A problematic move

New gas pricing formula defies economic rationality

It is clear that the government is in a hurry to work out exactly how the price of gas from the Krishna-Godavari basin should be revised. It has been reported that the chief executive of British Petroleum (BP), Bob Dudley, and the chairman of Reliance Industries, Mukesh Ambani, met senior members of the government on Monday. The deputy chairman of the Planning Commission told reporters afterwards: "They are very concerned, they are very keen that the government comes out with a view." An empowered group of ministers (EGoM) is currently supposed to be considering the Rangarajan Committee report on gas pricing. If the committee's recommendations are accepted, the price of gas produced by the Reliance-BP consortium from the KG basin will rise from $4.2 per million metric British thermal units (mmBtu) to double that, between $8 and $8.5 per mmBtu. The consortium has made no secret of its belief that this new price would still be too low for it to justify extensive risk capital on the high seas. Nevertheless, the EGoM should stand firm against any such pressure. Indeed, it should in fact question the price formulae that the committee has suggested, which are disconnected from economic rationality and would serve in effect to unjustifiably reward private producers at the cost of either the exchequer or end-users - the citizens of India who, according to the Supreme Court, own the natural gas in question.

The Rangarajan Committee suggested that KG basin gas be valued by averaging two "prices". The first is obtained by subtracting an assumed value of transportation - between $3 and $4 - from the price of liquid natural gas in India. The second is obtained by weighting spot gas prices in various worldwide markets. Neither makes much economic sense as a way to determine a fair rate of return to a producer in India, selling to India; averaging them makes even less sense. The formula fails to even achieve its own ends, to price KG basin production the same as some imagined cost of production elsewhere - for it is calculated that US liquid natural gas becomes uneconomical in Asia when the price at the US' Henry Hub is over $6 per mmBtu. That is also the estimated average cost of production of shale gas in the US - more complicated to extract than regular natural gas. Israel projects that its new undersea deposits of natural gas can be sold to Europe with pipeline transport costs of $3 per mmBtu, and are profitable when the European price is $9 per mmBtu - again giving $6 per mmBtu as a break-even cost, and this for new undersea exploration like KG-D6. Reliance and BP are already being promised a better deal than anywhere else in the world.

Three further points are worth making. The first is that many cynics have noticed that as renegotiation of KG basin pricing approaches, "new discoveries" have been made in area MJ1 of the existing gas block. Meanwhile, in the full financial year, according to Reliance's results on Tuesday, gas output at KG-D6 fell 39 per cent. The second is that the Centre's action on gas pricing, where it is allowing extraction companies higher prices, contrasts sharply with its action on coal pricing, where it is intervening on behalf of power generation companies using coal. In the first case, the extraction companies are powerful and private sector; in the latter, the generation companies are. By all means, keep the energy sector moving - but it should be done without giving the farm away to India's new oligarchs, at the expense of struggling household and government budgets. And finally, no review of gas prices will make sense unless and until necessary pricing reforms take place in industries such as power and fertilisers that use gas as feedstock.