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Welcome to the pool party - Views on News from Equitymaster
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  • Sep 9, 2000

    Welcome to the pool party

    In the last few months, crude oil prices have started to resemble some ride in an amusement park. This has brought the commodity publicity in the form of front-page coverage in the top dailies. Readers are now familiar with the oil industry jargon; oil pool account (OPA), administered pricing mechanism (APM) etc. But not many have heard of oil pool's lesser-known sibling, gas pool account (GPA) and the gas pricing mechanism (GPM).

    Till 1986, the Government permitted the producers to determine the price of natural gas. This was based on the thermal equivalence of substitute fuels.

    However, from 1986 onwards the Government decided to fix a uniform price for natural gas on a yearly basis. It was only in 1995 that a committee was appointed under the chairmanship of Mr. T.L. Shankar to review the GPM. Based on the recommendations of the committee the Government introduced several changes.

    In October 1997 the pricing policy shifted from a fixed price regime to a more market driven mechanism. Under the new mechanism, domestic gas prices were linked to a basket of international fuel oil prices. Also, this pricing mechanism was based on thermal content (international practice) of the gas as compared to the volumetric formula under the fixed price regime.

    The basket consists of an equal mix of low and heavy sulphur oils. Namely

    • Italy medium sulphur (1% sulphur) on F.O.B basis
    • New, ARA (1% sulphur) on C.I.F basis
    • Singapore HSFO (3.5% sulphur) on F.O.B basis
    • Arab Gulf, HSFO (3.5% sulphur) on F.O.B basis

    To ensure a smooth transition to a complete market driven mechanism (MDM) the Government adopted the policy of gradually linking domestic prices to international prices.

    Gas price = Consumer price + Transmission charges + Royalty + Sales tax

    Consumer price (based calorific value) = Basket of international fuel oil price * respective linkage rate * foreign exchange rate

    The consumer price is linked to a calorific value of 10,000 Kcal (Kilo calories)/tscm (thousand standard cubic meters) and will be adjusted accordingly. It also has a floor and ceiling price level of Rs 2,150/tscm and Rs 2,850/tscm respectively. In the North Eastern states the rates fall between Rs 1,200/tscm and Rs 1,700/tscm. Gas prices in the North Eastern states have been subsidized to promote commercial and industrial activity in the region.

    Transmission Charges: Gas Authority (GAIL) is to be paid a fixed rate of Rs 1,150/tscm. The charges are linked to a calorific value of 8,500 Kcal/tscm and will be adjusted accordingly. Further, GAIL is to be paid an additional 1% of the transmission charges for every 10% increase in the consumer price index (CPI). This additional charge will be borne by the GPA and not by the consumer.

    These transmission rates apply only for the Hazira, Bijaipur, Jagdishpur (HBJ) pipeline. For the non-HBJ pipelines the rates are based on independent contracts. The average rate for non-HBJ pipelines is Rs 195/tscm and has an escalation provision of 3% p.a.

    Royalty: It is to be paid to the gas producer, Oil & Natural Gas Corp (ONGC), at the rate of 10% of producer price. Sales tax of approximately 4% is to be levied. The Gas price or Total consumer price is to be collected by GAIL and is to be allocated as follows:

    • GAIL is to retain the difference between the gas purchase price from joint ventures (JV's) and the producer price.
    • A flat sum of Rs 2.5 bn is to be contributed to the Gas Pool annually.
    • After deducting the gas pool charges and compensation for gas purchases from JV's, GAIL is to pay the balance amount to the gas producer.

    Producer Price = Gas Price - Gas Pool Account - compensating GAIL for gas purchases from JV's.

    The funds in the Gas Pool Account are to be used for:

    • Paying additional 1% transmission charges to GAIL for every 10% increase in CPI.
    • Compensating Oil India Ltd. (OIL) for supplying gas to the North Eastern states at subsidized rates.
    • Research and development purposes for exploration of new gas fields.

    With the low consumption of gas in the North Eastern states, there is only a small outflow from the gas pool for compensating OIL against the subsidies provided. Thus, the gas pool is in surplus as compared to the large deficit in the oil pool.

    However, the contribution to the gas pool is static. With crude prices firming up over the past year gas prices have also soared, in fact they have doubled over this period. Consequently, the burden on the pool has also increased.

    Gas has been termed as the fuel of the future and is one of the fastest growing energy sources in the country. With usage rates expected to increase in the coming years the burden might further increase on the gas pool. This threatens to send the gas pool the oil pool way.

    The current pricing policy was valid till FY00 and since no new policy has been enunciated the existing arrangement continues. It is expected that the new policy will increase the linkage rates to 85% and 95% in the next two years respectively.

    From FY03 the APM in the petroleum sector is expected to be dismantled, one can expect a similar fate for the GPM.



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