A consultation paper floated by ministry of petroleum and natural gas [MPNG] for stakeholders comments has proposed granting freedom of pricing and marketing to producers of natural gas. This has led exploration and production [E&P] companies to believe that this will enable them to get much higher price than what they are getting under the present dispensation of administered pricing.
Ever since a high power committee under Dr C Rangarajan submitted its report in December, 2012 [based on the formula recommended by it, price of domestic gas was US$ 8.4 per mBtu], E&P companies have been clamouring for market-based pricing. But, Modi – government which took charge in May, 2014 neither accepted Rangarajan formula nor their demand for market determined price.
Under guidelines notified in October, 2014, it fixed price of all domestic gas based on weighted average of gas prices prevailing in key international locations viz., Henry Hub [USA], NBP [National Balancing Point] [UK], Alberta Gas Reference [AGR] [Canada] and Russia. Fixed at US$ 5.61 per mBtu from November 1, 2014, the price was reduced to US$ 5.18 per mBtu from April 1, 2015 and further to US$ 4.24 per mBtu from October 1, 2015.
E&P companies have been uncomfortable with this formula and resultant low price which they contend, is unattractive. In this backdrop, MPNG proposal has come as a shot in the arm prompting them to contemplate massive investment [about US$ 50-60 billion]. But, hold on; this is just a view of oil & gas ministry and all ministries need to be on the same page before the cabinet could take it up for approval. In this regard, it is important to look at the stance taken by ministry of finance [MOF].
About six months back, in a bid to incentivize exploration and development of challenging fields viz., deep water & ultra-deep water etc, MPNG had proposed that operators be allowed market-based pricing for a certain percentage of production from these fields. The share eligible for market determined price could vary from 20-50% depending on degree of toughness of concerned field. But, the proposal was shot down by MOF.
Even now, the MOF sticks to the stance it had taken then. It is therefore unlikely that it will allow freedom of pricing for all of gas from existing fields and those to be allotted under 10th NELP [new exploration and licensing policy]. So, what reasons it has given for rejecting the idea?
First, at present the market for gas is ‘nascent’. The supply is much too less vis-a-vis the demand. The shortfall in indigenous availability is exacerbated by inadequate development of infrastructure for transporting gas. This also limits the ability to move imported gas to points of consumption. In such a scenario, leaving producers free to charge a market based price will lead to a sharp hike.
Second, fertilizers and power, two major users of gas [together, they account for about 75% of total consumption] have their output prices under control. The maximum retail price [MRP] of urea where bulk of gas allocated to fertilizers is consumed, is under statutory control even as central government fixes it a low level unrelated to cost being much higher. In power even though, there is no statutory control on tariff, a major portion of units generated is sold to households and farmers at low tariff to make it affordable to them.
In this backdrop, until such time output prices of these industries are freed [unlikely in foreseeable future in view of low income of farmers/households and sensitivities associated with any such decision], removing control on price of gas will have grave implications. In fertilizers, while this will increase subsidy payments, in power, the government will be forced to compensate for resultant losses of state electricity boards [SEBs] via sanctioning bail-out packages [as in 2002, 2012 and now 2015].
Third, even if an increase in gas price is allowed, there is no guarantee that this will lead to higher investment in exploration and development of oil & gas fields and even more crucially, whether more gas will flow there from. What happened to high profile KG-DWN-98/3 [also known as KG-D6] field operated by Reliance Industries Limited [RIL] in Krishna-Godavari basin off Andhra coast amply confirms this doubt.
For gas from KG-D6, the then UPA-government had allowed a price of US$ 4.2 per mBtu which was much higher than even the price of US$ 2.34 per mBtu determined under competitive bidding in 2004 under a tender floated by National Thermal Power Corporation [NTPC]. Yet, production [commenced in 2009] after reaching a peak of 60 mmscmd in 2010 declined sharply thereafter and is currently hovering around 10 mmscmd. This is a fraction of the committed output of 80 mmscmd – as per field development plan [FDP] approved in 2006.
ONGC which had discovered a field KG-DWN-98/2 adjacent to RIL’s KG-D6 around the same time did not take steps to develop it for more than a decade. At present, the field is under development and company hopes to commission it by 2018. However, in view of ONGC’s allegation that RIL had stolen about 12 billion cubic metre of gas from KG-DWN-98/2, its ability to deliver the desired output is doubtful. As in case of KG-D6, investment and production worries cannot be attributed to price.
The aforementioned three reasons advanced by MOF for not agreeing to freedom of pricing are perfectly logical. These were on government’s radar last year when it decided to continue with administered pricing [determination of price and its revision based on a transparent formula] ignoring intense lobbying for market-based price. Since then, there has been no change in underlying fundamentals to warrant switch-over to pricing freedom.
In view of above, if E&P companies are basing their plans on freedom of pricing and marketing alone, the impression is mis-placed as this is simply not going to come. Yet, there are other features in the policy that provide sufficiently strong incentive.
First, it marks a shift from extant profit-sharing to revenue-sharing model. Under it, bids will have to specify the share of revenue government will receive from oil and gas blocks being sold depending on stage of production and overall fuel market scenario. Second, there will be a shift to “open acreage” in which companies can bid for blocks that they wish to explore, and then it is up to the regulator to “authenticate” the geological data. Third, it permits “uniform licensing” that allows companies to explore various hydrocarbons in the blocks they win at the auction – methane, shale gas etc.
Under extant profit-sharing model, companies would bid by quoting minimum work program they would undertake; they would first recover their investment and only thereafter, begin sharing profit with government. While, making them completely immune from risk associated with investment, this also gave rise to the possibility of inflating or “gold plating” cost in order to reduce the pay out to government. This also led to excessive government intervention, opportunities for quid pro quo and corruption.
The dispensation was a loosing proposition for all stakeholders. While, companies would spend their energies on managing bureaucrats to get FDPs and costs approved, government was uncertain as to when it would start getting its share of profits from investment in fields and for how long. Even worse, it led to an uncertain and un-predictable policy environment under which companies were unable to take investment decisions.
The revenue sharing model eliminates scope for government intervention, reduces interface with bureaucracy, eliminates delays and catapults the operator in a commanding position. The company can remain focused wholly on taking all necessary steps to optimize production without having to worry as to whether any activity and associated cost would be recognized or not. This will assure government of its share of profit from day one of commencing production. Above all, it provides a certain and stable policy environment.
Under the “open acreage” policy, companies will have much needed flexibility to decide which blocks they would intend to work on unlike extant dispensation wherein government decides the menu. A uniform licensing regime is an added sweetener enabling operator to diversify sources of revenue augmentation without having to go to ministries for fresh approvals [currently, different hydrocarbons are governed by different policy regimes and some areas like shale gas for instance, are reserved only for public sector undertakings].
In short, the policy regime offered by MPNG is attractive even without freedom of pricing and marketing. This should enthuse investors as it unshackles them from all sorts of controls/approvals and gives them opportunity to maximize production which holds the key to making good profits even while keeping gas price at level affordable to major users like fertilizers and power.