If the price of domestic natural gas is almost doubled next year to $7.4 a million British thermal unit ( mmBTU), little will change for those using natural gas at home and in vehicles. Retail consumers already pay a higher price for imported gas at over $16 per mmBTU. The impact on government finances will, however, be substantial and unless the government raises the administered selling price of electricity and urea-based fertiliser, its own subsidy obligations will jump by over Rs 28,000 crore.
To be sure, this revised price is only an unofficial estimate that flows from a complex formula devised by a committee headed by C Rangarajan, who chairs the Prime Minister’s Economic Advisory Council. The question is, does the new formula really help producers or shortage-hit consumers? The current price of $4.2 per mmBTU was fixed for Reliance Industries Ltd (RIL’s) KG-D6 output in 2007 based on a formula linked to Brent crude oil. Like any other linkage, the pricing would have been dynamic. Indeed, the terms of the New Exploration and Licensing Policy (NELP), under which KG-D6 gas is produced, talks of “arms-length” pricing and requires only an approval from the government.
But owing to a dispute between Mukesh Ambani-owned RIL and his brother Anil Ambani over the price of gas for one of the latter’s power plants, a group of ministers imposed a five-year freeze from the day production started. This price was set after two government committees, including one under Rangarajan, studied a formula submitted by RIL but recommended changes in the process of calculation.
It should be emphasised that under the NELP regime, gas pricing has formally been approved only for RIL’s KG-D6 field. The Niko Resources-operated field in the Cambay basin, which currently produced negligible quantities, has sold gas even at a higher rate of $6.22 per mmBTU. The only arms-length pricing till 2007 was $2.34 per mmBTU for an NTPC Ltd tender, in which RIL had bid but the contract is now in court. Anil Ambani’s Reliance Natural Resources Ltd wanted gas at the same price but the government did not approve it. If the government had not rejected this price, the younger sibling would have been getting gas at $2.34 per mmBTU for more than the quantity currently being produced under a contract that was to last 17 years.
Since 2007, the government has benchmarked domestic natural gas to RIL’s $4.2 per mmBTU. So, if RIL manages an increase, a host of gas producers, including Oil and Natural Gas Corporation and British Gas, will get a higher price. The price calculated through the Rangarajan formula, which is a mean of two averages – the producer price of liquefied natural gas (LNG) imports to India and the price prevalent in the US, Europe and Japan – comes to $7.4 per mmBTU. The committee has officially refrained from committing itself to a likely figure in its report. Perhaps this is to avoid any controversy, since pricing and lower production from RIL’s KG-D6 block have invited sharp criticism from political parties and anti-corruption activist Arvind Kejriwal.
By replacing one formula by the other and recommending that the new one be in place till a free competitive market is allowed after five years, the committee has set a pricing regime that is more reflective of the realities of global energy pricing. The crucial difference though between September 2007 – when the price was frozen till 2014 – and now is that no cap or floor is being proposed. In 2007, RIL had proposed an annual average Brent crude price for the previous financial year with a cap of $65 a barrel and a floor of $25 while submitting the formula. The government not only chose to lower the cap to $60 but also freeze the price. Brent has since moved to over $100.
Without a floor, a producer is not assured on any minimum return on investment he makes in a gas field. Besides, if the idea of not allowing free pricing in a chronic shortage market was to ensure that natural gas is not priced exorbitantly, then the Rangarajan formula does not serve the purpose without the cap. This is so since the price at which LNG is being currently sold in the country ranges from $8 to $11 per mmBTU and will rise to $15 per mmBTU when imported gas from Gorgon, Australia arrives in India in two years. The impact of such distortionary pricing can be seen in Argentina where producers received only about $1.5 per mmBTU for indigenous gas that was about one-fifth of what Argentina paid for Bolivian gas. According to a June 2011 report of the International Gas Union on Wholesale Gas Price Formation, this discouraged exploration and development activity in that country and gas production stagnated. In March 2008, the Argentinean government authorised higher prices for gas produced from new, remote or tight fields with above-normal development costs.
At the same time, in some CIS (Commonwealth of Independent States) countries and even in West Asia, a substantial proportion of indigenous gas supply that comes from oil fields is supplied free of cost or even below cost not only to directly to the people but also as feedstock for chemical and fertiliser plants. But this free gas is associated gas treated as a by-product with the liquids covering the costs of bringing the gas to the well head.
In India’s case, the steep fall in gas production from KG-D6 from 65 million standard cubic metre a day (mmscmd) in April 2010 to just about 25 mmscmd is attributed by many to low prices. From the government’s perspective, the subsidy outgo on account of low prices of some fertilisers and power remains at the root of pricing controls on natural gas. The country is already paying the price of this policy in terms of a power-generation crisis for lack of gas. But it is also true that with the government as a partner in RIL’s field and earning a 10 to 30 per cent share in the revenue remaining after meeting costs, pricing controls will also see it losing some. It will also delay a competitive gas market from emerging in the country since imported gas sellers will not be able to compete with domestic gas.
