One-and-a-half decade ago, Reliance Industries Limited [RIL] had created history by announcing the biggest ever gas discovery in Krishna Godavari [KG] basin off the Andhra Pradesh coast with an estimated in-place reserve of 12 trillion cubic feet [tcf]. It started producing from its most prolific bloc KG-DWN-98/3 in 2009 with a promise to deliver 80 million standard cubic meter per day [mmscmd]. After reaching 69 mmscmd in March 2010, production started declining and the trend never got reversed. Currently, it produces only 7 mmscmd which is not even 1/10th of the promised quantity.
The precipitous decline in production has remained shrouded in mystery even as the operator is entangled in four arbitration cases with Union Government over various aspects of the issue viz. cost recovery, shortfall in production, pricing etc. Meanwhile, RIL lost interest in development of other blocs citing among others lack of an attractive pricing policy for natural gas.
After a hiatus of over 4 years, RIL along with its foreign partner BP plc [UK] – in 2011, latter had acquired 30% stake in KG-DWN-98/3 and twenty other blocs operated by former for an investment of about US$ 7 billion – has now announced an investment of Rs 40,000 crores for development of R-Series, Satellites and D-55 discoveries in the area besides NEC 25 off Odisha coast. What has prompted this resurrection of interest?
The heads of RIL-BP duo viz. Mukesh Ambani and Bob Dudley, highlight two factors. First, they believe that Modi – government will introduce free market pricing for natural gas. Second, for gas produced from deep/ultra-deep, high-pressure/high-temperature fields [those in KG basin fall in this category], from March, 2016, it had allowed ‘premium’ pricing linked to prices of alternate fuels – against normal price bench-marked to gas price at 4 international locations as per formula effective November 1, 2014.
As regards, free market based pricing, the system in place should satisfy two fundamental requirements viz. (i) there should no government intervention; (ii) price determination should be the outcome of interaction between suppliers and buyers but in a competitive framework. The extant dispensation satisfies both.
By putting in place formula based pricing, team Modi has completely eliminated scope for any government intervention. Using a ‘clear-cut’ and ‘transparent’ formula, the exploration and production [E&P] companies can themselves calculate the applicable price. They can also make a reasonable assessment of what would be the likely price in future and accordingly dovetail their investment decisions. In short, the extant dispensation offers a ‘stable’ policy environment free from bureaucratic and political encumbrances.
The second requirement is also fully complied as prices at global hubs – to which Indian price is bench-marked – are determined by free inter-play of demand and supply forces. At those international locations viz. Henry Hub [USA], National Balancing Point [UK], Alberta Gas Reference [AGR] [Canada] and Russia, numerous transactions take place giving ample opportunity to both buyers and suppliers to find the right price under a competitive environment.
However, the price determination could not have been left to inter-play of market forces within the territory of India as we have an imperfect market here. The domestic supply being substantially short of demand, this leads to a monopolistic situation and arriving at the price even by floating bids would throw up an exploitative price. Hence, this will not be fair; that is why this was rejected by a committee of secretaries [CoS] whose recommendations formed the basis for pricing guidelines effective from November 1, 2014.
There is good reason for RIL-BP to be enthused by ‘premium’ pricing allowed for deep/ultra deep, HP/HT or in short geologically difficult areas. Currently, this price works out to more than double the normal price US$ 2.75 per million British thermal unit [mBtu]. But, the key question is: was it at all necessary to allow premium price?
True, because of greater depth and difficult geological terrains, higher capital expenditure is needed in exploration and development. But, then such fields also yield substantially higher quantity of gas vis-à-vis shallow areas. That more than pays for higher investment even with same price. Let us illustrate this with R-series [or D-34] for which field development plan [FDP] was approved in August 2013.
The duo has proposed to invest about US$ 3 billion on developing these fields and produce about 15 mmscmd for a period of 13 years. Let us do a calculation with US$ 2.75 per mBtu [though this gas will be entitled to premium price]. 4 mBtu make up 1 million Kilo calories [mKcl]. So, per mKcl, the price is US$ 11 [2.75×4] or Rs 715 [Rs 65 to a dollar]. Further, 1 cubic meter has 10,000 Kcl or 1/100th of mKcl; hence, its value is Rs 7.15 [715/100].
On production of 15 mmscmd, it will be generating revenue of Rs 107 million. Annualized, this will be Rs 39055 million or 3905 crores. Over a period of 13 years, cash generation will be Rs 50,765 crores. Compare this with an investment of around Rs 20,000 crores [corresponding to US$ 3 billion]. After meeting running expenses, the company will have a huge surplus left. With premium price US$ 5.5 per mBtu, revenue will be a whopping over Rs 100,000 crores!
If, however, the operator is unable to achieve committed production or does just a fraction of it [as happened with KG-D6] then, any level of price howsoever high cannot make the field viable. It would be preposterous to blame it on the price. It is equally absurd to use it as an argument for seeking higher price.
Clearly, the government had erred in allowing premium price via March, 2016 guidelines. This is because it will give E&P companies super-normal profit at the cost of user industries – mainly fertilizers and power who cater to majority of the poor. On the other hand, the pricing formula as per November, 2014 guidelines is fair to the latter while being sufficiently attractive to former.
Modi – dispensation will do well to take a re-look.