Gas pricing: Is price pooling the answer? - Views on News from Equitymaster

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Gas pricing: Is price pooling the answer?

Apr 14, 2011

Multiple gas prices in India have existed since ever. But never before the case for gas price-pooling# gained so much momentum as in the recent times. And the reasons are not hard to find. The gas supplies from APM reserves and KGD6 basin continue to decline. The key sectors of Indian economy - power and fertilizer that account for 70% of the gas energy demand are facing the issue of procuring enough gas to keep them running. Till now, they could bear subsidies on final products as the gas input also cost low (subsidized at US$ 4.2 per mmbtu).

But now, they depend more on imported gas which is priced higher than APM gas . The price of imported gas is linked to oil price. That makes it volatile. Hence, there are issues regarding economic viability of industries in these sectors with subsidies on the end products (In India, power tariffs and urea /fertilizers are subsidized).The industries in the priority sector are not ready to enter long term gas contracts at such high prices.

Expectations galore

The Government of India (GoI) believes pooling gas prices could be a solution. It will reduce the price of imported LNG by spreading the higher costs of imported gas over larger volumes of cheaper domestic natural gas. This can induce priority sector to go for long term contracts and let them plan investments based on LNG.

The other reasons are to ensure uniform prices for the end users . The pooling concept will allow efficient swapping of gas across networks and states as per pure play of demand and supply. Besides, it will send stable signals to attract meaty investments, especially foreign funds. It will encourage discovery of new gas sources. Further, it will make gas transmission business more viable.

The pitfalls

Pooling gas prices will take away the pricing power from gas producers. It will transfer all control in Government's hands. While company like RIL could bear it because of the sheer scale of operations, it will crowd out small and new players in the sector. It is for the same reasons that there are no private retailers for sale of Petrol and diesel.

Hence, while the intention behind gas pooling is good, it may lead to a deliberate slow down of the field development work .This will end up in retarding the growth of the sector.

Since nothing can be done about the imported gas, for the pooled concept to make sense, the GoI will ask domestic players to cut costs or reduce margins. This will work against market dynamics and discourage investments in the sector. Ultimately, it will increase our dependence on imports and feed the vicious circle. Things can get even worse. Knowing that highly priced imported LNG will be absorbed after getting pooled with the domestic supplies, the RLNG negotiators may end up with commercially unattractive contracts . This will increase operating costs for priority sector.

Impact on upstream sector

Ideally, the gas prices of upstream producers should be based on market dynamics in tune with the risks taken . This can be taken care of by a competitive bidding process approved by the GoI (as envisaged in PSCs). However, in a pooling scenario, any increase in imported prices will put pressure on domestic players to reduce the domestic prices so that pooled prices remain below a particular level*. As APM blocks already continue to decline, this will be a disincentive for domestic players to invest in oil recovery techniques. It will also discourage Private investors to make investments in the sector.

Gas pooling is not a new concept in India. Even APM was a sort of pooled price concept for gases from various pre NELP^ blocks. But this time, a nominated Government agency will be responsible for allocating amount and deciding common prices for priority sectors (power and fertilizer) for gas produced from NELP. Hence, this will be bad for price discovery mechanism. Such a move does not align well with India's long term energy policy. It works against the linked value chains.

Gainers /losers?

GAIL is having a tough time selling the LNG procured by Petronet from Australia at an estimated cost of US$17 per mmbtu (to be delivered by end of 2014). This compares to APM price of US$4.2 per mmbtu. NTPC which was expected to be biggest consumer of these supplies also requested for a roll back. The price pooling, if happens, will bring huge relief to Petronet and GAIL and other consumers of imported gas/highly priced gas from Panna, Mukta and Tapti fields. However, it will be at the expense of domestic gas producers like ONGC. The uniform pricing to the consumer will also hit the fertiliser and power plants who get gas below this price in the current set up. Hence, the move is not in long term interests of power companies like NTPC and fertilizer units. Having said that, it will make it easier for these companies to go for imported LNG (as post pooling, the prices for imported gas will smooth out to some extent).

While it will depend on a case to case basis, we don't think that under current scenario, power plants/fertilizers based on imported gas supplies is a very good idea. The reason is power tariffs in India are controlled and fertilizers subsidized. Such a system will restrict margins in the sector. Due to tight supply of LNG at unviable prices, it will be hard to secure long term contracts .Unless firm supplies are in place, either lender will not be willing to fund the priority sector or cost of funds will become too high. Hence, companies like NTPC will be at disadvantage. The pooling of gas prices could make APM gas way costlier than current levels thus increasing the cost of power generation/producing fertilizers.

Is there a solution?

To be honest, we do need uniform pricing . However, it should be transparent and should reflect the market trends. The pooling system may ensure a uniform pricing but that comes along with cross-subsidization that results in distortion of the market. Also, we can't keep selling gas at low prices forever as we do now.

None of these approaches promotes investment in the domestic sector . Instead, they work against a positive competitive environment.

The only long term solution that is sustainable is market pricing of gas. Gas prices need to be below certain level mainly for the priority sectors , i.e, Power and fertilizers. The remaining sectors, which have the freedom to set prices of final products, should be able to afford gas at market prices. Hence, the optimum price to be charged for gas to priority sectors should be determined by the price of substitutes- imported fertilizers and alternative fuel (imported coal). But if current trends are anything to go by, it seems it will be better to have long term security of imports of coal and fertilizers at reasonable prices rather than relying on imported LNG.

#Pooling means outputs from different sources are pooled together and dispatched according to pre set rules. It will lead to a uniform gas price. Producers who join the pool price system would get the price agreed with their consumers and approved by the government as per the production sharing contract (PSC). However, pooling will iron out the difference in price of gas from different sources. Hence, those who get it cheap now under government administered pricing will have to pay more. Those who pay more now, for e.g., consumers of imported re-gassified liquefied natural gas (R-LNG) would get the fuel cheaper

* The aim of pooling is to make gas prices uniform and affordable. Since we can't control prices paid on imports, domestic producers will bear the brunt of any unsustainable increases in oil prices

^In India, all natural resources embedded in the earth's crust belong to the state. To explore and produce crude oil and gas, private operators need a licence from the Centre. The process of awarding licences is via open bidding and is called new exploration licensing policy (NELP).The aim is to encourage FDI and private-sector participation in exploration and production (E&P).

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