Gas price formula evokes strong reactions6 min read . Updated: 22 Apr 2013, 01:15 AM IST
Producers fear using US gas prices will skew the Indian price downward
Mumbai: Oil companies and their investors cheered the hike in petrol prices while retail consumers jeered.
It is indeed not uncommon for a government’s policy to elicit starkly different reactions from two different sets of stakeholders. But the formula for setting natural gas prices in India—as suggested by a committee headed by C. Rangarajan, chairman of the Prime Minister’s Economic Advisory Council—seems to be evoking extreme reactions.
The formula takes the average of the price of imported gas across sectors over a 12-month period and that of prices in the three major international gas trading hubs—US Henry Hub, UK National Balancing Point and Japan’s custom-cleared rate—to arrive at the final price for gas in India.
The oil ministry has accepted the proposed formula and floated a note to other ministries even as gas producers and consumers such as power and fertilizer companies have been voicing their reservations on various platforms. The power and fertilizer ministries, too, may oppose the formula and the resultant price hike.
An email sent to oil minister Veerappa Moily on 4 April and repeated phones calls and messages did not elicit any response.
While producers fear that taking into account US gas prices will skew the Indian price downward, consuming companies have a problem with factoring in Japanese prices, which they say is calculated twice and skews the prices higher than what it should be.
Analysts, however, say the proposed formula tries to strike a balance between the divergent gas prices prevalent across the globe. It may not be the ideal price for either producers or consumers but it will certainly keep the business running.
Reacting to the Rangarajan committee’s pricing formula, the industry lobby Confederation of Indian Industry (CII) said in a note dated 8 February that the formula “is not in line with the intent of the production sharing contract (PSC) as it neither provides for an element of price discovery through competitive arms-length bidding nor provides import parity prices".
CII goes on to say the formula is not driven by the realities of the demand-supply dynamics of the Indian gas market. “There is substantial linkage to the US which is a mature market and very different from the Indian market," it said in its statement. “Hence, the resultant price produced by the formula does not take into account the risks and cost of exploration and development in India and is unlikely to incentivize investment in existing discoveries and future exploration in technically challenges areas."
Due to the abundant availability of shale gas in the US, supply has outstripped demand pushing prices downwards. On 18 April, the Henry Hub spot price of gas (the primary gas price index in the US) was $4.23 per million British thermal unit (mBtu). A year ago, prices had fallen to under $2 per mBtu. The current price of domestic gas in India ranges between $3.5 and $5.73 per mBtu. Imported natural gas costs around $14 per mBtu.
The Rangarajan committee formula puts natural gas prices in India at around $8 per mBtu.
The argument against looking at US gas prices in the formula was also reiterated by the Association of Oil and Gas Operators of India (AOGO), an oil and gas industry lobby, in its letter dated 28 January to oil minister Moily.
The association states in its letter that in consuming economies that are short supplied, prices are higher than a producing economy. “Congruence with production intensive economies like US or Europe is therefore defective," it said.
AOGO also pointed out that the cost of risk and development capital in significant gas producing countries like the US was lesser than in India, as was also cost of infrastructure due to economies of scale.
However, companies like Reliance Industries Ltd (RIL), which operates the KG-D6 reservoir, India’s largest gas find till date, called the recommendations of the Rangarajan committee a “move in the right direction", in an investor presentation on its website dated 16 April.
RIL and its British partner BP Plc. are eagerly anticipating a gas price hike in India and even indicated that future capital expenditure towards augmenting gas output from the troubled KG-D6 block to the tune of $5 billion was contingent on more remunerative gas prices.
Sashi Mukundan, region president and country head of BP in India, was quoted in the CII statement as saying that the proposed mechanism did not deliver a market price as promised in Nelp (New Exploration Licensing Policy) and the PSC and was unlikely to incentivize investments in technically challenged and high risk areas.
Power and fertilizer companies, on the other hand, have raised several concerns ranging from the accuracy of the formula to the effect that the incremental cost of gas will have on business. In a statement dated 12 February, the Fertiliser Association of India (FAI), an industry lobby of fertilizer makers, said that the sector was not consulted at all for its view on gas pricing.
FAI projects that if the cost of natural gas was to go up by around $4.25 per mBtu, the cost of production per tonne of urea would rise by ₹ 5,500 per tonne, or ₹ 10,000 crore for the 18 million tonnes of urea per year, produced using natural gas.
The government subsidizes 60% of the cost of domestic urea to fertilizer manufacturers, which works out to around ₹ 25,000 crore a year, the statement says.
The additional burden of the government due to the proposed hike in gas price is estimated to be 40%. FAI pointed out that till February the government hadn’t released subsidy payment to urea producers for six months.
FAI contends that any formula to determine gas prices in India should take a weighted average of the entire gas markets, taking into account the volumes traded at various prices.
It recommended that if another formula had to be worked out, it should place at least 50% weightage to the cost of production of domestic gas.
A statement issued by the Association of Power Producers (APP) in January pointed out that the Japanese price of natural gas was, in effect, counted twice in the Rangarajan committee’s formula. The association said that the Indian LNG import price that the formula factors in is often linked to the Japan Korea Marker index, and another component in the formula takes the weighted average of three international hub prices, of which Japan is a large portion.
“Thus, the formula... counts the Japanese LNG import price twice," APP said in its statement. “Since Japan LNG import price has historically been much higher than the global market, this would have a distortionary effect on gas pricing."
“There is a significant difference between the Japanese and US Henry Hub gas prices and what this formula may be trying to do is to reach an equilibrium in between," Akhil Sambhar, associate director (oil and gas practice) at international audit and consulting firm Ernst and Young, said. “The formula is based on an average and while it may not entirely please either producers or consumers of gas, it may possibly keep business running."
Another senior oil and gas expert from an international consulting firm said that if gas prices in India are too close to either US or Japanese prices, it may kill the gas market in the country. “On the one hand, it is not feasible for gas producers to be given a price comparable to Japanese spot prices, since downstream sectors (like power and fertilizer) are regulated, and high gas prices will impact their viability," this consultant said, speaking on condition of anonymity. “On the other hand, very low gas prices will not spur new investment in the oil and gas sector in India, which the country desperately needs."