A first step forward

To solve gas price problem, reform energy and fertiliser sectors

The Rangarajan Committee on the production-sharing contract (PSC) mechanism in the petroleum industry has recommended major changes, which would alter the parameters of exploration and production (E&P) and have a major knock-on effect on consumers in the fertiliser, power, transport and household sectors. The committee recommends all domestic gas prices be linked to an averaged price that takes into account the landed price of Indian liquefied natural gas imports, the customs-cleared price of LNG imports into Japan (JCC) and prices at major international trading points. The pricing would be equal for all consumers, though gas would be allocated on a priority basis to the power and fertiliser industries. The formula would apply only to new contracts and would, at current rates, hike Indian gas prices to about $8.1 per mmBtu (million metric British thermal units), from $4.2 per mmBtu. It is suggested that the formula be reviewed in five years, when the Indian market may be mature enough for competitive gas pricing.

Another key recommendation is that the PSC should scrap the concept of cost recovery, wherein the government receives profit gas and oil only after the block operator recovers its costs. Instead, it suggests that explorers bid for blocks by offering a share of production after royalty. The post-royalty value of the output of oil and gas would be shared by the government from the start of production. Production sharing would be linked to average daily production, and to averaged oil and gas prices in a defined period. Other recommendations include extending the exploration period of E&P contracts from the current seven years to 10 and redefining the role of management committees in private-operated blocks. The committee notes that the PSC must also be modified to remove ambiguity in certain clauses and the grant of statutory clearances must be accelerated.

This is a reasonable attempt to address persistent issues with the PSC mechanism and the complexities of Indian gas pricing. Cost recovery leads to disputes over exact costs (including transfer pricing between entities owned by the operator) as it gives operators an incentive to gold-plate projects. It also leads to tardy clearances for further exploration within the same block since the government is loath to allow more expenses. These factors have been in play in the KG-D6 block held by Reliance Industries, which has seen declining production and disputes. Given India’s growing demand-supply gap in energy, it is vital to enhance domestic production to assure energy security. By the end of the 12th Plan, if domestic energy demand grows at a projected 6.5 per cent, 81 per cent of crude oil, 28 per cent of gas and 22 per cent of coal would need to be imported. The proposed regime would clearly increase incentives for E&P operators by linking prices to international rates. It would simplify monitoring procedures and assure larger rents for the government.

However, the knock-on effect of increased input prices in highly subsidised and politically sensitive downstream sectors also requires the rethinking of subsidy mechanisms in those segments. In particular, rigid price controls on power and fertilisers will need revision. This should not inhibit the acceptance of the committee’s recommendations — instead, it should be seen as the occasion for reforming the controlled and inefficient downstream sectors.