Europe set the bar on Russian gas high enough to leave India unaffected

The movement of fuel prices in 2023 will dictate how much India will be affected by the combined impact of two petroleum price caps imposed by western nations.

On December 19, a fortnight after the US-led G7 group of nations had imposed a price cap on crude oil supplied by Russia, the energy ministers of the European Union (EU) agreed on a “market correction mechanism” to cap prices of natural gas in Europe. Both these measures taken together were designed to reduce Russia’s earnings from exports of petroleum, and stabilise prices of fuel, a key inflationary determinant, in the US and Europe. But the measures, which currently have little impact because of lower commodity prices amid a higher sanction bar, threaten to hurt energy import-dependent nations such as India if prices of crude and gas surge.

Crude prices rebounded Friday after Moscow said it may cut oil output to offset price caps on Russian crude. Russian Deputy Prime Minister Alexander Novak said Russia may cut its oil output by 500,000-700,000 barrels a day in early 2023, preferring to cut production rather than sell crude in line with the price cap. Brent rose 3.6 per cent to $84.5 per barrel, and Goldman Sachs expects Brent to average $98 next year, a forecast made prior to the Russian output cut warning.

Price caps on both oil and gas by western nations matter for India because it depends on crude imports to meet 86 per cent of its needs while gas holds the key to India’s immediate future. The Modi government has spurred over Rs 2 trillion in investments in gas infrastructure to boost usage of the fuel to 15 per cent of the country’s energy mix by 2030, which basically means near quadrupling gas consumption to around 500 million cubic metres a day from current levels. Dependency of around 50 per cent on imported liquefied natural gas (LNG) is set to further rise in the absence of any major domestic discoveries, and amid reducing output from older areas.

Before we look at the impact of EU’s gas price cap on India’s LNG purchasing patterns, it would also be illustrative to observe the impact of the crude price cap on Russian supplies, which began December 5, on India, though a grace period of a month allowed shipments until January 19 to be unaffected by the cap. Brent crude fell to as low as $76 a barrel after the cap was announced. After factoring in the discount that Russia offers for Urals crudes, the price of Russian oil traded below the $60 a barrel cap. Russian supplies to India in December continue to be strong, according to Vortexa data, as these supplies were contracted in October before the caps, an official from a state refiner said.

But 2023 may be different as Brent is trading higher by around $9 a barrel from early December lows, and any further increase in prices whittles away the discounts and vaults Russian barrels over the $60 a barrel ceiling. At such rates India will have to arrange its own ships and insurance to transport Russian crude, a daunting task for now. The problems begin when oil prices rise and Russia insists on a rate beyond the price cap, said Narendra Taneja, a Delhi-based leading energy expert.

The impact of the gas price cap on India may, however, be muted as the EU, fearing disruptions to domestic gas supplies in winter, set the bar very high. In fact, interruptions to India’s gas supplies kick in at levels much below the EU price cap. Spot LNG rates this year, trading at just half of the EU cap levels, sent India’s gas use down by 6 per cent in April-November of the 2022-23 fiscal to 40.9 billion cubic metres from a year earlier — reversing a 5 per cent growth in gas demand in fiscal 2021-22 from a year earlier when LNG was much cheaper.

EU’s gas price cap starts on February 15 if the month-ahead price on TTF, a European gas benchmark, exceeds €180 per megawatt hour (Mwh), equivalent to around $53 per million British thermal units (Btu) LNG, for three working days, and if the month-ahead TTF price is €35 per Mwh higher than a reference price for LNG on global markets for the same three working days. The EU gave itself an escape clause that states that if risks to “the security of supply” (however defined) occur, the European Commission can suspend the price cap rule.

Nikos Tsafos, an energy expert and chief energy adviser to the Prime Minister of Greece, reckons that the cap allows for uninterrupted supplies, keeps a lid on domestic demand, and avoids any added financial stress. Gas and LNG prices have been disconnected from fundamentals, Tsafos said.

But the price cap is steep even by European standards. Dutch gas fell below €91 per Mwh last week, half the level of the cap, and so the cap does not matter until prices double again sometime — and that might not happen for a long time, said Mathew Carr, a London-based energy expert and founder of Carzee.org.

India need not bother for now about the EU’s price cap because it is set very high, said Rajesh Kumar Mediratta, CEO of Indian Gas Exchange, the country’s premier gas trading platform. India anyway does not buy LNG at $50 per million Btu levels, he added. India’s term LNG costs around $12 per million Btu with anything over $20/million Btu becoming unaffordable for Indian consumers, a Petronet LNG official said. Even at current TTF levels, equating to $26 per million Btu, India cannot outbid Europe for supplies.

“As for the impact of the cap on the Asia market, there is potentially more supply available to the region and less pressure to switch fuel as buyers could bid only slightly above the ceiling to attract LNG to northeast Asia,” said Ryhana Rasidi, LNG analyst at Kpler. But India will still not be able to compete with Japan, South Korea or China for supplies because of low affordability.

Measures by free market western economies to impose price controls on fuels are being viewed favourably by Narendra Modi’s government, which has unleashed measures to control fuel prices. Gas constitutes 34 per cent of Europe’s energy mix compared to 6 per cent for India. So, what Europe effectively accomplishes in setting a ceiling on gas rates also holds a lesson for India, which is proceeding on the same path. The Kirit Parikh committee, set up to tame soaring domestic gas rates, has suggested price caps on supplies of the fuel, which is 24 per cent less than the $8.57 per million Btu that ONGC and others currently charge for supplies.

Any binding price constraint will cause shortages of the fuel, said Tilak Doshi, a London-based energy expert with senior level stints at Unocal and Saudi Aramco. “The only correct solution is to support an increase in supply,” he added, something that both the EU and the Modi government should take heed.

ENERGY MIX

• Last week, the energy ministers of EU agreed on a “market correction mechanism” to cap prices of natural gas in Europe
• Price caps on both oil and gas by western nations matter for India because it depends on crude imports to meet 86% of its needs while gas holds the key to India’s immediate future
• Impact of gas price cap on India may be muted because EU has set the bar very high
• EU’s gas price cap starts on Feb 15 if the month-ahead price on TTF, a European gas benchmark, exceeds €180 per Mwh, equivalent to around $53 per million Btu LNG
• Gas constitutes 34% of Europe’s energy mix compared to 6% for India