Should gas prices be market-determined?

DEBATE

While market-determined pricing may be consistent with the government's policy initiatives, can the spin-off effects be overlooked?

Ashish Kashive
Head, Fuels Practice,
CRISIL Infrastructure Advisory

"Market- determined pricing will serve the country's energy security objectives better"

The current gas-pricing regime in the country is a mix of market-based and regulated pricing. About 50 per cent of the total gas consumed in the country is sold at administered prices; the balance being sold at market-determined or commercially discovered prices.

The Ministry of Petroleum and Natural Gas signalled through its pricing order, that only gas from the nominated fields of ONGC or OIL would be made available to power, fertiliser and other small-scale consumers at the price of Rs 3200 per million cubic metre(MCM). All non-Administered Price Mechanism (APM) consumers of GAIL would be on market-determined prices.

Market-determined pricing of natural gas will serve the country's energy security objectives better in the long-term and it is consistent with a number of policy initiatives the government has already undertaken in various sectors.

The Integrated Energy Policy (IEP) envisages a gas demand of 224 million tonnes of oil equivalent (MTOE) for India by 2031-32. To secure energy supplies and attract investments from the private sector, the Centre formulated an investor-friendly New Exploration Licensing Policy (NELP) in 1998. This policy has been successful in meeting its objectives with India's gas reserves accretion increasing from 151 billion cubic metre (BCM) in 1990-1998 period to 624 in the period 1999-2005.

NELP was successful on account of various commercial and fiscal incentives made available to contractors. One of the incentives provided to the contractors was to sell the gas in the market at prices, which are determined on a competitive arms length basis. In order to encourage investments in the upstream and secure energy supplies, continuation of the provisions of NELP is essential.

In the upstream business, an entity can survive in the long term only if it is able to replace the resource it produces. Hence, one of the key parameters to measure the performance of an upstream entity is its reserve replacement ratio. The cash, which the upstream entity generates, needs to be invested in the "finding" of new resources, and no certainty can be attached to this "finding". The inputs are deterministic, while the output is probabilistic. As it would be difficult to prescribe a reasonable return for the sector, pricing of gas needs to be undertaken through a market-determined approach rather than a cost-plus reasonable return approach.

One of the main arguments against market-based pricing of gas is that the end use sectors would not be able to adjust to the higher gas prices. In this regard, it may be noted that as APM gas volumes decline and gas from new NELP fields will increase, the pooled price of gas would gradually move to market levels for these sectors and allow for a smooth transition to a market-determined gas pricing regime. This would provide sufficient time and support to evolve policies in the end-use sectors, which encourage targeted subsidies. A mechanism wherein all the customers are charged on market-determined prices for commodity elements of supply (and hence market-determined fuel prices) with specific needy customers getting subsidy through other mechanisms, could ensure optimal utilisation of resources, minimisation of subsidy payouts, efficient price discovery of fuels and investments in fuels and demand-side sectors.

It is noteworthy that the Indian government has dismantled APM in the refining and marketing sector. The Electricity Act and other policies propagate a competitive market structure for the power sector.Even in the telecom sector, a competitive market structure enabled its growth. Hence, the market-based approach to gas pricing is in line with the prevailing and evolving policies of the government in other sectors.

It is imperative to develop a market-based approach to the pricing of NELP gas in order to create a conducive environment for the development of the upstream sector in India and the attainment of energy security. The prevalent process of aligning APM gas to market-based pricing could continue in a phased manner.

The views expressed here are personal

P Panduranga Rao
Director & CEO,
LANCO Kondapalli
Power Pvt Ltd

"Pricing of the domestic gas on import parity crude price basis cannot be justified"

The pricing of natural gas should not be market determined. Before finalising a pricing policy, the government needs to consider the interests of major user industries such as power and fertilisers. High gas prices mean negative spin-off effects down the whole consumption chain "" from farmers to domestic and industrial power users.

Gas pricing of the domestic gas on import parity crude price basis cannot be justified. At the best the comparison can be made on export parity of gas because the large volume of the gas which is produced by the very large exportable countries need to be bench marked for fixing the gas price.

If the large volume of gas is to be exported after converting the gas into LNG by making huge investment for a long term supply contracts, the net back price (recently concluded in Iran contract is $3) has to be arrived after considering the re-gassification and transportation cost.

The netback market value approach has been the basis of gas pricing in Europe.

The price mechanism was initially developed in the pipeline gas business which needed to recover the large capital costs involved in the construction of transmission networks.

There is no justification to link the price of domestically produced gas to international oil prices as other countries which produced gas are not doing it.

So why should India do this?

It is interesting to look at other gas producing countries around the world.

In the large gas producing countries of the world, the domestic customers are priced varying between $1.6 to $3.0 per MMBTU. The pricing of the domestic gas should be on similar lines "" large gas producers in the Krishna Godavari basin should be pricing gas at around $ 3.0 per MMBTU.

It is imperative that a significant portion of domestic gas production, including the contractor's share, should be earmarked for the power sector, according to Article 21.1 of the profit-sharing contract (PSC). The Article states that all proposals by the contractor related to the discovery and production of natural gas should be in the context of the government's policy for utilisation of natural gas.

It is also important to note that large quantum of gas can be monetised quickly by the anchor customers like power and fertilisers and these customers are to be supplied at a concessional rates than the gas being supplied to other customers like CNG and other industries requirements.

The government should also consider the pipeline network in place. The charging should be not on the quantum of gas flowed through but based on the recovery of the investment in the pipeline network over the life of the pipeline.

Ideally, the cost of natural gas should be decided by the end-use and not by its source because nowhere in the world is the price of gas based on its source. It is always on end-use pattern or demand-supply situation.

Gas is not fungible commodity which can be exported like other commodities and it cannot be compared like cut flowers or international crude oil to bench mark with the domestic gas prices.

On the contrary, gas is a primary commodity, which is being produced within the country and being used for the purpose of domestic power, fertilisers and industrial customer's needs. Pricing formulae should be oriented towards the industrialisation of the nation to generate employment and wealth for all.

It is important that prices should be made affordable to power and fertiliser plants.

The views expressed here are personal