In August, 2014, Modi – government had set up an inter-ministerial committee of secretaries (CoS) under chairmanship of secretary, ministry of petroleum and natural gas (MPNG) to recommend a new structure of pricing domestic gas. The committee submitted its report on September 16, 2014
Guidelines for pricing domestic gas
Based on its recommendations, on October 18, 2014, cabinet committee on economic affairs (CCEA) approved guidelines for pricing of all domestic gas [except supplies from fields awarded prior to NELP (new exploration licensing policy) where PSC (production sharing contract) did not provide for approval of price by government] based on ‘modified’ Rangarajan formula.
Nicknamed after Dr C Rangarajan, chairman, economic advisory council to prime minister [he headed a committee on gas pricing which submitted its report in December, 2012], the formula takes average prices of global benchmark at Henry Hub (USA) and NBP (national balancing point), UK on one hand and producers net-back from supplies of liquefied natural gas (LNG) to India and Japan in preceding 6 months on the other.
In the aforementioned formula, Modi – government substituted LNG price of gas supplied to Japan and price of LNG imports by India by Alberta Gas Reference (AGR) price for consumption in Canada and actual price in Russia weighed by consumption in Russia respectively. The guidelines effective from November 1, 2014, provided for revisions bi-annually (once in 6 months) based on movement in these indices.
For deep/ultra-deep water blocks and those fields with gas at high temperature and pressure, the government threw a hint that it may consider allowing a ‘premium’ price. This was done ostensibly to take care of higher expenses in exploration and production (E&P) from these areas riddled with difficult geological and physical environments.
As a follow up, the government held consultations with stakeholders including E&P companies and representatives of user industries to collect views on manner of determining the premium price and lay down criteria for the same. This exercise has now been completed and MPNG has already circulated a note for inter-ministerial consultations.
Oil & gas ministry’s proposal for ‘premium’ pricing
Reportedly, the ministry has mooted that a certain percentage of gas viz., 20-50% produced from such fields be sold at market determined price. The fields will be categorized in to 5 groups based on difficulty parameters. The least difficult field will be allowed to sell 20% of production at market-determined price whereas for most onerous ones, percentage share will be 50%. The market price will be determined vide auction. The benefit of premium price will be restricted to fields discovered after November, 2015.
Adoption of this proposal will lead to a bizarre situation characterized by multiplicity of prices depending on how difficult the field. The ‘difficulty parameter’ is a vague and ambiguous term susceptible to multiple interpretations and one could come up with dozens of configurations involving varying intensity of several factors viz., ‘geology’, ‘physical environment’, ‘temperature’, ‘pressure’ to name a few.
In the past, there were multitude of prices depending on source of supply viz., from fields given to ONGC and OIL on ‘nomination’ basis; fields awarded under NELP and those under pre-NELP dispensation to private operators or their joint ventures [JVs] with state owned companies like ONGC. The basic price of gas [excluding royalty and taxes & duties] varied from less than US$ 2 per million Btu [British thermal unit] for supplies from ONGC/OIL to a high of over US$ 7 per mBtu applicable on supplies from JVs.
Such a messy price structure gave wrong signals to stakeholders. While, individual customers vied with each other to get hooked to supplies from ONGC/OIL at throw away price, producers especially private companies had a vested interest in looking for buyers willing to pay high prices. The overall short supply of gas [at present, there is deficit of about 100 million standard cubic meter per day (mmscmd)] exacerbated these aberrations.
To make matters worse, there existed a Gas Linkage Committee (GLC) headed by secretary, MPNG which decides which sector viz., power, fertilizers, petrochemicals, sponge iron, CNG etc will get how much and even within each sector which company will get how much. Given widely varying prices, this was surest invitation to ‘crony capitalism’ that has taken a serious toll of economy during a decade of UPA – dispensation!
Differential pricing for deep/ultra-deep water fields – a retrograde step
The gas pricing policy notified in October 2014 sought to address above anomalies by putting in place a uniform pricing structure for gas. The government not only applied the same price to supplies from ONGC/OIL and fields awarded under NELP [for pre-NELP fields too where PSC required approval of price by government] but also to coal bed methane (CBM), a new avenue that is being tapped now to tide over gas shortage.
In this backdrop, any attempt now to create a differentiated price structure depending on characteristics of the field will set the clock back nullifying much of gains that flow from new pricing policy. Even worse, this will give greater leverage to bureaucrat in deciding various parameters and in turn, prices applicable to various fields. This will be completely out of sync with prime minister’s over-arching philosophy of a “policy-driven” state.
This will also disturb the level playing field even as ministry fixes November, 2015 as cut-off point for deciding the eligibility of premium pricing. For instance, KG-DWN/2 operated by ONGC is a deep water block discovered over a decade ago and is being developed now. Under the criteria, this will be disqualified. Strangely, RIL/BP/Niko are demanding that the benefit of premium pricing methodology be given in respect of all fields discovered before November, 2014. In other words, they want to avail of this benefit even for KG-DWN/3 discovered in 2002 for which they have already recovered all expenses on exploration and development. It will open up a Pandora box with a host of other companies staking their claim leading to utter chaos.
It will put avoidable burden on fertilizers & power
The government must not be oblivious of user’s interest. After all, all the rigmarole about giving incentive to E&P companies to produce more is to meet the growing demand from them. Nearly 75% of gas consumption is by fertilizers and power. Given the rapidly growing demand in these two critical sectors, this equation is not going to change. A big slice of incremental supply from the so called challenging fields will have to be given to these industries who [given their criticality in the economy] cannot afford to meet the high price expectations of E&P companies.
MPNG proposal says ‘market price will be determined vide auction’. Because of huge demand-supply gap and extremely tight situation projected for a minimum of decade, this provision will be of little help as suppliers will get away with exploitative price leaving users in the lurch. In fertilizers, government will be saddled with ever increasing subsidy burden. If in the meanwhile, it goes for direct cash transfer to farmers [this will inevitably happen in the medium-term of 3-5 years], millions of small & marginal farmers will be directly exposed to such vulnerabilities.
Premium pricing is a ‘flawed’ concept
The concept of premium pricing is flawed. For gas pricing, there can only be 3 rational approaches viz., (i) marked based pricing; (ii) formula based pricing and (iii) pricing based on production cost. It will be illogical and imprudent to go for a hybrid carved out of these three. If, government feels every field is unique and pricing should reflect such heterogeneity then it may go for cost of production approach and apply to all sources of gas. But, that is an outdated approach and completely out of tune with changing times.
Alternatively, it may leave pricing of all gas to market forces. But, that is a risky proposition especially at this juncture when India faces a heavy shortage and leaving things entirely to market could be seriously detrimental particularly to critical sectors like fertilizers and power. On the other hand, formula based pricing with benchmark indexes from countries viz., USA, UK, Russia and Canada [where markets for gas are well developed and prices are determined in a competitive manner] will be an ideal choice.
That is why in October, 2014, the government opted for this approach. It should stick to this for all sources of supply irrespective of the vintage and characteristics of the fields. It provides a viable and sustainable basis for attracting investment in exploration and production [including the deep/ultra-deep water fields] besides ensuring optimum utilization of already discovered fields for maximizing production.
Government must avoid falling in to a ‘trap’
The government should refrain from premium pricing albeit for even 20-50% of production as by doing so, it will only be falling in to the trap of E&P companies. Earlier, they wanted a price of their choice on entire production using a flawed formula [read Rangarajan formula] and even forced the erstwhile UPA – regime to crawl [on January 10, 2014, latter had even approved doubling of price; unfortunately for them, elections came in the way and its implementation was deferred]. They tried with Modi – dispensation but did not succeed.
Now, these companies are coming through a different route but the objective continues to be to extract an un-justifiably high price. Their argument since field is deep or ultra-deep hence it will entail higher cost is untenable. What they are not saying is that for a challenging field “the output is also many times more”. For instance, KG-DWN/3 [commonly known as KG-D6] is a deep water stuff and production at committed rate of 80 mmscmd even @ US$ 4.2 per mBtu [applicable price when it commenced production in 2009] would recover entire investment of US$ 5.6 billion in just about 15 months.
In view of above, it is the output which holds the key. If a company delivers on its production commitment, even with modest price it will recover cost and make good profits. On the other hand, if it does not deliver on output then, even with high price [say, premium price], it won’t be able to recover. Merely to give E&P companies extra comfort, the government should not take the risk of burdening consumers with high prices.
Current policy stance of ‘uniform’ pricing must continue
Modiji should stick to October 18, 2014 guidelines which are based on sound principles – with focus on uniform pricing for all sources of supply – and strike a judicious balance between the interests of producers on one hand and consumers on the other besides providing a stable policy environment for long-term investment and growth of gas industry.