The questionable logic behind gas price hike

Mon, 8 Jul Pre-Open

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The stock markets this week have opened on weak note with rupee slipping past the psychological barrier of 61 against the dollar. As rupee touches new low of 61.1 versus dollar, the Sensex today is down by around 230 points (1.2%), while the NSE-Nifty is down by around 77 points (1.3%). One of the worst hit victim of this development will be the oil and gas sector. This is because India is mostly reliant on imports to meet its energy needs.

Last week too was eventful for India's energy sector as the Government approved a twofold hike in gas prices, to be effective from April 2014. While a gas price revision was due, what is surprising here is the quantum of hike. The suggested price at US$ 8.4 per mmbtu is much higher than US$ 6.7 per mmbtu as proposed by the oil ministry. So what is the logic behind this number?

As per Cabinet Committee on Economic Affairs (CCEA), the new price is based on the formula that includes the cost of imported LNG in the country and average of international benchmarks. But what we are finally looking at is not a formula approved by the Cabinet, but a final price tag with little regard to transparency.

While the current average is estimated at around US$ 6.7 per million metric British Thermal unit (mmbtu), the price at US$ 8.4 per mmbtu (to be applied from April 2014) takes into account expensive Australian LNG imports and lifting on the price cap of Qatar LNG next year. As per the Government, the hike in prices will boost the investment in domestic gas sector. However, we wonder what this noble intention has got to do with international prices. Why did not the Government consider long term return on investment criteria over the life of the project for coming up with the viable price for the gas? Further, why is the price quoted in dollars, and that too without any consideration for exchange rates? While it can increase the acceptability of imported gas, the new price ignores exploration costs and return on investment- the key factors that should be borne in mind while deciding the viability and ways to incentivize the sector.

Also, it is worth noting here that few years back, the gas prices were increased from US$ 1.79 per mmbtu. Interestingly, the revised level of US$ 4.2 per mmbtu was arrived at by Reliance Industries (RIL), a private gas producer. It is ironical that RIL itself has been crying foul over the unviability of business at current prices and has stalled a major share of domestic gas production. Far from getting penalized for blocking a national resource, the company seems to be getting its own way. In short, hiking prices in the past has not helped India in improving the gas production profile. It will be naive to assume that future will be any different.

As far as impact on fiscal health is concerned, the increase in prices will increase royalty income for the Government. However, it will lead to even higher subsidy burden to compensate priority sectors like fertilizer and power sector (that are the key consumers of natural gas). And it is quite likely that the burden will finally be passed to state run gas exploration companies like Oil and Natural Gas Corporation (ONGC), thus defeating the entire logic of incentivization. On the other hand, the private gas producers like RIL will just enjoy the upside of the move, that too if they find it good enough to resume production. To conclude, the new price levels seems to be serving corporate interests under the pretext of reforms.