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Cover Story | July 2014

Gas prices should be market linked

The intention of the government is focused towards long term benefit and growth. Hence the proposed increase of natural gas prices should augur well for the country in the long run, says TK Ananth Kumar, Former Director (Finance) Oil India Ltd.

Do you agree that the natural gas price hike will be a game changer for the industry? How will the gas price hike accelerate development in prospective basins like Krishna Godavari, Mahanadi and Daman?
? I agree that revision in gas prices will certainly attract more investment in the Indian oil and gas sector and 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 price will certainly enable the operators in deployment of appropriate technology, which should result in more discoveries and consequently higher production.

Can you explain the economics behind the proposed gas price hike? How is it economically feasible?
The economics is easy to understand. We cannot have lower prices 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 E&P in India. We are literally witnessing this situation as large international E&P companies are not participating in our NELP auctions or they have exited due to one or other reasons.

The 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 and unless appropriate returns are provided operators will not come to participate in our 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 LNG. For any commercial activity to be performed economically, a fair price is essential. The solution doesn't lie in keeping the prices artificially low. Instead of a general subsidy to all consumers, certain sectors which may really require subsidy can be subsidised directly from the Government Budget.

What are the potential steps that can be taken to revive the gas sector in India?
The most important step for revival of the gas sector will be to offer market linked prices to domestic gas producers which will attract more investments in the exploration sector and consequently more discoveries and production. This is also necessary for several other valid reasons. First, the costs of exploration and production (E&P) services, for which we are largely dependent on foreign service providers, are very high as they are generally linked to international oil and gas prices. Secondly, deployment of latest technology for extracting gas from increasingly difficult basins requires higher incurrence of costs. Thirdly, reducing price differential between domestically produced gas and imported liquefied natural gas (LNG) will help optimising demand for imported LNG and improve utilisation of facilities created for imports. The other important steps include facilitation by the Government in faster clearances (environmental, land acquisition), removing tax hurdles, a consistent policy regime and to avoid ambiguities, which will lead to better participation of international players in various New Exploration Licensing Policy (NELP) rounds. Thus having a fair pricing regime and faster clearances coupled with consistent policies will help us in reviving our gas sector.

Is a hike required at this point of time where the contractors are unable to extract the required gas and are asking for a hike too?
It is very difficult to say why the contractors are unable to extract gas. We need to understand that E&P is a sector where the size of reserves is highly subjective and is based on certain assumptions with respect to geological and geophysical conditions of the basins. Even if existence of reserves is established, application of appropriate technology is important for extraction. In this context also it is pertinent to add that fair price may allow the contractors to aggressively apply appropriate and latest technology which would improve production. Although higher price may not guarantee increase in production, this may certainly help as contractors will find it incentivised and encouraged to deploy latest and modern technology which is so vital for the industry.

Do you think that the methodology used by the earlier Government is questionable? What should be the correct methodology as per your experience in this field?
I don't think the methodology used by the earlier Government is questionable. It is desirable that the prices are linked to the prevailing international prices or close to them and the Government has been working towards it. We have slowly, steadily and systematically moved to a pricing regime wherein prices of all petroleum products have become or are moving towards international price parity. Therefore natural gas pricing also should be linked (or should be) at least close to international price. It can perhaps be achieved in a phased manner as was done for crude oil in 1998.

Since the gas pricing issue will have implications for power tariffs as well, do you think the State Governments should be consulted on the matter? If there is a gas price hike, do you see a revision in power tariff too?
Gas price revision is a subject of the Central Government. Hence no consultation with State Governments may be necessary. Gas price revision may need some upward correction in power tariffs too. However, since the revenues of the State Governments will also go up from ad valorem taxation (VAT, royalty, etc.), this can be utilised for neutralising the increase of power tariffs to some extent.

The Standing Committee headed by Yashwant Sinha opined that the contractor responsible for supplying gas from the KG-D6 gas field should deliver the shortfall in supply at the original price and not be allowed to take advantage of a possible upward revision. Will this work?
This may not work as it may be practically impossible to prove that the gas production was intentionally withheld. Secondly, differential pricing from the same fields may not be workable and as far as possible things should be kept simple.

What are the possible causes and consequences of higher gas prices? What will be the impact of gas price hike on city gas distribution networks?
The justification for revising gas pricing and linking the same to import parity has been explained in the earlier paragraphs. The hike in gas price will certainly lead to some price increase to gas consumers, which is inevitable. However from the long term point of view this is justified as more investment in E&P which will lead to more discoveries and more investments is possible only if the gas price is attractive for gas producers. The subsidy, if needed to be provided to certain sectors, should be directly provided by the Government. Moreover, I do not see any significant impact on city gas distribution companies. The prices to their consumers will remain competitive as all alternative fuel costs are also rising (petrol, diesel) or are set to go up (LPG).

How will this impact private and PSU companies, as in who will be the beneficiaries?
Removal of price controls and proceeding towards market linked price realisation will attract more PSU as well as private sector investment in the sector and the ultimate beneficiary will be the country and the people of the country in the long run. While there may be some temporary setbacks to the consumers, in the long run it is beneficial.

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