The current problems in reaching a consensus on the pricing of natural gas can be traced back to a series of past ad hoc policy decisions, exacerbated by clever footwork by the producers of gas. It all started when ONGC and OIL were the sole producers of gas, and GAIL had the monopoly to transport. The gas was sold to allottees at government-controlled prices linked to a basket of fuel oils. It was felt that the fertilizer and power sectors needed cheaper gas, at lower-than-market prices. Industry freeloading onto this supply developed a vested interest, and efforts to open up to market-based pricing have regularly run into political speed breakers.
Next came the allocation of a few gas fields to “selected” operators, with permission to market the products at freely contracted prices, subject to approval. Significant production is marketed thus, and the producers have been quite happy. The advent of LNG some three years ago introduced another dimension, an attempt, on a large scale, to sell gas at market rates. The market is now absorbing these prices, and there were instances last year when NTPC bought spot market cargoes at more than $10 per mBtu.
The third stage was the allocation of exploration blocks under the NELP bid process, which led to significant offshore finds by RIL, ONGC and GSPC. The current natural gas supply (excluding LNG) at around 75 million standard cubic metres per day (mscmd) is expected to more than double in three to four years. All incremental output will come from the new discoveries, and in the short run, from a single private player. The new regime is that of production sharing contracts between the producers and the government, which specify that price should be discovered through open competitive bidding, a view reiterated by a committee of the petroleum ministry in November 2006. The contract also provides the government a share in cash or kind, after the developer has recovered his capital spend.
Some quick fancy footwork then emerged. The capex estimates of 2002 were revised upwards by the operator in 2004, with an enhanced production estimate, and then quickly doubled in 2006, with no further output increase. The goal post for government’s share or profit petroleum receded into the horizon. Capex approvals for these huge investments require only the approval of a low-level bureaucratic group. The second piece of footwork has been the quick approach to “price discovery” through a limited, selective tender now being quoted as the contractual base. There is some concern about the transparency of the process as well as the capex estimates.
The consuming ministries, including fertilizer and power, have woken up to the fact that the so-called market pricing will affect them adversely, and have been preparing long memoranda on why they should get preferential allocations of the new gas, at subsidized prices. States that the gas pipeline is passing through want regional demands to be met at subsidized prices before market-based pricing is allowed. The Prime Minister’s Office has said in a letter that the gas should be primarily used for the fertilizer sector. The Mumbai courts are dealing with a dispute between the power firm and the gas supplier on privity of contract, where the question is how bilateral commitments outside the official production sharing agreements are enforceable. And now the committee of secretaries is debating how to please all, and still not get into a mess.
The petroleum ministry is clearly responsible for much of this confusion. Power and fertilizer have been the anchor consumers for gas, and both are tightly regulated. Fertilizer pricing, subsidies and, indeed, the costs of operation are under government purview. In power, the regulator decides on tariff, on capital costs as well as details of use. The petroleum ministry’s view that gas prices will be market-determined, while the consumer sectors are tightly controlled, is an aberration. There is no regulator for gas, and the ministry has said it won’t decide on pricing. But there is no free market for gas—only a market where the major consumers are used to cushioned prices—why overlook this? The options are to make the supply and the demand market equally free, which would push up fertilizer and power prices, or else to exercise some control on the fuel price. If product pricing in petroleum is subject to control, why not gas? The counter-argument is that there will be no incentives for investment if output prices are regulated. But surely it is possible to put in place a transparent mechanism that can look professionally at the development costs, work out the trade-offs between subsidies and gas prices and, indeed, work towards a dual pricing concept with some regulated prices for the regulated sectors, and free market prices for other consumers?
If this debate brings institutional changes towards a more transparent gas market, it will serve its purpose.
S. Narayan is a former finance secretary and economic adviser to the Prime Minister of India. Comments are welcome at firstname.lastname@example.org