State-run Oil and Natural Gas Corp. Ltd (ONGC) may be forced to sell natural gas at a discount to its originally expected price from its newest deepwater block in the Krishna-Godavari basin as gas prices remain subdued due to a supply glut internationally, three people directly aware of ONGC’s discussions said requesting anonymity.

ONGC plans to begin natural gas production from the deepwater block KG-DWN-98/2 in about two to three months and is expected to finalize shortly agreements for the sale of gas from the asset.

The company, according to the people cited above, has been in talks since August to assess demand potential from buyers which include Gail India and several city gas distribution companies. “Several buyers who have met ONGC have expressed reservations at buying gas at the upper ceiling, which was initially proposed by ONGC," said the first person cited above.

KG-DWN-98/2 is an ultra-deepwater, high-temperature and high-pressure field and according to a pre-determined pricing formula, ONGC can charge customers up to $8.43 per million metric British thermal unit (mmBtu) fixed for the second half of this fiscal. This current ceiling price is 9.5% lower than the ceiling price of $9.32 per mmBtu fixed for the first half of this fiscal. Situated 35km off the Andhra Pradesh coast in the Bay of Bengal, the block would cumulatively produce around 25 million metric tonnes (mmt) of oil and 45 billion cubic metres (bcm) of gas with peak production of 78,000 barrels per day of oil and 15mmscmd of gas. ONGC expects to bring first gas from this project to market by December-end and oil in 2020. “Given the pricing constraints, ONGC may now price the gas at around $6-7 per mmBtu, factoring in the current LNG spot price plus a markup price," said the first person cited above.

For the second half of this fiscal year, the government has notified a domestic gas price of $3.23 per mmBtu, a decline of 12.5% from $3.69 per mmBtu applicable in the fiscal first half.

This is expected to dampen the profitability of the gas producers, rating agency Icra said in a note on 1 October. The decline in domestic gas price is in line with the decline in global gas indices primarily Henry Hub over the fiscal first half. Also, with prices of gas at various international hubs remaining low, domestic gas prices are expected to remain depressed.

“At such low gas prices, gas production remains loss-making proposition for most fields for the upstream producers notwithstanding some decline in oil field services or equipment. Nonetheless, the depreciation of Indian rupee against the US dollar in the past few months provides some support to the realisations of the gas producers," said K. Ravichandran, senior vice-president and group head, Corporate Ratings, Icra, adding that with several new gas liquefaction capacities coming online globally, the supply glut is expected to keep prices of domestic gas low in the near to medium term, leading to poor returns even as domestic gas producers such as ONGC and RIL-BP ramp up gas production significantly.

Lower gas prices at international hubs has been further accentuated by the commissioning of new gas liquefaction capacities with about 35 million tonnes coming online in 2018 and another about 30 million tonnes expected to come online in 2019. Moreover, shale gas production continues to be healthy in the US. Accordingly, Asian spot LNG prices which remained at $9-11 per mmBtu during the winters of 2018-2019 have already declined to $5-6 per mmBtu.

For ONGC, a gas price lower than the ceiling of $8.43 per mmBtu would mean it has to take a hit on its profitability as buyers may prefer lifting gas from the spot market at $4-5 per mmBtu.

“Even if ONGC gets buyers at $7 per mmBtu, it will be a decent price for the company. More than that, it will be a case of opportunity lost for ONGC," said one of the three persons mentioned above.

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