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Cover Story | July 2014


It was on the cards, but surprisingly, it didn't happen. A few private players may claim now that the Government has backstabbed them. The powerful gas lobby was expecting some decision on the proposed gas price hike recommended by the Rangarajan Committee. However, the Government, ignoring pressure tactics and heated lobbying, has put the gas price hike on the back-burner for the next three months.

The deferment of the proposed gas price hike for the next three months has stymied a few players. This lobby might have convinced the earlier government that a hike was necessary, but the Election Commission put the decision on hold. The Modi government has not just put the hike on hold, it has also slapped a Rs 7,000 crore on Reliance Industries Ltd (RIL) for poor gas output. Maintaining the status-quo has given a big boost to sections like the fertiliser industry, which consumes nearly 35 per cent of the gas produced in the country.

Remember, the trajectory for natural gas prices is decided mainly by five factors: usage predictions, demand forecasts (See the graph on next page), current inventory levels, a healthy dose of speculation and of course the weather.

It is expected that the government's decision to defer the proposed hike will add to the speculation that the quantum of the increase may not be the same as per the Rangarajan formula. In April, Morgan Stanley had said it expects that RIL may get $6.8 per unit for its output from the Krishna-Godavari basin (KG-D6) against the $8.4 recommended by the Rangarajan formula.

Although television has been full of debates on the gas pricing issue, all the arguments seem to hinge on only one factor, the beneficiaries of the proposed hike. PT has gone beyond the debate to figure out the economics behind the proposed hike.

A roadmap to $8.4 gas
TK Ananth Kumar, Former Director (Finance), Oil India Ltd, says, "We cannot have lower prices ($4.2/mmbtu) for domestic gas producers for long as this may lead to a situation where practically no players, particularly (from the) private sector, will come forward to participate in exploration and production in India." .

Debasish Mishra, Senior Director-Energy Practices, Deloitte India, points out that in the US, gas prices have not always been below $5/mmbtu. As prices were market determined, higher prices attracted huge investment in the shale gas sector and prices dropped dramatically when supply increased. For a long time in America, the prices were more than $10/mmbtu. .

But in India, prices have to go up; large international E&P companies are not participating in NELP auctions, or they have exited due to one or other reasons. Public sector companies will also find it difficult to continue operations beyond a point in absence of proper returns and capital creation as the E&P industry is highly risk prone. Unless appropriate returns are provided, operators will not come to participate in the nation's E&P sector in a big way..

Secondly, a large price gap between domestically produced and imported gas is leading to non-optimum utilisation of facilities created for imported liquefied natural gas (LNG). For any commercial activity to be performed economically, a fair price is essential. The solution does not lie in keeping the prices artificially low. Instead of a general subsidy to all consumers, certain sectors which may really require subsidy can be provided help directly from the forthcoming Budget. .

According to Rajiv Biswas, Asia-Pacific Chief Economist, IHS, and Kash Burchett, Senior Analyst, IHS Energy, higher revenues per unit will stimulate investment into additional, more expensive gas fields and incentivise greater exploration investments, in turn yielding more discoveries. Over the long run, substantial exploration will occur only if the price of gas is higher than the anticipated cost of supply. Increased Indian gas production will yield additional government revenues, a reduced balance of payments deficit and improved security of supply. (See the graph below).

Can this be a game changer?
FY14 marked a new low for gas supplies in the country since FY10 at 130 mmcmd, with downtick in both domestic gas supplies and regassified LNG. Demand weakness kept LNG consumption low during FY14. But with a rise in prices it's expected that domestic gas output will almost double to 150 mmcmd by FY18 from 82 mmcmd in FY14, with output from the KG basin (RIL and ONGC) and Daman/GK (ONGC). (See the graph page 34) If experts are to be believed, a revision in gas prices will certainly help in increasing domestic gas production which is very vital for the country's growth. Production of gas and oil from offshore deepwater blocks like the ones in Krishna-Godavari, Mahanadi and Daman is very costly and highly risk prone. Higher gas prices will certainly enable the operators in deployment of appropriate technology, which should result in more discoveries and consequently higher production. (See graph: Significant demand remains above USD10/mmbtu price curve) Initially, the additional gas would likely come from two regions, the deepwater Cauvery Basin off the southeastern coast and the deepwater Krishna-Godavari Basin which lies further north in the Bay of Bengal. Looking further ahead, unconventional gas production may also develop in India..

No impact on power and CGD
According to Deloitte, a $1 hike in gas prices would necessitate a Rs. 0.36/ unit increase in electricity tariff. The Rangarajan Committee's recommended price of $8 /mmbtu is a good base price as it is feasible for power companies to use gas at (a price point) up to $10/mmbtu. The bigger challenge in India is availability of domestic gas. Over a long term, to promote more investments in exploration, the Government should come out with a market based pricing mechanism and a transparent allocation policy..

The thorny issue
Research indicates that the total impact on the power sector is likely to be around Rs 46,000 crore per annum and the annual hit on the fertilizer sector would be nearly Rs 17,000 crore, if gas prices are doubled. The government was planning to hike subsidies to both these sectors to negate the impact of the price hike. Any hike in gas prices would only add to the subsidy burden. Government estimates indicate that the additional subsidy burden for every $1 increase in price will be Rs 2,233 crore per annum for the fertiliser sector. The subsidy to power units is expected to be Rs 3,457 crore per dollar of hike. The main question here is whether the gains from higher profit sharing, royalty and taxes from the gas price hike would be enough to foot the subsidy bill.

Criticism of the current formula
Experts have pointed out that the Rangarajan formula prices deep-sea gas production on the same lines as the much cheaper inland output. Deep sea, shallow water and inland gas production should have different prices, goes the argument. Further, the current gas pricing formula takes into account Henry Hub, European and Asia-Pacific prices. Henry Hub prices are around $4 per mmbtu (thanks to the shale gas explosion), while European prices are around $6-$8 per mmbtu (due to existing long-term contracts). The gas-starved Asia-Pacific market pays around $18 per mmbtu, it is the inclusion of this index that has driven up the prices envisaged by the Rangarajan Committee.

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