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The KG basin price hike socialises costs and privatises profits

Why the Rangarajan Committee's complex pricing formula will inflict heavy burdens on the power and fertiliser sectors and give a private gas producer windfall profits

E A S Sarma 

E A S Sarma

The ministry of petroleum and natural gas has proposed to increase the price of natural gas from the Krishna Godavari (KG) basin from $4.20 per million metric British thermal unit (mmBtu) to more than $8 per mmBtu on the basis of a convoluted pricing formula recommended by the committee headed by C Rangarajan, chairman of the Prime Minister's Economic Advisory Council. The proposal will not only inflict a heavy cost burden on two price-sensitive sectors, namely, electricity and fertilisers, but also give away a huge windfall profit to the private gas producer.

It is bizarre that such an imprudent proposal should be mooted at a time when the producing company's recoverable gas deposits, as well as annual gas availability from its franchise area, have dipped - with no plausible justification - to less than a fifth of the originally assured levels. This has caused debilitating power shortages and idling investments made on gas-based power generation units downstream. Should the producer not be penalised for this mayhem?

It is all the more bizarre that there should be such a price hike when gas prices are falling the world over. A report in The Economist (June 1, 2013) reveals that, in North America, gas prices touched a low of $2 per mmBtu in 2012 and temporarily recovered to $4 per mmBtu. The increased availability of shale gas in the United States, Canada and China has already started exerting a downward pressure on gas prices everywhere. To propose a steep increase in domestic gas prices at this juncture is to ignore market signals, thereby inflicting heavy costs on consumers and showering an undue largesse on the private gas producer.

The production sharing contract for gas in the KG basin mandates "competitive, arm's length price, to the benefit of parties to the Contract" and requires that "the gas price formula/basis have approval of the Government". Evidently, whatever gas pricing formula the government approves should be competitive and mutually beneficial to the parties to the contract. In a perfectly competitive market, the producer's price would be no more than an efficiency-based unit cost plus a reasonable rate of return. If no competition exists, an independent regulator should necessarily determine such an efficiency-based price. There can be no via media solution.

The high costs of storage, liquefaction, re-gasification, pipeline transportation of gas and so on have rendered the gas market opaque and fragmented. The gas market responds to regional supply and demand pressures, driven further by short- and long-term trade perspectives. It is sensitive to local trends in the availability of substitutes such as coal, oil and shale gas in different sectors.

In search of the elusive benchmark indicators for pricing our own gas, the Rangarajan Committee has relied heavily on prices prevailing at regional trading "hubs" ("Henry Hub" in the US and National Balancing Point in the UK) and "netback" well-head prices for LNG imports in India and Japan. Those familiar with the gas trade know that spot prices could be as low as half the hub prices in a given region. When producers vie with each other to sell their gas, a prudent buyer can negotiate a price that lies somewhere between the hub price and the spot price. In such a scenario, to rely exclusively on the hub prices will be grossly imprudent.

The netback prices, derived by subtracting the costs of liquefaction and transportation from the delivered prices, can be equally misleading. For example, it has been alleged that India is being overcharged for LNG imports from some West Asian sources.

What the Rangarajan Committee has recommended is a virtual cocktail of tenuous hub prices and misleading netback prices. The committee has first averaged the two hub trading prices and the netback price derived from Japan's LNG imports, both for the previous 12 months. This is to be further averaged with the average netback price for Indian LNG imports for the previous 12 months. This final cocktail benchmark is to be deemed the "competitive, arm's length price". There cannot be anything more contrived than this, nor anything more inappropriate.

Coming back to the actual unit cost of exploration and development of gas in the KG basin, knowledgeable sources place it below $1 per mmBtu. The Rangarajan Committee has admitted that "a proposal of RIL in 2006 to approve the price of $2.34/mmBtu, which was the contractual price with RNRL, was rejected by the Government on the ground that the price was not derived on the basis of competitive arm's length sales in the region for similar sales under similar conditions". In fact, NTPC did receive a similar price bid from the same company for KG basin gas but, under duress, it was not allowed to accept it.

A group of ministers (GoM) ignored all this and, for reasons best known to it, fixed the price at $4.20 per mmBtu. Ironically, this price was fixed on the basis of bids obtained by the producers from a few power companies that had no incentive to quote a lower price, as they knew that whatever price they had quoted would be allowed to be passed through in the cost-plus regime of electricity regulation. The long and short of it is that the government, instead of appointing an independent regulator to fix gas prices, chose to step in and pass on a largesse of $1.86 per mmBtu to the producer at the expense of electricity and other consumers.

In the case of gas development in the KG basin, there have been other complaints too. One of them is that the ministry of petroleum and natural gas allowed the operator to enter successive exploration phases without the stipulated relinquishment area, and then allowed the operator to declare the entire contract area as "discovery area", thus avoiding any relinquishment whatsoever; that there is land subsidence and possible damage to the field and so on. The recent report of a "huge" gas discovery in the KG basin could be a repetition of the unfulfilled promises of the past, aimed at lobbying for a price increase in the name of creating a conducive investment climate. An independent inquiry alone will bring out the real facts.

Meanwhile, "socialise costs; privatise profits" seems to be the ministry's approach to KG basin gas!


The writer is former Union power secretary

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First Published: Mon, June 03 2013. 21:46 IST
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