Pricing pressure

Gas pricing needs a long-term perspective

A steep decline in prices of natural gas is a cautionary tale of second-guessing demand-supply dynamics in a globally traded commodity. Prices of global gas and liquefied natural gas (LNG) have plunged and now trade below oil parity, meaning it is now cheaper for users to burn gas rather than oil. Prices of Dutch TTF, a European benchmark, US benchmark Henry Hub, and spot LNG prices have dropped by over 70 per cent from last year’s record levels. The price of spot LNG, a key fuel source for Indian businesses, soared 40-fold from a low of $2 per million mBritish thermal units (one mBtu is 1,000 Btu) in May 2020 to a high of $80/million mBtu in March 2022, before crashing to $13/million mBtu levels now. US Henry Hub, a key reference rate to set domestic gas prices, has declined to $2.50/million mBtu from close to $9/million mBtu last August.

The declines happened amid tight supplies and an ongoing war in Europe and the weather has been an overriding factor. A warmer than expected winter in Europe, coupled with over 80 per cent gas inventory levels, proved a drag on fuel prices. The winter was equally warm in Northeast Asia, which includes the world’s biggest LNG importers such as Japan, China, and South Korea. China’s stringent zero-Covid policy also reduced demand for LNG. Spot LNG, which was trading at a premium of 100-400 per cent last year to crude oil, now trades at a discount. It is unclear what the future holds. Notably, new LNG production capacity in the US and Qatar, the world’s biggest producers of the fuel along with Australia, will come online in 2026-27, bringing a wave of LNG supplies to the market. But until then the weather will continue to play a key role.
 

It is not uncommon for governments to interfere in fuel prices. Even the US and Europe do so to protect the interests of consumers. A short-term subsidy in this context is understandable, but implementing wholesale changes and changing the rules of the game for investors can hurt a nation’s energy security. In principle, it is important for the government to balance the interests of both producers and consumers, and not tilt the scale towards gas utilities and other users. For instance, producers had been complaining for years about lower rates of gas under the administered pricing mechanism. Equally, the ongoing war in Europe upset the economics of city gas distribution firms last year.  
 

The Kirit Parikh Committee, set up in September last year to recommend changes in the natural gas pricing mechanism, proposed in November to alter the peg to set the rate of domestic gas to crude oil rather than global gas rates. It also introduced a ceiling on domestic prices, which were 24 per cent lower than the prevailing rates. The new pricing regime is expected to start on April 1. A price cap of $6.50/million mBtu corresponds to $65 a barrel of crude oil as suggested by the committee. Some forecasters expect Brent crude oil prices to average $92 a barrel this year and $100 a barrel in 2024. At such levels, domestic rates ought to be $9-10/million mBtu, but the price cap will nix any upside for producers, which have faced years of low realisation. The current gas-pricing mechanism has kept large oil companies away, leading to underinvestment in India’s exploration sector. The government needs to follow a long-term policy on gas prices.