Dinakar Sethuraman: No room for gas

Last fortnight, the government decided to hike the prices of subsidised natural gas to the power and fertiliser sectors and decided to peg domestic natural gas prices to other consumers in line with global gas prices.

A decision to finally hike prices of natural gas will reduce the subsidy burden and increase investments, but more important, it helps Indian and foreign oil companies investing in gas infrastructure here to negotiate effectively with foreign gas-sellers for imports of LNG and pipeline gas.

The changes in gas pricing should be implemented with immediate effect but as always it has been postponed. From next July, power and fertiliser units are likely to pay Rs 3,200 per thousand cubic meters of gas ($ 2.12 per million British thermal units or MMbtu), an increase of around 12 per cent over existing subsidised gas prices. Other sectors, barring transportation, which continue to pay at subsidised rates, will pay market rates at around $ 3.86/MMbtu.

India consumes around 88.1 million cubic metres per day (MMcm/d) of natural gas as against a latent demand of more than 120 MMcm/d, implying a shortage of gas. Power and fertiliser units consume around 55.1 MMcm/d and pay a subsidised price of Rs 2,850 per thousand cubic metres per day. They will now pay higher prices but will continue to be subsidised to a certain extent.

Prolonging subsidies is harming India's interests at the negotiating table because it reflects a skewed market structure. On the one hand, companies such as Gail India, Petronet LNG and Royal Dutch/Shell are hemmed in by market postures by gas users such as National Thermal Power Corporation, which agrees to pay only around $ 3/MMbtu for gas delivered at its power plants, when a substitute such as naphtha is priced much higher.

On the other hand, gas importers in India have to take cognisance of the new global gas pricing realities that are likely to keep LNG prices hovering around $ 6/MMbtu in the future and accordingly chart out negotiation strategies.

What are those new realities? Fereidun Fesharaki, head of FACTS, a Hawaii-based energy consultancy, predicts in a new report that LNG prices will stay high because of the entry of the US as a major LNG importer, overtaking Japan by 2015 as the world's biggest LNG importer.

Japan currently imports close to 55 million tonnes per annum of LNG and the entry of such a huge player as the US in a such a short span of time coupled with high oil prices will keep LNG prices high and the market tight, especially when there has been difficulty in the past few years getting LNG supplies to market from new projects, says Fesharaki. He predicts a global LNG price of around $ 6 to $ 8/MMbtu in place for the next decade or two with power plants in India and China switching to coal as they will be unable to pay such high gas prices.

India's recent LNG purchase deal with Iran defines the changing economics of gas pricing. Iran offered LNG at around $ 2.20/MMbtu in late summer 2004 "" India should have grabbed it but insisted on $ 1.80Mmbtu. Hardly a few months later, in January 2005, India signed up with Iran to buy 7.5 million tonnes per annum (mtpa) of LNG at a free-on-board (FoB) price of effectively $ 3.10/MMbtu.

Moreover, the LNG price was indexed to Brent crude, the first time in Asia because the world's biggest LNG buyers in Japan and Korea index LNG to a basket of cheaper Japanese crudes, and set a ceiling of $ 31 per barrel, compared to a $ 24 per barrel ceiling for the Japanese Crude Cocktail (JCC) in Petronet LNG's 5 mtpa LNG purchase contract with Qatar.

The Iranians charged India higher for LNG because Iran makes more money in using the South Pars gas for reinjection into ageing oil fields to increase output rather than convert as LNG and export the gas. For instance, Fesharaki calculates that LNG sales to India would earn Iran a margin of $ 1/MMbtu at the wellhead (gas origin point), or less than $ 6 per barrel of oil equivalent "" clarifying the financial incentive to Tehran to boost oil production through gas reinjection.

The 18 development phases of South Pars currently envisage 21.4 billion cubic feet of gas per day (Bcf/d) of production, with only 6 Bcf/d of that going into Iran's three projected LNG developments, says Fesharaki, adding that Iran may export up to a maximum of 25 mtpa of LNG globally.

Given such a tight supply scenario and demand from power plants for cheaper gas, India might need to work on innovative pricing formulas. Qatar, which has been insisting on a gas-to-crude price linkage for India, has signed up a 2-mtpa 20-year LNG sale deal with Belgium's Distrigas, the first long-term sale to continental Europe with no oil-price linkage.

Instead, LNG is indexed to a domestic gas price. Pricing under the deal is indexed to "existing Zeebrugge terminal pricing", not to oil, Ibrahim B Ibrahim, RasGas vice chairman and economic adviser, told the World Gas Intelligence (WGI), a leading gas-industry publication. Asked if this is RasGas' first "gas-indexed" European contract, he replied: "Yes, but it definitely won't be the last."

Indian oil companies can also explore gas linkages to coal. Exxon Mobil, the world's biggest oil company, expects coal to determine LNG prices in China and India, as well, along with other Asian markets where crude oil indexation is now standard.

Phillip Dingle, president of Exxon Mobil Gas & Power Marketing, told WGI that gas "" whatever the form "" will have to compete with clean coal if it wants to retain, much less expand, its share of the power-generation market. And that will determine the long-term price of LNG. He said he couldn't say what the price of coal might be, but "it won't be $ 6 per million Btu," the price of US gas.

There seems to be a hurry to sign gas import agreements "" at last count oil minister Mani Shankar Aiyar had signed an LNG deal with Iran, and inked two preliminary pipeline gas import deals from Myanmar and Iran, all within a year of becoming minister. In contrast, the Japanese and the Chinese take ages to sign an LNG deal, trying to wear out gas sellers with patience and new information.

Ignorance of global market conditions and undue haste in securing a deal does more harm than good, especially when you are negotiating multibillion dollar long-term gas-purchase contracts, with such onerous conditions that any breach leads to huge penalties.

India has paid more than 30 per cent higher for Iranian LNG in 2005 compared to Iran's initial offer in 2004, which works out to a few billion dollars over the 25-year contract period. The Dabhol power fiasco was another example of how ignorance, haste and corruption has resulted in huge losses to the country, so much so that the cost of reviving Dabhol is much more than setting up a new facility.

Gas pricing is key because state companies including ONGC, Indian Oil Corporation, Petronet LNG and Gail are planning imports of a combined 20 mtpa in the coming decade. They are all counting on Iran but it is unlikely if Iran can offer India anything more than 10 mtpa.

Qatar has refused to offer more than 2.5 mtpa to India and is instead diverting its sights on the Chinese, US and UK markets. And LNG from Indonesia, Malaysia and Australia is likely to be more expensive than LNG from west Asia because of higher freight rates and more travel time.