Coal, gas and misaligned priorities

Policy confusion over fixing administered prices for these fuels is inevitable given the disconnect with reforms in user industries

Should the government impose a uniform price regime on coal and natural gas producers? Since there is such a huge unmet demand for these fuels, it could be argued that some sort of control is necessary. Besides, coal and natural gas reserves are held by the government in public trust, with their producing areas leased to companies and, according to a Supreme Court judgment, profiteering cannot be the sole motive in the use of such resources, especially when they are not bid out like in the case of coal. Natural gas pricing is completely under government control, but coal prices are fixed via public sector monopolist, Coal India Ltd (CIL). Yet, attempts to pool prices of both have proved so complex that the struggles with the first are yet to end and attempts with the second have come to nought.
 

Take coal pricing first. Last week, after months of confabulation, the Cabinet finally dropped the idea of a price pooling mechanism - much to CIL's relief. The purpose of the coal price pooling mechanism was to meet the demand of power plants, given that some 60,000 Mw had been committed supply during the 12th Plan (2012-17).

CIL had committed coal supplies to these power plants following an unprecedented government diktat to the state-owned company last February. Under this, CIL has to ensure that 80 per cent of the committed quantity is made available, either through domestic production or imports with a minimum of 65 per cent being met through indigenous coal. With an over 70 million tonnes shortfall in domestic supply to the existing power capacity alone, imports have become inevitable.

Even factoring in a margin of about 20 per cent, CIL prices its coal roughly 40 per cent lower than imported coal after adjusting for the same calorific value. The problem is that a pooled price would naturally be higher and create an uneven playing field for buyers. That is because several power plants have substantial domestic coal linkages, so a pooled price would have raised their costs. On the other hand, later entrants in power generation were largely dependent on imported coal and would have been major beneficiaries of a domestic-imported blended price.

The price pooling mechanism would have raised the cost of power generation - estimates vary from 11 to 22 paise a unit in 2013-14, and 30 to 101 paise a unit in four years, depending on which of four options was adopted. This assumes an imported coal price of Rs 6,027 a tonne and domestic coal price of Rs 1,100 a tonne. Since power pricing is a tricky issue, where the ability to pass through costs is dependent on a host of political factors and the exigencies of state politics, it became clear that the price pooling mechanism would have been too controversial to enforce and the proposal was dropped.

Now, CIL will import coal, take responsibility for shipping it through government canalising agencies MMTC Ltd and State Trading Corporation of India, and then supply it to power plants. Effectively, it will be the producer of power and not the supplier of coal that will pool the price - something several power plants already do (though CIL is not the importing agency for them). Whether CIL is able to find the best deal in the global market is an open question because the net sale price will carry a two per cent service charge. Thus, a major power producer like state-owned NTPC Ltd, which imported 12 million tonnes last year and plans to import 10 per cent of its total coal requirement of over 150 million tonnes, will probably prefer to buy its own coal in the overseas market.

In natural gas, the issue of pooling is scarcely discussed so there are no estimates on the impact of such a mechanism on gas price or, for that matter, on the power or fertiliser manufacturers who buy this fuel. For gas, the biggest policy challenge has been setting the price itself. And, since there is no monopoly producer in natural gas, fixing a uniform price is even trickier.

Over the last few years, prices of domestic natural gas have been aligned to the government-approved $4.2 a million British thermal unit (mmbtu) for Reliance Industries Ltd (RIL's) KG-D6 gas. For RIL, this price has been fixed till March 2014. A six-member committee headed by the head of the Prime Minister's Economic Advisory Council, C Rangarajan, was tasked with suggesting a formula, which is under discussion. The formula takes the trailing 12-month average of the producer price of liquefied natural gas (LNG) imports to India and the price prevalent in the US, Europe and Japan. If this formula is adopted, the price of all domestic gas being produced in the country at the current level will be a uniform roughly $8.8 an mmbtu though the committee has not said so explicitly.

The ministries of power and fertiliser have, predictably, opposed the Rangarajan formula, since this near-doubling of gas price will mean a rise in input costs for these sectors. And with prices of both power and fertiliser partly administered, the ability to pass on higher costs to consumers is limited. The finance ministry, too, has opposed the formula since, and has even pitched for taking wellhead prices of suppliers in Qatar, Oman, Abu Dhabi and Malaysia as the benchmark for pricing domestic gas. It says there is no logic in linking it to spot LNG contracts since they are more volatile.

It appears the government wants gas produced under contracts given out on bidding or under nomination to be priced in the same policy perspective. Effectively, this will mean a uniform price regime for domestic gas. And, if this uniform price for domestic gas is pooled with that of imported gas, it will mean an even higher increase in cost for users of domestic gas.

There aren't many takers in the government for gas pooling. Jyotiraditya Scindia, Union minister of state for power, in an interview earlier this year told Business Standard, "Price pooling makes sense in coal where an additional 15 to 20 per cent of imported fuel is being added to a total of 377 million tonnes of coal supply and, thus, the impact gets averaged out. But in gas, it will make sense only if the base is large enough."

Besides, unlike coal, there is no monopoly producer in natural gas. A uniform price regime will, therefore, mean all producers get paid the same price irrespective of different costs or risks undertaken during exploration and development. Deep-water gas from KG-D6 block will be available at the same rate as gas produced from the shallow Ravva field, where Cairn India and Oil Natural Gas Corporation Ltd produce gas, or an onshore field in Assam. The only price differentiator will be the transportation or pipeline tariff based on the distance the gas is shipped. From a pure investment point of view, this kind of uniform pricing has no logic.

Unlike coal price pooling, the issue of the natural gas price has still not come to a conclusive policy resolution. The problems have cropped up because the government policy on pricing of both these fuels has so far been inconsistent with the policy adopted for the user industries. Even now, power and fertiliser pricing reforms have little or no correlation with the pricing policy being pursued for coal and natural gas. Until these issues - always fraught with political implications - are sorted out, fossil fuel pricing will remain a contentious issue for government.