India is deficient in energy resources [albeit conventional] especially oil and gas. Whereas, 80% of our oil requirement is imported, in case of natural gas, the import dependence is about 35%. The latter is a ‘clean’ fuel and ‘environment friendly’. It is therefore natural that in the overall energy mix, the government is laying greater emphasis on use of gas more so in fertilizer and power plants.
Fertilizers and power together consume nearly 75% of the total gas consumption. These sectors also cater primarily to the requirements of vulnerable groups. Fertilizers supply essential plant nutrients to some 120 million farmers households more than 80% of whom are small and marginal or poor in short. Power too is used by farmers besides millions of households who are poor.
Therefore, these have to be so priced as to make them affordable to farmers and poor households. To ensure this, union government gives subsidy routed through fertilizers manufacturers. In case of power, states indirectly foot the bill by supporting losses that power distribution companies [PDCs] suffer on supplies at low tariff.
The best way to achieve the objective is to ensure that the price of natural gas [NG] – feed/fuel in making of fertilizers and power – is kept low. The domestic gas is governed by a formula based pricing dispensation [since November 1, 2014] that uses prices at 4 international hubs as benchmark [a higher price is allowed for geologically difficult deep water/high pressure fields as an incentive, but such fields being in development stage are yet to start supplies]. This has ensured that price is reasonable currently at US$ 2.75 per million million British thermal unit [mBtu].
But, domestic supplies meet only 65% of total requirement. For balance 35% sourced from import as liquefied natural gas [LNG], even as there was dire need to bring it at lowest possible price, various long-term contract signed during the past – mostly during the first decade of 2000s – have led to highest possible price.
Petronet – a private company in which Gas Authority of India Limited [GAIL], Indian Oil Corporation Limited [IOCL], Bharat Petroleum Corporation Limited [BPCL] and Oil and Natural Gas Corporation [ONGC] hold 12.5 per cent each – had entered in to a long-term 25 year contract with RasGas of Qatar for import of 7.5 million tonnes a year LNG or around 30 million standard cubic metre per day (mmscmd). A ‘take-or-pay’ clause was built into the agreement.
Initially, in an open tender floated by Petronet, RasGas had won a firm bid that would have translated to a floor or minimum price of $3 per mBtu and a cap or maximum price of $4 per mBtu for supply of 30 mmscmd over the 25-year period. Yet, the price bid was re-negotiated exclusively with RasGas without approaching the competing bidder [Petronas, Malaysia].
Under a unique formulation – unheard of in long-term contracts globally – the price was fixed at mid-point of quoted floor and cap for first five years; followed by an annual increase equal to 33 per cent of originally bid cap, for each of the next five years. For balance 15 years, price was linked directly to the average price of crude in immediately preceding five years without any floor or cap.
On this formula, in 2015, when price of gas in the spot market was on the downswing [having declined to US$ 6.5-7 per mBtu in November], Petronet LNG would have to pay US$ 13 per mBtu. Back of the envelope calculations show that for every extra US$ 1 per mBtu, import of around 30 mmscmd [quantity under the contract] lead to excess payment of US$ 438 million per annum. On excess of $ 6.5 per mBtu, this would be $ 2.85 billion annually. When compared to $ 3.5 per mBtu [mid-point of floor and cap in firm bid offered by RasGas], the excess price of $ 9.5 per mBtu would imply still higher excess payment of $ 4.16 billion or Rs 27,000 crore per annum.
Modi – dispensation got this contract re-opened and persuaded Qatar government to modify the pricing formula to link it with immediately preceding 3-month average price of Brent crude oil thereby bringing down the LNG price closer to its spot rate.
In August 2009, Petronet LNG had signed a 20-year deal with Exxon Mobil to buy from latter’s Australia’s Gorgon project 1.44 million tonnes per annum of LNG [6 mmscmd] at a price equivalent to 14.5 per cent of ruling crude rates. This translates into US$ 14.5 per mBtu at $ 100 per barrel oil price. After adding shipping cost, 5 per cent import duty and cost of re-gasification, this gas will cost close to $ 17 per mBtu at Kochi port. Even at oil price of US$ 50 per barrel [current price], the landed cost would be US$ 9.5 per mBtu. Compared to spot rate, this would lead to excess payments of over US$ 263 million or Rs 1700 crores annually.
GAIL had entered into a contract with Cheniere Energy [2011] to buy 5.8 million tonnes of US LNG per annum [23 mmscmd] for 20 years. The payment terms were (i) yearly fixed fees of US$ 548 million; (ii) price of US$ 3 per mBtu plus 115 per cent of final settlement price for the New York Mercantile Exchange [NYME] Henry Hub natural gas futures contract for the month in which the relevant cargo is scheduled and (iii) 15 per cent of the fixed portion of the contract sales price to be subject to annual adjustment for inflation. All put together, the landed cost of this LNG works out to US$ 9.7 per mBtu. Compared with spot price, this would imply excess payment of about US$ 1.1 billion or Rs 7000 crores annually.
Unlike the contract with RasGas [Qatar] wherein Team Modi succeeded in getting the terms reset saving thousands of crores annually, negotiations with Exxon Mobil/Cheniere Energy to seek relaxation has not yielded results thus far. The latter are citing ‘take-or-pay’ clause to deny the benefit of reduction in international price.
While, efforts to re-negotiate with these companies must continue, for the future, all contracts should be done keeping ‘India first’ at the back of the mind which Modi is committed to. The government should also do away with existing system of giving subsidy through manufacturers/PDCs which acts as a cover for irregularities and resulting excess payments.
Instead, subsidy should be given directly to beneficiaries. This will push gas procurers [Petronet LNG/GAIL etc] to secure lowest possible price in turn, helping India via lowering subsidy payments and reduced price of fertilizers and power tariff.