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Zonal tariff: Blockage in the gas pipeline?

Apr 19, 2011

Transmission tariffs (charges for gas transmission along the pipeline) are a key component of gas prices at the consumer end. Normally, it accounts for around 25% of the end price of gas. Needless to say, for city gas distribution (CGD) to become a success story in India, the tariffs need to be fair and reasonable. But , does current system of Zonal tariff along major pipelines in India fit the bill? We don't think so .

What is Zonal tariffing system?

Under zonal tariffing system, the pipeline network is divided into zones of 300 km each. All customers in the same zone pay the same tariffs. The tariff keeps rising at every next zone moving away from source to destination. Hence, the consumers located beyond 300 km of the gas source pay higher transmission tariff vis a vis the ones located within.

Zonal tariffing : An illustration (rates in Rs per mmbtu)
ParticularsEWPL (East west pipeline of RGTIL)HVJ-GREP-DVPLDVPL/GREP upgradation
Zone 1 (closest to gas source)152042
Zone 2422248
Zone 3542554
Zone 4592859
Zone 5 (farthest from gas source)61nana

Implications...

It implies that RGTIL will charge different fee for supplying gas to users in Andhra Pradesh, Maharashtra and Gujarat, depending upon their distance from the gas source. So, users in Maharashtra, for e.g , Dabhol Power Plant (which is closer to gas source) will have to pay less than those in Gujarat.

What is wrong with Zonal tariffing?

  • It leads to imbalance in economic growth. It promotes investments and market development close to gas sources. This will lead to concentration of industrial investments in states like Gujarat, Maharashtra and Andhra Pradesh at the cost of other states. Simply because they happen to be home/ closer to natural gas reserves. We should not forget that social problems for e.g. Naxalism exist in our country due to such disparities only.

  • The retail consumers located far from the gas source will pay higher tariffs vis a vis their competitors who are located close. This will be like unfair penalty on them.

  • The move renders the industries that are located far from gas sources uncompetitive as far as cost management is concerned. Especially because final products from all companies have to compete in the open market only.

  • Such a system may lead to irrationally priced gas. To give you an insight, KG-D6 ( a prominent domestic gas field) gas consumers in Delhi pay a tariff which is about 70% of the gas price at source ($4.20 per unit). Infact, the fuel costs 100% more in Punjab and extreme north. This certainly does not make sense. These tariffs have already been passed to consumers.

  • Variable tariffs also apply to CNG/PNG*. For users located far from fuel sources, such a system will make CGD unviable. Hence, this system doesn't bode well for India's plans to allocate CGD licenses for over 200 cities. Especially, for the PNG segment that already has to compete with highly subsidized LPG.
As per the earlier system, all the states /consumers paid same tariffs along a pipeline. This system is also known as Postalized tariff system.

Arguments against Postalized tariff system

  • Such a system where distances from the gas sources don't impact tariffs may lead to investments that don't make much economic logic. It may end up in non optimum allocation of capital and wrong siting decisions.

  • Uniform tariffs, if taken a closer look at, are same as 'Freight equalization'** policy that imposed huge economic costs and had to be done away with.

PNGRB's*** flawed logic in favor of Zonal tariffs....

PNGRB defends Zonal tariffs saying that a similar system exists for other sectors as well like railways, civil aviation and power transmission. However, we don't think that this analogy makes much sense. The dynamics of the other sectors are different. The share of operating costs for the other sectors is much higher than natural gas sector. Any kind of uniform pricing for other sectors will demand huge subsidies. However, in gas transmission, capital costs weigh way more and uniform pricing is a feasible option.

The other reason cited by PNGRB is that even developed nations have gone for zone based tariffs. All we can say is that as when it comes to natural gas sector, India is still at stage of infancy compared to others where such markets are stable. We should take a holistic view and should not blindly ape the systems outside.

As an offshoot of non uniform pricing, the weighted average rate of upgraded HVJ gas pipeline would be higher than the non upgraded by more than 100%. Hence, the existing consumers will pay the lower tariffs. On the other hand, the new ones in the same zone and using gas from same source will pay more than double. Such pricing defies all logic and is silly to say the least.

Conclusion...

Zonal tariff can put the CGD story to an abrupt end. It questions the viability of PNG. Also, it does not provide a level playing field to same industries located in different areas. The states having natural gas resources already get revenues from royalty on onshore (on land) fields. There is no reason to offer them double returns by such a system. It just doesn't go well with concept of pooling gas prices to ensure uniform pricing. The current system is at odds with Gas utilization policy as well wherein the gas is allocated to the priority sectors at a fixed cost with a purpose to address the gap in demand and supply. As far as question of economic logic is concerned, if consumer goods companies in India can ensure uniform prices for their products irrespective of raw material sources, taxes and logistics costs and can remain viable, it should not be that daunting a task for gas transmission companies.

*CNG/PNG : Compressed Natural Gas ( fuel for vehicles) and Piped Natural Gas (for cooking etc.)

** Freight equalization policy implied that a factory could be set up anywhere in India and the transportation of minerals would be subsidized by the central government. Thus, factories were set up all along the ports or around big cities except Bihar which was one of the richest in mineral resources . The policy simply destroyed Bihar's huge competitive advantage of holding minerals. Though, the policy has been removed now but, presently Bihar lacks the infrastructure to compete with other states.

***PNGRB : Petroleum and Natural Gas Regulatory Board


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1 Responses to "Zonal tariff: Blockage in the gas pipeline?"

Ashish Dimri

Apr 21, 2011

The article ovelooks one simple fact - what is the cost of gas as a percentage of cost of production for an industrial user? Generally, the cost of natural gas in an industry using natural gas for its heating requirement (except glass/ceramics/foundry) would be not more 20% of the total cost of production. The difference in transmission cost for KG D6 gas (for zones 1 & 5) is 20% of the cost of gas. Which means, the cost of production for the farthest customer would increase by only 4%. Considering the differential between natural gas & other fuels, the farthest producer would still manage to generate savings by switching over to natural gas. Of course, it would have to put in extra efforts to reduce other costs/overheads to bridge the 4% gap vis-a-vis its competitors nearest to the gas source. Thus, as far as the industrial users are concerned, the location does not make a big difference.

In the case of PNG & CNG, the would not be true, but the argument can proceed along similar lines if the subsidies on LPG & Diesel are removed. The govt. has already allocated domestic gas, which is around 60% to 70% cheaper than LNG, to CNG & domestic consumers. e.g. Gujarat is located closer to the domestic gas fields as well as LNG import terminals. Yet, the CNG price anywhere in Gujarat (there are 3 companies marketing it) is higher than that in Delhi!

Moreover, natural gas is not the only source of energy. An industrial consumer has a choice of liquid & solid fuels as alternative to gas, apart from electricity. Industries in regions away from gas sources are closer to sources of coal (a cheaper fuel) & hydroelectric power. Thus, the higher cost of natural gas would be offset by a lower electricity cost, if they convert to gas. Else, coal is always going to be more economical than even natural gas at wellhead.

Thus, a zonal tariff policy would in no way influence the industrial development of an area. The story considers only the transportation cost of east cost gas. There are other sources of gas too - developed ones like LNG import terminals, developing ones like the CBM fields in Central & Eastern India & potential ones like shale gas. Once all the sources are well developed, gas would be available at all corners & no location would be too distant from the source. The, the customer would make a choice based on the cost of gas at source plus the transportation cost to site & the zonal tariff would make the playing field level.

A postal tariff is cross-subsidising one set of consumers at the cost of others. At a time when we have removed most of the subsidies (except fuels), it would be contradictory to push for the same in a new industry.

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