordingly, usage and transportation fees will be fixed at the lira equivalent of $0.062378/m3 and $0.001480/m3, respectively, for 10 years. Investors will, therefore, enjoy decade-long predictability and protection against currency fluctuations.

On an absolute basis, natural gas will see the biggest growth of any energy resource over the next decade. Whether that benefits natural gas producers or consumers will depend on the price of gas. Whoever wins the İGDAŞ tender will no doubt touch on the lives of Istanbulites, and be viewed as a global strategic gas player or, if already so, enhance its competitive position significantly.