Dinakar Sethuraman: Turning off the gas knob

Since most of India's gas sells at under $2 per MMbtu as compared to global prices of $36, supplies are now getting hit.

India can ill afford to continue its extended honeymoon with cheap gas when global gas prices are sky high. Feeding domestic industries with a constant diet of subsidised gas for the past few decades is crimping economic growth and investments in the country's natural gas sector.

Worse, a reluctance to pay market prices for natural gas has led to severe supply shortages, cascading into shut-downs and blackouts as user industries such as power and fertilisers run out of fuel, and while naphtha is technically an option for these plants, it would be expensive. "This is a very disturbing trend. A situation like this may send wrong signals to investors and funding agencies," Power Secretary R V Shahi told reporters recently.

The blame for fuzzy sourcing policies of domestic gas users lies with the government. Most of the 88 million cubic metres of gas per day that is supplied to Indian industries sells for less than $2/MMbtu (million metric British thermal units) when global gas prices are much higher.

Spot LNG "" gas supercooled to a liquid state for transportation in tankers before being regassified at the destination "" prices climbed this week in Belgium and the UK to an unprecedented $36 per MMbtu or $200 per oil equivalent barrel. Gas prices tripled in Europe's deregulated gas market since last week because of a combination of weather, a strike and storage problems. Natural gas prices in the US averaged $9/MMbtu last year, five times more than what Indian gas users pay for their fuel.

A reluctance to realign Indian gas prices with global levels is hurting investments. An immediate casualty is Royal Dutch Shell, which was forced to temporarily close a $600-million facility in Hazira to import LNG. Shell's new LNG import terminal on the west coast, its first regassification facility in the world, has processed only three cargoes "" a fraction of its 2.5 million tonnes per annum capacity "" eight months after launch.

Shell found no takers for imported LNG at $7/MMbtu when industries in northern and western India were facing a shortage of gas. Shell had sold its first three cargoes at a loss to Gujarat State Petroleum Corporation to kickstart the LNG terminal. When global pricing realities kicked in, Shell, which imported LNG from the spot market at closer to $6/MMbtu into India, could not continue selling at below-cost. Shell argued with petroleum ministry officials that it was offering LNG at a price 25 per cent lower than naphtha, a substitute fuel. But end-users of gas preferred to run their plants at low capacity or on expensive naphtha rather than pay more for gas.

One could, perhaps, agree with the government if fuel subsidies were temporary, and reached the poor; instead, cheap gas and oil for perpetuity has ended up subsidising the middle-class and the rich, and increasing corruption.

Even worse, price controls have led to misallocation of scarce energy resources and lower investments. Shell built adequate infrastructure at Hazira to eventually increase capacity four-fold to 10 million tonnes; today, it is looking for buyers to sell a portion of terminal capacity. Shell's experience has put off other oil majors such as BG, BP and French Total, which were once planning a slew of LNG terminals dotting the country's coastline, but have since shelved plans.

Closer to home are continuing losses at public sector oil companies. ONGC lost Rs 30,000 crore in the four years to March 2004, selling gas at subsidised prices. The company has stopped investing in existing gas fields, with production declining 3 per cent to 62/MMcmd (million metric standard cubic meters per day) in April-January 2006 compared to a year-earlier period. Instead, ONGC announced plans to invest Rs 16,000 crore in downstream businesses such as refining and petrochemicals, something unrelated to its core exploration business.

Also the government's refusal to lift controls on gas prices reveals an ignorance of global gas pricing realities. Petronet LNG CEO P Dasgupta recently said that LNG pricing formulas will change significantly by 2010-11, with multiple suppliers seeking out India and the price at $3.50-$4/MMbtu. Indeed, Petronet LNG secured a $2.4 MMbtu gas price on free-on-board terms from Qatar in 2001 "" when oil prices were low and LNG prices were tied to the oil price "" but it is unable to get similar terms today for additional volumes.

Energy prices have been hardening for the past two years because of new demand from India and China, and inadequate supply capacities, but there are no overnight supply solutions in a business where it takes several years to build capacities. Spot LNG prices in Asia and Europe are more than $10/MMbtu, with production snags at new LNG trains, accidents and volatile weather threatening to keep prices strong this year.

Meanwhile, LNG suppliers, who have noticed that America's domestic gas production is in an irreversible decline and requires large doses of imported gas in the future, are demanding close to $6-$7/MMbtu for medium and long-term contracts. Woodside Petroleum, Australia's biggest oil company and a big LNG producer, CEO Don Voelte told Forbes, "We can see tremendous opportunities to sell into the US, where gas demand and prices are high."

China, which had subsidised gas users for long, has decided to bring gas prices closer to global levels because of fuel shortages. Ex-factory gas prices may rise to 1.7 yuan per cubic metre "" $5.87/MMbtu"" while some consumers along the east coast may pay as much as $11.95-$13.62/MMbtu. Beijing's decision to hike gas prices by 50 per cent to 70 per cent increase over current levels underscores global gas pricing realities and is a wake up call to Indian policymakers. Further delays will only increase the costs and time taken for India's economy to adjust to the inevitable "" market prices for gas.