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Devesh Kapur: Riding the shale gas revolution

India must take advantage of low US gas prices by setting up fertiliser plants in America

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With growing reports of shale gas discoveries and probable recoveries in diverse locations including Argentina, China, East Europe and (especially) the United States, India needs to consider the possible ways it can leverage the strategic implications of this major new development in global energy markets.

For one, if the recoverable shale gas in China and the US proves to be as large as some estimates project, their dependence on Middle East energy will drop. This could reduce the strategic importance of the Middle East to American interests. And Indian strategic thinkers who had thought (or hoped) that dependence on Middle East oil would make Chinese supply lines through the Indian Ocean vulnerable might have to dampen these expectations.

On the other hand, the shift to domestic gas sources by two of the world’s largest energy consumers will by itself attenuate projected increases in energy prices, especially in substitutes like oil and coal, which would mitigate India’s burgeoning energy import bill. But this will not change the fundamental reality that India faces: a growing demand-supply energy imbalance whose implications for economic growth and national security are profound.

But India can be more proactive and leverage this new development to greater advantage, in particular by rethinking its stance on fertiliser production and imports. While there are several hydrocarbon feedstocks for fertilisers, including naphtha, fuel oil/low sulphur heavy stock (FO/LSHS), and coal gasification, the most preferred feedstock is natural gas, since it has the highest hydrogen-to-carbon ratio (hydrogen’s percentage by weight in methane is 25 per cent as compared to 15 per cent in naphtha).

While about 30 per cent of India’s domestic production of natural gas is used for fertiliser production, the scope for increasing this is restricted by the limited supply of gas. Hopes that Reliance’s Krishna-Godavari fields would be a major supplier have been dashed — either since the estimates of the gas fields were too optimistic or because Reliance is simply playing hardball to extract a higher gas price. (The latter is more likely, given BP’s decision to invest $7 billion, or Rs 38,000 crore, for a 30 per cent stake in Reliance’s 21 oil and gas production-sharing contracts.) Priority sectors like power and fertilisers that built capacity on the promise of assured supplies now have to scramble to find alternative fuel and feedstock.

The need to lower the cost of fertilisers is further underscored by escalating fertiliser subsidies. In the last financial year, these (including arrears) approached nearly $20 billion (Rs 1 lakh crore). Given uncertainties in the supply and pricing of feedstock, together with micro-managed fertiliser prices, it is not surprising that there has been no new investment in urea in India since the late 1990s.

Urea production costs in India vary considerably between the gas-based plants located at gas landfall sites (such as at Hazira and Nagarjuna Fertilisers at Kakinada), which can access the cheapest gas; gas-based plants located in the interior that incur additional costs of pipeline transport and taxes, or even buy merchant liquefied natural gas () at very high rates; and the highest-cost plants (more than double) running on naphtha and fuel oil. Given the large differences in the price of natural gas between the point of production and off-take, and the continued existence of much higher-cost non-gas based plants, the question should be asked: is it not better to establish dedicated production facilities overseas, in close proximity to gas production sites? India has consistently resisted this on the grounds of food security. This stance has changed gradually since the late 1990s; but, to date, there has been only one significant success story — OMIFCO, a joint venture between Oman Oil Company and India’s and Kribhco.

The plant was started in Oman in 2005. While the government of India agreed to buy all the urea produced by OMIFCO under a long-term urea off-take agreement for 15 years at predetermined prices, Oman had contracted to sell gas to OMIFCO at $0.77 per million British thermal units for 15 years in 2002. As per the contract, the price revision was due only in July 2015, after 10 years of the commencement of the plant.

However, with escalating global gas prices, Oman trebled the price of gas ahead of schedule. Nonetheless, even with this unilateral gas price hike, the price of urea from this plant will be considerably less than world prices, with savings to the government of several hundred million dollars annually.

Still, until now, a case could be made for the Indian government to be cautious. The only viable option for large urea plants was in the Middle East, where political risks stemming from security vulnerabilities and unilateral and capricious state actions (such as reneging on contracts) meant that putting too many eggs in this basket carried considerable risks.

However, the discovery of vast reserves of extractable shale gas in the US considerably changes the picture. For the first time, the pricing of natural gas in the US has been delinked from oil parity pricing, leading to much lower natural gas prices in the US compared to Asia. While both Indian private firms and PSUs have been making investments in US shale gas assets (notably RIL and GAIL), a critical pillar of a long-term strategy should be to set up urea plants in the US based on shale gas feedstock, with guaranteed off-take by the government at predetermined, contracted prices.

There are several key advantages of this strategy. First, it will ensure urea supplies at costs considerably lower than in India, even taking into account transportation costs, thereby lowering the subsidy bill. Hence, instead of throwing good money after bad and attempting to revive sick fertiliser units (as currently planned), India should instead invest in fertiliser-manufacturing facilities in the US. Second, it will diversify the sources of gas (and urea) supply. This should enhance India’s bargaining power vis-à-vis domestic producers like Reliance, and also in gas contract negotiations with Middle East countries. Third, given private ownership of mineral rights in the US and a strong property rights and contract enforcement regime, India will have long-term supply assurance that contracts are not annulled by fiat or inflation. This is critical since, as Oman and indeed the Indian government’s own actions vis-à-vis foreign companies have recently demonstrated, sovereigns can be capricious when the asset is in their country. 

Finally, such a strategy would also add ballast to the India-US economic partnership. India would not be simply availing itself of cheap energy; instead, it would be contributing to a revitalised US manufacturing sector and deepening its trade relations with that country — even as it would be helping itself.

The writer is director of the Centre for the Advanced Study of India at the University of Pennsylvania

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