Cap on gas price turns out to be the floor price

Cap on gas price turns out to be the floor price
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First Published: Tue, Sep 18 2007. 01 12 AM IST

Updated: Tue, Sep 18 2007. 05 36 PM IST
New Delhi: Contrary to a widely circulated belief that the government has capped natural gas price at well below prevailing global rates, the price of $4.2 (Rs170.10) per million British thermal unit (mBtu) fixed by the Centre last week for the gas pumped out of the Krishna-Godavari (KG) basin, is not a cap, but actually the floor price that industrial consumers will have to pay for the first five years after Reliance Industries Ltd (RIL) starts selling the gas.
This also means that the price could vary within the specified five years, unlike earlier understanding of the decision. While this may be not so good news for those buying the gas, it also means that fears about India’s price decision deterring companies, especially global energy firms, from future gas exploration appear to be unfounded.
An examination and analysis of the minutes of the 12 September meeting of an empowered group of ministers (eGoM), which approved the price, shows a significant variation between their decision, as noted in the minutes of that meeting, and a press note put out that later that evening by the ministry of petroleum and natural gas.
Based on the press note, everyone, including Mint, had concluded that the $4.2 per mBtu price was a cap on natural gas price and that it would apply as a benchmark for all gas producers in the country.
In reality, the eGoM did not remove a so-called “biddable component” portion in the pricing formula, as was widely believed, but had only assigned a “zero” value on it for now. In other words, the government has retained the right, at an unspecified later date, to use the option of allowing consumers to bid for the gas.
The minutes of the meeting of the eGoM reveal that the group decided to retain that biddable component as a “positive non-zero integer” to decide allocation of gas among priority sectors, something that the press note omitted to mention. As of Monday night, it was unclear why the ministry left out this crucial information in its press note.
Ministry officials as well as a spokesperson for RIL declined to comment. The eGoM had been convened to resolve a protracted pricing imbroglio on gas that will be produced by RIL, India’s most valuable company by market capitalization, from the D-6 block of the KG basin. Independent analysts, who were read minutes of the eGoM meeting, for Mint agreed that the $4.20 mBtu price was not a cap.
“The formula approved by the eGoM has fixed the floor price,” said Ajit C. Kapadia, vice-chairman of the Centre for Fuel Studies and Research and former director at GAIL (India) Ltd.
The formula approved by the eGoM has three basic components: the “fixed price element”, which has been set at $2.5 per mBtu; the second component is the “biddable character”, and a third element that seeks to link gas prices with Brent crude oil quotes between a band of $25-60 per barrel.
As a result, if oil prices dip below $25 per barrel, then the consumer has to pay a minimum of $2.5 per mBtu. On the other hand, if prices, like they are at present, are more than $60, this would result in an additional cost of $1.7, leading to a final gas price of $4.2 per mBtu. At present, the Indian crude oil basket is at $75.35 per barrel and the Brent crude oil is trading at around $80 per barrel, and very few economists and forecasters expect oil prices to fall below $60 in the next few years.
While that leaves the impression that $4.2 per mBtu is a cap, since the biddable component has been assigned a “positive non-zero integer” by the eGoM, it would mean that the final price, assuming oil prices remain above $60, would, in effect, be at a minimum of $4.2 per mBtu. This is because, if the government decides to adopt “price discovery” through bids among consumers, then the biddable component would assume a positive value and hence push it above the floor price.
Mint compared the minutes of the eGoM with the press note issued by petroleum ministry. According to the press note, “The eGoM observed that since C was the only biddable component in the submitted formula, assigning a value of zero to this component would also address the transparency aspect of the bidding process.”
What the note failed to say, but included in the minutes of the eGoM was this additional information: “...for the purpose of retaining the biddable character of the formula, an allocation of gas among priority sectors, the formula must retain C as a positive non-zero integer.”
The eGoM minutes show that this clause was included at the behest of Montek Singh Ahluwalia, deputy chairman of the Planning Commission. Ahluwalia declined to comment for this story. M.S. Srinivasan, petroleum secretary, also refused to comment.
News that the $4.2 per mBtu isn’t a cap could help companies such as Exxon Mobil Corp. and BP Plc. participate more actively in developing some 20 trillion cubic feet of gas that was discovered in India. The price is sharply lower, by some 34%, from prevailing gas prices in the open market.
Gas for October delivery was recently trading around $6.4 per mBtu on the New York Mercantile Exchange. In July, for instance, Japanese importers paid an average of $7.29 for imported liquefied natural gas (LNG). Prices of LNG delivered to Japan, the world’s biggest importer, have more than doubled since 1999.
Bloomberg contributed to this story.
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First Published: Tue, Sep 18 2007. 01 12 AM IST