Investing in gas-related businesses carry the promise of decent profits, but at a huge risk.
Monopolies lend themselves to price-gouging, poor service standards, lack of innovation and distortions along the value-chain. Monopolies can develop in competitive markets when one player has a serious competitive advantage. Microsoft is a classic example.
Even in such situations, regulators need to prevent the market-leader from say, forcibly buying out rivals, or indulging in predatory pricing.
There are also natural monopolies. Power and gas are prime examples. There will almost never be two rival power supply companies operating in the same region. Ditto for gas distribution. The incumbent enjoys the shelter of a huge entry barrier. Governments often recognise this tacitly by awarding licenses to single operators.
In natural monopolies, the role of an independent regulator is crucial. It sets or oversees tariffs, monitors quality of service, allows open access (to gas pipelines and power transmission-grids) and generally prevents abuse of monopoly status.
The Indian government recognised the need for independent regulation quite recently. In theory, the Central Electricity Regulatory Commission (CERC) and various state ERCs, are independent bodies, even if they are stacked with retired civil servants and PSU personnel.
In gas distribution, the PNG Regulatory Board (PNGRB), an independent body, oversees transport and distribution. The Directorate General of Hydrocarbons, an arm of the PNG Ministry, controls exploration and production. While transport tariffs are to be regulated by PNGRB, the price and allocation of gas is controlled by the government through complex, opaque mechanisms.
There is an administered price mechanism (APM) that controls price of gas produced by PSUs. There is a “closer-to-market price” mechanism that prices gas produced by private producers like Cairn and Reliance with global pricing as a benchmark. Landed imports are sold at market-determined prices. Perniciously, the government has allocated gas supply from new finds such as the KG Basin with power, fertiliser, city gas, etc, being awarded quotas at differential prices.
The RNRL-RIL dispute has provided many talking points. One is that the disputed contract price ($2.34/ million BTU) is being compared to the benchmark price ($4.20) set by an Empowered Group of Ministers (EGoM). The EGoM could probably not have set any price at all but simply tied prices to globally traded gas contracts.
Global gas prices fluctuate directly with crude prices and those, as we have seen, can swing from $145/ barrel down to $25 in less than a year. The concept of APM as applied to crude (in terms of the realisation allowed to PSUs like ONGC) and to retail product prices of petrol, diesel, aviation turbine fuel, etc has been a financial disaster because it refuses to pay heed to this volatility.
By imposing price-allocation controls in a nascent market, the government risks major distortions and not just in gas markets. There will be new power plants and fertiliser-manufacturing facilities set up with fixed feedstock/ fuel price assumptions. A look at the tangled history of Dabhol suggests potentially painful consequences.
Nevertheless the gas industry is attracting interest on the basis of several large assumptions. One is that the RIL-RNRL dispute will be settled fast, allowing gas offtake from the KG facility. Another assumption is that GSPC and others who have made finds will be able to commercialise strikes quickly. A third is that the PNGRB’s regulations on pipelines (including 33 per cent spare capacity for open access) and its suggested structure of city gas distribution (silent on the subject of exclusivity) will work.
If all this comes to pass, gas supply in the Indian market triples. Gas has cost advantages as an auto-fuel and assured supply means ready markets. Despite price-quota controls, the new CGD networks could be cash-cows. There will also be investments in pipelines, translating into business for engineering contractors, manufacturers and software providers for pipeline management, and so on.
Most analysts assume gas prices will gradually align towards global rates as APM supplies are overtaken by non-APM sources. This is only true if the government chooses to minimise its interference. It is also being assumed that global rates will trend naturally higher. That assumption could be wrong, and the error may be of large dimensions.
So investing in the gas transport and distribution business or somewhere along its value-chain carries the promise of potentially decent profits and also potentially high or even incalculable risks. But it is still worth a look.
