Panel for linking domestic gas price to global average

The Rangarajan Committee, looking into the Production Sharing Contracts (PSCs) in the oil and gas sector, has suggested an annual revision based on an average of international gas prices unlike the five-year cap currently in place for gas produced in Reliance Industries’ KG-D6 block. Currently, $4.2 per million british thermal units (mbtu) is the benchmark for domestic price.

“We have suggested that domestic gas price has to be comparable to prices elsewhere in the world and do not result in undue profits at the same time. The alternative pricing recommended will apply to all price decisions in the future. For existing contracts, companies will have to wait till their expiry,” C Rangarajan, Chairman of the Prime Minister’s Economic Advisory Council (PMEAC) said.

The recommendations are part of the panel’s report submitted to the prime minister recently. The suggestions are now expected to be vetted by the oil ministry before being put up for consideration by the Empowered Group of Ministers (EGoM) on gas pricing. According to sources, the suggestions may also be taken up by the Cabinet.
 

PRICING FORMATIONS IN OTHER COUNTRIES

• North America: During mid-80s gas market was deregulated and was operated through various hubs. Most of these hubs are now linked to the Henry Hub located near Gulf of Mexico 
• UK: Regulations allowed customers to directly buy gas from producers, bypassing British Gas, the earlier sole buyer and distributor of gas. This paved the way for a wholesale gas market hub called National Balancing Point. This is the most liquid and mature gas market in Europe
• Asia Pacific : Market dominated by Japan. Currently, most Japanese contracts are weighted price of oil imported into Japan as the index

Industry sources said the price would still be an arrived one and would not give pricing freedom to the contractors. The committee has proposed the formula for five years after pricing comes up for review. Considering the gas price is due for revision in 2014, it will mean that the possibility of pricing based on direct Gas-on-Gas competition will arise only in 2019. Gas-on-gas competition is the dominant pricing mechanism in the US and the UK where price is determined by the interplay of gas supply and demand over a variety of periods.

Though the proposed policy, in the committee’s view, would provide for estimation of “an unbiased arm’s length price”, industry executives said it was an extremely complicated formula and would cause confusion leaving the contractors with no incentive.

The committee has suggested an annual revision in price based on monthly moving average of net back price for producers of Indian LNG and the other volume weighted price of US’s Henry Hub, UK’s NBP and Japan Custom Cleared. “The arm’s length price thus computed as the average of the two price estimates would apply equally to all sectors, regardless of their prioritisation for supply under the Gas Utilisation Policy,” said the committee.

The Rangarajan panel’s recommendations also included audit of major blocks by the Comptroller and Auditor General of India (CAG) and the rest by auditors empanelled by the national accounting watchdog. “The authority of the CAG is unquestionable,” he said. The committee has said CAG audit should be done concurrently with, or prior to, the audit of the ministry. This will ensure that decision-making processes in determining profit and cost petroleum are not implemented. This comes at the backdrop of a recent row over CAG’s audit of Reliance Industries’ KG-D6 gas block.

With a new fiscal regime in place, the committee sees no requirement for an audit by CAG. Besides, in a relief to government-owned companies and coal bed methane producers, the committee has recommended that since the element of cost recovery is not currently applicable to CBM blocks and the nominated oil and gas blocks, CAG audit for such blocks may not be required. Instead production monitoring through field surveillance may be considered adequate.

The panel has suggested moving away from the current cost recovery formula that guides PSCs. “Since cost recovery is at the root of the problems experienced, it is proposed to dispense with it, in favour of sharing of overall revenues of the contractor, without setting off any costs,” Rangarajan said.

Under the suggested mechanism, the bidder will offer different percentage revenue share for different levels of production and price levels. “The bids will have to be progressive with respect to both volume and price. This will ensure that as the contractor earns more, government gets progressively higher revenue,” Rangarajan said. He added that the new arrangement is much simple and will help avoiding disputes. It will also enable speedy implementation of projects and encourage more bids.

For disputes between the government and operator nominees on the management committee that oversees blocks, the issue should be referred to the Empowered Committee of Secretaries if it remains unresolved for a particular time.

On the issue of tax holiday, the executive said the committee has not brought any clarity on whether it should be made applicable for gas production as well. The committee has proposed that the tax holiday be extended to 10 years, as against seven years already available for all blocks, blocks having a substantial portion involving drilling offshore at a depth of more than 1,500 metres, since cost of a single well can be as high as $150 million.