PNG price cut transmission falters

Against 18% reduction in domestic gas prices, PNG cut was a mere 3%

The government had recently announced an 18 per cent reduction in the price of domestic natural gas from $4.66 million British thermal units (mBtu) to $3.82 mBtu, reflecting the fall in global prices. The price of piped natural gas (PNG) in Delhi was cut by 70 paise from Rs 25.35 to Rs 24.65 per standard cubic metre (scm). Compared to the 18 per cent reduction in domestic gas prices, the price of PNG was cut by a mere three per cent.

In contrast, Ind-Ra, a rating agency, has estimated that PNG prices should be cut by Rs 2.1 to Rs 2.3 per scm to fully reflect the fall in domestic gas prices. “The PNG price cut in Delhi does not fully reflect the recent reduction in domestic gas prices,” says Vikash Anand, analyst at Ind-Ra, a rating agency. (INDIA’S PNG MAP)

What explains this incomplete pass-through? The explanation in part rests on the way the city gas distribution (CGD) model works. CGD firms, as K Ravichandran, senior vice-president and co-head, corporate sector ratings, ICRA, points out, “largely enjoy monopoly positions”. This gives these firms unique pricing power in markets where competition is largely restricted.

Pricing of PNG, as Nitin Zamre, managing director of ICF International, a consultancy firm, says “is generally done on the basis of alternate fuel pricing - LPG, fuel oil, diesel, etc.” This implies that PNG pricing has to be only marginally competitive to subsidised LPG for it to be an attractive proposition.

CGD firms are also free from the clutches of the regulator when it comes to pricing decisions. Following a decision of the Supreme Court, city gas pricing is not regulated by the Petroleum and Natural Gas Regulatory Board. This implies that firms are under no obligation to completely pass on cuts in domestic gas prices to the end consumer.

One could argue that because of underrecoveries in the past, the price of PNG has now not been cut fully to reflect the fall in domestic gas prices.

But, industry experts contend the pricing strategy employed has varied at different points in time. “Initially, PNG was priced at a discount to LPG. This pricing strategy drove conversions during the initial phase of expansion,” says Vivek Jain, associate director, Ind-Ra. This strategy attracted customers shifting them away from subsidised LPG.

Subsequently, PNG prices rose sharply, making it less competitive to LPG. This was largely because of the change in the energy mix. As demand for PNG rose, CGD firms had to rely on imported gas, which is costlier than domestic gas, to bridge the gap. The higher price of imported gas ended up being passed on to the end consumer.

However, after the government gave CGD top priority in domestic gas allocation, PNG prices came down although they remain more expensive than subsidised LPG. Prior to the recent revision in gas prices, PNG was 7.9 per cent more expensive than subsidised LPG, while after the recent revision it is five per cent costlier. By comparison, Ind-Ra estimates PNG prices should be cut by Rs 2.1 to Rs 2.3 per scm to fully reflect the fall in domestic gas prices, making it 1.1-1.4 per cent cheaper than LPG.  This reflects a change in pricing strategy. Jain says, “The pricing strategy is driven more by convenience. PNG is a sticky source. There is a degree of convenience that customers associate with it.”

Indraprastha Gas Limited, which supplies PNG in Delhi, did not reply to questions sent by Business Standard. In its press release, IGL said: “The revision in retail prices of CNG and domestic PNG has been effected after gauging the overall impact on the cost as a result of the reduction in prices of domestically produced natural gas notified by the government and the increase in cost due to depreciation of rupee vis-à-vis US dollar apart from increase in various operational expenses since the last price revision.”

Customer convenience stems from the fact that the LPG subsidy is capped at 12 cylinders per connection. After consuming subsidised LPG, households have to pay the full amount for consuming LPG. But in comparison, there is no cap on consumption in the case of PNG.  Further, PNG offers customers a hassle-free uninterrupted supply, which requires no advance booking or waiting period which is typically the case with LPG cylinders. This makes shifting back to cheaper LPG a less attractive proposition. According to ICRA, as of June 2015, CGD firms were operating in 11 states, servicing 2.8 million connections. In Delhi alone, there are 540,000 connections.

In large measure, the pricing power of CGD firms stems from the absence of competition in the PNG segment.

Theoretically, competition is allowed in PNG. Currently, CGD companies get marketing exclusivity for the first five years of their operations. Once this exclusivity period is over, third parties can use the incumbents network to supply gas, thereby ushering in competition in an otherwise closed market. This is known as the common carrier principle – a concept similar to open access in the power sector.

However, experts contend the common carrier principle could end up meeting the same fate as open access.

“Operating on the common carrier principle will face several challenges as the incumbent operators may not cede their market leadership positions that easily,” says Ravichandran. This would limit competition in the segment, leaving the pricing power of incumbents intact.

Further, there is no clarity on the issue of domestic gas allocation. While the government has placed CGD at top priority in domestic gas allocation, which is cheaper than imported gas, experts contend there is no clarity whether third parties interested in supplying gas to cities will be allocated this cheaper domestic gas.