On March 10, 2016, the cabinet committee on economic affairs [CCEA] approved a policy to incentivize gas production from deep water, ultra-deep water and high-pressure-high-temperature areas. For such areas, which are yet to commence commercial production as on January 1, 2016 and for all future discoveries in such areas, the producers will be allowed marketing freedom including pricing freedom. This would be subject to a ceiling price based landed price of alternative fuels.
The ceiling price will be determined as the lowest of the (i) landed price of imported fuel oil [FO]; (ii) landed price of imported LNG [liquefied natural gas] and (iii) weighted average imported landed price of substitute fuels viz., coal, FO and naphtha with weights of 30%, 40% and 30% respectively.
The prices will be taken as those prevailing in the preceding year, a quarter [Qr] prior to commencement of relevant [albeit 6 month] pricing period. For instance, if such area commences commercial production from April 1, 2018, the prices of fuels will be for January 1 – December 31, 2017. The ceiling gas price thus determined will be applicable to April 1 – September 30, 2018.
This meets a long-pending demand of gas producers ever since October, 2014 guidelines to fix price of all domestic gas based on weighted average of gas prices prevailing in 4 international locations were notified. The government hopes that this will resuscitate 28 discoveries with gas deposits of 6.7 trillion cubic ft [tcf] worth over Rs 180,000 crores to yield 35 million standard cubic meter per day [mmscmd] of gas for 15 years.
The sole basis of this optimism is that producers will be free to sell to users of their choice [under the extant dispensation, all gas supplies are allocated by an inter-ministerial committee] and price as they deem fit but within the cap. The cap by itself gives sufficient leeway. On the basis of prevailing prices of fuels, the above methodology yields about US$ 7 per million British thermal unit [mBtu] as against current price of US$ 3.82 per mBtu.
The next revision of current price is due on April 1, 2016 when it will further reduce to about US$ 3.0 per mBtu. Therefore, the maximum price that producers can charge for deep water/ultra-deep water fields will be more than 100% vis-a-vis current level. US$ 7 per mBtu is when crude has plummeted to a low of US$ 30 per barrel. 2-3 years from now, crude price will only go up and other fuels viz., FO, naphtha etc will increase in tandem.
Therefore, gas producers can look forward to a ceiling price much higher than US$ 7 per mBtu by the time their fields start churning out gas. True, this has put them in an exhilaration mode. But, they need to pause and objectively think through the demand side. Their happiness will be meaningless if users are unable to pay this price.
Fertilizers and power alone consume over 75% of the total gas and this position is not going to change even over a long time horizon. These are used by millions of poor farmers and households and to make them affordable, the government controls their price at low level unrelated to cost of production/generation and distribution which is much higher. The difference is subsidized.
The maximum retail price [MRP] of urea where gas use is over 50% of domestic output is currently at Rs 5360 per ton; only last year CCEA decided to freeze price at this level for 4 years. This price does not cover production cost even at current low gas price of US$ 3.82 per mBtu leading to high subsidy on domestic urea [Rs 38,000 crores in 2015-16]. What would happen if urea manufacturers are made to pay US$ 7 per mBtu or even higher?
Will the government keep on increasing subsidy payments? It cannot do this either because it has vowed to stick to fiscal
consolidation road map. CCEA has argued that ceiling is fixed to protect user industries from what it calls ‘market imperfections’ or in simple terms exploitation by producers. Yet, by fixing ceiling at high level [by benchmarking to un-related fuels such as naphtha and FO], it seeks to legitimize exploitation.
Clearly, what appears to be an attractive policy environment is inherently un-sustainable. It is heavily tilted in favour of producers paying no attention whatsoever to interest of users. A comparison with human beings will bring out the fallacy. A healthy body is one where both legs are equally strong. If one is weak, the other cannot stay fit for long!
This brings us to a fundamental question. Why do producers need higher price for deep water/ultra-deep water fields? Their argument is that investment in surveys, exploration, drilling, laying pipelines etc is high [this itself is weakened as under current global slump, their cost have declined drastically]. But, they have much higher reserves than found in shallow water or on-shore. The resultant extra revenue should more than offset higher capital spend.
The proof of pudding is in eating. When, the initial development plan [IDP] of high profile KG-DWN-98/3 [better known as KG-D6] was approved in 2006, its recoverable reserves [RR] was estimated at 10-11 tcf. On this basis, the operator Reliance Industries [RIL] promised production @80 mmscmd. But, in 2012, RR were lowered to 1.9 tcf. Currently, production is a measly 10 mmscmd and the field go dry within 2 years.
RIL spent about US$ 6-7 billion in exploration and development of above field [that may include ‘gold plating’ – a euphemism for inflating cost – as pointed out by CAG]. It has already recovered the entire cost and shared with government profit under PSC [production sharing contract] despite reserves/production being a fraction of initial estimate and at extant price of US$ 4.2 per mBtu [much lower than what they will get under new formula].
Clearly, it is the reserve and production which holds the key. If, producers do a proper job on this front, then even with low price they can generate a handsome revenue stream. On the other hand, if this aspect is not managed [or mis-managed] then, any price level howsoever high will be inadequate.
The oil & gas companies need to do some introspection and government should re-consider its decision. After all, all along since October, 2014 finance ministry had opposed the hike on the basis that this would hurt fertilizers and power. Nothing has changed since to warrant a complete reversal of its stance.