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Gas based Power plants: An economic blunder? - Views on News from Equitymaster
 
 
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  • Jul 6, 2011

    Gas based Power plants: An economic blunder?

    Power generation in India is heavily dependent on coal. However, recently, gas based power generation is slowly picking up and it contributes to around 10%- 11% of the total power capacity. In a scenario where gas supplies are officially falling short  and imported gas prices continue to rise, will this shift make sense?

    Is the timing right?

    As domestic gas has been officially announced to decline and international gas prices remain high and volatile, financial viability of such gas based power projects is called into question. Especially because the basic raw material, natural gas, is highly in demand in other sectors which can afford it. The existing domestic fields can assure gas supplies only till 2016, unless new discoveries are made. The imported gas is too volatile and costly at current levels. Besides, too much reliance on imported gas jeopardizes the energy security of the nation.

    Lessons from the past

    There is no dearth of examples of the cases we can learn lessons from. For e.g., Jhanor (Gujarat) power plant had a good start but over a period of time, the gas supply from domestic gas field was disrupted. As a result, the plant had to struggle for gas supplies and had to bear high gas costs that had an adverse impact on the economics. A similar fate was met by Andhra Pradesh and Gujarat where either the gas based power plants could not take off or the power generation was stalled.

    Gas based versus conventional power plant

    A natural gas based power plant has a shorter gestation period (less than 3 years) and lower fixed costs  as compared to conventional power plant (3- 4 years). However, a gas based power plant makes sense (16% of RoE) over a coal based one if gas costs remain below or at US$7 per mmbtu. If the gas prices rise above US$ 10-US$ 12, it leads to unviable economics for the power sector.  In last one year, the spot natural gas prices have risen by 50%. This has turned power generation companies averse to the use of spot LNG. The power companies have stopped buying gas from companies like GAIL and Petronet (PLL)

    Logically speaking....

    Using plain economics, any resource that is in short supply should be used in the order so that the value addition is maximized. It will make more sense to use imported gas supplies in the sectors where they can be afforded at market prices like transport, cooking gas, refineries and gas retailers etc. This is because no matter how high the price of imported gas is, it will still be cheaper than oil (the substitute fuel for natural gas), 80% of which is imported by India. These sectors will willingly shell out high gas prices (still cheaper than other options like Petrol/diesel and LPG).

    Again, competitive bidding for power projects has shown that base-load power even from imported coal is mostly cheaper than gas-fired power at current gas prices. Hence, using gas for power generation is economical neither for power nor for other relevant sectors (where the marginal economic utility of gas is higher).

    Around 40% of the gas supplies serve Power sector. It will be much better to use gas as a substitute for oil rather than coal. Its value addition for other sectors like industrial fuel and for cooking and transport purposes is much better. The reason is that country is more self sufficient in coal rather than in oil. Such a move will also strengthen energy security of the nation.

    The fairness principle...

    Unlike the base power plants which will be reluctant to pay more than US$5.8 per mmbtu, the industry users like refineries and petrochemical plants would be willing to switch to gas up to fairly high gas prices (US$17-18 per mmbtu). Also, gas will be a much better (cheaper) substitute for diesel and petrol and unsubsidized cooking fuels rather than coal (coal based power plants).

    Consequences

    Any allocation of funds for such gas based power projects may turn out to be bad investment and may kill or raise the costs of funding for other profitable and viable projects. Long term security of the fuel through which power will be generated is imperative. The companies need to understand the cost bearing capacity implications which they are prepared to bear
    .
    Recently, GAIL forayed into gas based power generation. This is a big boost to company’s position along the value chain and potentially a sound business decision if domestic gas supplies increase in the near future. However, that is something only time can tell. The company’s RoE in the past few years has hovered above 19%.This compares to an approximate 16% RoE of a gas based power plant at US$7 to US$ 8 per mmbtu of gas costs (it is at this level that use of gas in a power plant makes more sense than coal). The company has already got ambitious capex plans for constructing gas pipelines and is at a high risk of facing low capacity utilization that can be stressful on its balance sheet. In such hazy circumstances, the decision to go far power plant doesn’t look too impressive as there will always be a risk of these power plants operating below their plant load factors.

    The parallel implications...

    PLL had struck a contract with Australia for gas supplies for its upcoming terminal at Kochi. Now, GAIL, the marketer of RLNG (regasified liquid natural gas) is in a fix as there are no off takers for this gas and GAIL had entered back to back agreement with PLL for this gas. The deal has turned out to be ridiculously expensive as the delivered price turns out to be US$ 20 per mmbtu versus a cost of US$ 15.6 per mmbtu for the imported gas from Qatar. The single biggest consumer of this gas, NTPC (for its power plant at Kayamkulam) is not for ready to pay such exorbitant prices at existing power tariffs and has insisted for a price rollback. If GAIL enters power markets with use of this gas, it will definitely strengthen the case for gas price pooling  which will make it easy to sell its expensive gas. This is because it will narrow down the relative difference between price from other cheaper gas sources and costlier imported gas.

    However, the move will be negative for market determined pricing of natural gas (a concept opposed to pooled gas prices). It should be noted that while pooling/averaging out prices of domestic and imported gas may benefit companies like GAIL and Petronet (they are finding no users for contracted imported gas supplies because of the high differentials in domestic and imported gas supplies), it has some fundamental flaws:

    1. There will be no incentive for such companies to negotiate for lower prices for imported gas in the future.
    2. It will lead to inefficient allocation of a resource already in short supply.
    3. It will be a disincentive to discover and produce more domestic gas. 

    Conclusion

    To conclude, even if the companies carry out fast execution and bureaucratic delays are ruled out, we think fuel supply, fuel costs and ability of users to afford higher fuel prices will be a tough challenge. Hence, before taking giant leaps towards gas based power generation, we need to look at breakeven efficiency and economics of power generation. We should rather focus more on long neglected city gas projects. In a novel idea by Petroleum and Natural Gas Regulatory Board (PNGRB), the gas allocated to power plants should be diverted for city gas distribution (CGD). CGD networks can deliver gas for localized power generation. It will tackle power shortage in peak hours because such localized gas fired units can easily be turned on and off as per the demand. This will also make CGD projects more viable for which already huge investments are in the pipeline without ignoring the power sector which is the back bone of the Indian economy.

     

     

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    1 Responses to "Gas based Power plants: An economic blunder?"

    Altaf Rahman

    Jul 16, 2011

    An excellent article. What attracted my attention is the argument that Gas should be used as replacement for Oil rather than Coal.
    My priority list of sectors for Gas supply are :
    1. Extraction of Helium and other fractional industrial gasses from every cubic meter of gas in India.
    2. Replace LPG for house hold use by piped CNG.
    3. Urea plants. Infact all Naphtha and other oil derivative based plants should be ordered to use Natural gas.
    4. Incentivize use of CNG in as many vehicles as possible.
    Ban use of Gas in Steel, Cement, Power sectors as it is a wastage as it is only replacing coal.
    If surplus gas is available after the above 4 users, conserve it for future.

    Like 
      
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