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Cover Story | July 2014

A game changer!

The authors of a major study published by IHS Energy in May ('Indian Gas Pricing') discuss the prospects for gas pricing reform in India.

Potential steps to revive the gas sector
Past Indian governments have had a long-standing policy of capping the price of domestically produced gas. Numerous commissions have sought to bring prices in line with costs, but there have been difficulties in passing reforms due to the sensitivities and administrative complexities surrounding deregulation. Policymakers have had to walk a tightrope between controlling energy costs and stimulating investment. The price caps have distorted India's natural gas supply and demand patterns over the last decade, with the resulting domestic supply shortfall having been met through LNG imports, which now account for 35 per cent of overall supply. In response to the burgeoning energy crisis, a package of reforms for the gas pricing regime was announced in July 2013, but the package of measures has not yet been implemented. There is a tentative expectation within the industry that the administered gas price will roughly double in 2014.

Will natural gas price hike be a game changer?
The gas price increase will in principle encourage investment in domestic gas production. This would be a major shift in policy and represents an important driver in India's gas market outlook. An increase in administered gas prices that stimulates domestic production can ensure that higher volumes of capital flow into India's economy rather than to overseas LNG projects. 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.

The power sector impact
The higher gas prices will not be passed on directly to all end users. For households prices will rise, but certain key sectors, notably the fertiliser industry and power generators, will continue to receive either preferential rates or additional subsidies to help meet high costs. The costs of supporting these industries will continue to be met by the upstream producers and distributors and the government itself.

The economics behind the gas price hike
The price increase will encourage investment in domestic gas production. Higher revenues per unit will stimulate investment into additional, more expensive gas fields and incentivise greater exploration investments, in turn yielding more discoveries. In 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.

Causes and consequences of higher gas prices
It should be remembered that at this stage important uncertainties remain regarding how the price mechanism will be implemented and how the higher regulated price costs will be distributed among end users. Power plant operators and the fertiliser industry will likely retain, if not increase, their price discount. Equally, if the majority of the higher price is met through additional burdens on the producers themselves, there is little incentive to produce additional gas and no benefit to the wider economy. A new gas pricing regime is expected to come into effect this year, which would double administered prices, encouraging investment in domestic gas production and more efficient consumption. However, analysis of reserves and expected development costs implies that a more ambitious reform program could yield substantially higher production.

Impact on city gas distribution networks
India's current gas pricing regime contributes to constrained gas supply. The nation is unable to attract sufficient gas to meet demand, and limited revenue from sales has impeded investment into new infrastructure, notably transmission pipelines. As a result, over the past three years, power generators have been forced to leave assets idle with increasing frequency. The resultant power supply interruptions are a constraint on economic growth and development. So long as gas price hikes are not too high, they stand to make an important supplementary contribution to overall gas supply, thereby limiting unmet demand and supporting economic growth.

Authored by Rajiv Biswas, Asia-Pacific Chief Economist, IHS, and Kash Burchett, Senior Analyst, IHS Energy.

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