Stepping on the gas

Defying populist cries, the government opts for a steep hike in gas prices.
Anilesh S. Mahajan        Print Edition: July 21, 2013

India is a highly price- sensitive market. Thus the challenge of pricing a natural resource in a way that simultaneously balances the interests of industries in that sector and those of the ordinary citizen is a daunting task. But it is one the Union government has confronted while revising the price of natural gas.

On June 27, the Union Cabinet, after a heated debate in a meeting, decided to change the pricing process beginning April 2014. The revised pricing formula was suggested by a committee headed by the Chairman of Prime Minister's Economic Advisory Council, C. Rangarajan. This will link the price of domestic natural gas to international gas prices. In addition, the domestic price will be reviewed every quarter.

The revised formula, if applied to today's international price, would raise the domestic price to around $6.775 per million metric British thermal unit (mmBtu). This would be almost 50 per cent higher than the current domestic price charged by Reliance Industries Ltd (RIL) at its KG D6 block, $4.21 per mmBtu.

Why is a price revision needed? The gap between India's domestic gas production and demand has been widening. The daily gap of 143 million metric standard cubic metres at the end of the last financial year will rise to 235 mmscm in 2015/16, according to petroleum ministry's presentation to the Cabinet. Imports, to cover the shortage, are going to cost a good deal more than before, with the rupee weakening to a record low of about Rs 60 to the US dollar.

"The only solution is to increase the domestic production of gas. No one will invest in India, especially in this high-risk business, if they do not get returns on their investments," says Petroleum Minister M. Veerappa Moily, justifying the stand his ministry, together with the finance ministry and the Planning Commission, has taken, maintaining domestic gas production needed to be incentivised by offering better prices.

Today, there are a range of domestic gas prices, depending on the contracts governing gas production, ranging from $1.08 to $5.65 for a unit of gas. The
RIL price of $4.21 per mmBtu yields a profit of roughly $2 per mmBtu, say oil ministry officials. In comparison, LNG imports cost almost $12 per mmBtu at the western shores of India.

As natural gas is feedstock for sectors as varied as electricity generation and fertiliser production, there is intense lobbying when the natural gas price is set to be revised upwards. The mere prospect of prices being raised had triggered a political maelstrom even before the Cabinet chose to bite the bullet. Communist Party of India (CPI) parliamentarians such as D. Raja and Gurudas Dasgupta had loudly opposed any move to hike the price. Dasgupta told Business Today that the price revision was only meant to help private gas producers, in particular RIL.

Moily brushes aside such arguments. "We need to encourage domestic players. India is floating on a great pool of oil and gas. There are some importers who don't want India to expand domestic production. They have threatened every petroleum minister," he said, sparking off a political uproar.

Following the decision to raise the price, Finance minister P. Chidambaram sought to soften the coming blow by saying the government could soon look at mechanisms to lower the input fuel costs for the power and fertiliser sectors, which would be hit most by the hike.

The gas price hike will put an extra burden on the government itself, increasing the subsidies it provides to the power and fertiliser sectors, at a time when Chidambaram has publicly committed himself to rolling back India's fiscal deficit as a proportion of its gross domestic product, from its current level of 4.9 per cent, by pruning subsidies.

The net margins of urea manufacturers may dip by 30 to 40 basis points once the gas price rises, says rating agency CRISIL. Thus the fertiliser sector alone will need additional subsidy by around Rs 9,000 crore. CRISIL also projects that the power purchase cost of distribution companies will rise by Rs 0.12-0.15 per unit as generation utilities pass on the increase.

Insiders maintain the government was a divided house on the gas price hike. Power Minister Jyotiraditya Scindia did not see any reason for an upward revision. Former petroleum minister S. Jaipal Reddy, too, reportedly opposed the revision at the Cabinet meeting arguing there was no compelling fiscal need to change the existing system. But Chidambaram and Moily prevailed upon the Cabinet to opt for the price hike.

The Rangarajan committee had suggested the price should be computed by taking the average of two scenarios. One, the average price of imported gas from different sources and two, the average of the gas price at three global critical points - Henry Hub (for North America), the cost at which the UK imports gas and the cost at which Japan imports gas. RIL, however, is not satisfied with the formula. "The price of gas should be market- determined. This is the accepted practice globally," says an official who does not want to be named.

The Cabinet's decision will also end the multiple gas pricing mechanisms currently prevailing in the country. There are different prices for gas produced under administered price mechanism (APM), non-APM, joint ventures, coal bed methane (CBM) ventures. Once the existing contracts end, everyone will move to the Rangarajan formula. This is expected to pave the way for refining the shale gas policy and could resolve the ongoing differences in pricing of gas derived from CBMs.

And the Rangarajan formula will be eventually replaced by a new pricing formula that is being devised by a committee headed by Vijay Kelkar, Chairman of the Thirteenth Finance Commission. "All gases flowing into the Indian gas system must have competitive pricing. But this will happen gradually," says an official, who worked on this new pricing mechanism at petroleum ministry. This concept, which is prevalent in the US, Canada and the UK, is also called as gas-on-gas competition, and is backed by the Rangarajan committee and Planning Commission.

With inputs from Ajay Modi

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