A Paradigm Shift in Pricing of Indian Gas Sector

1
Indian Gas Sector A Paradigm Shift in Pricing
Dynamics
Executive Summary The cabinet committee for econo
mic affairs (CCEA) has approved the Rangarajan
Committee's proposal to raise the price of
natural gas from April 1, 2014. The price of gas
is expected to be raised to around 8.4/MMBTU and
then revised every quarter thereafter as per the
Rangarajan formula. The price of gas is
determined by averaging the netback wellhead
prices of Indian imports and the gas prices
prevailing at global trading hubs of US, UK and
Japan. While upstream oil and gas companies have
been demanding a gas price increase for a few
years now, the fertilizer and power sectors have
voiced serious concerns over any increase in gas
price. The upstream companies felt that a low
price of gas did not adequately compensate them
for the substantial risks involved in exploration
activities. Further, the EP companies argued
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Indian Gas Sector A Paradigm Shift in Pricing
Dynamics
that offshore exploration and production is
significantly costlier than onshore exploration
and the low price of gas makes deepwater and
ultra-deep water exploration and production
unviable. On the other hand, the power and
fertilizer sectors are extremely price sensitive
and any increase in the price of gas has a big
impact on their profit margins. Both these
sectors have zero pricing power as the prices of
fertilizers and energy are heavily regulated by
the government. The production of gas from RIL's
KG-D6 block was expected to transform the gas
market in India. The gas consumers embarked on an
expansion spree encouraged by the prospects of
cheap and abundant gas. Although the gas field
showed great promise in the initial years of
production, production has been on the decline
over the last two years and production has
decreased to
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Indian Gas Sector A Paradigm Shift in Pricing
Dynamics
just 14 MMSCMD compared to estimated production 
of 80 MMSCMD. The gas utilization policy of the
government that assigns priority to various
sectors for allocation of domestically produced
gas resulted in a skewed distribution of gas
supply when domestic production declined,
benefiting the fertilizer sector at the expense
of the power sector. While the supply of gas to
the fertilizer sector was not affected due to the
decline in domestic production, owing to higher
priority, the supply to the power sector reduced
substantially leading to an overall drop in gas
power plants PLFs across the country. As a
result, the power industry in India is facing an
extremely tough business environment. The
sourcing of fuel, both coal and gas, has become
extremely difficult. The power companies are
burdened by excessive debts and banks have become
weary
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Indian Gas Sector A Paradigm Shift in Pricing
Dynamics
of lending to the sector. The decline in domestic
production of gas has increased the country's
dependence on imported LNG. The share of LNG in
total gas consumption has reached around 30 and
has been increasing over the years. There was a
huge disparity in prices of domestic gas and LNG.
While domestic gas cost consumers around
4.2-5.5/MMBTU, LNG prices were in the range
13-18/MMBTU. Private gas producers have argued t
hat gas should be sold at a competitively
determined Âarms length' price in line with
provisions of the production sharing contracts.
However, given the large supply-demand mismatch
and dependence on imported LNG, competitive
bidding for gas results in a price of gas which
is almost at parity with imported LNG. GSPC and
RIL conducted competitive bidding to sell gas
from their Deen Dayal West (DDW) field and Madhya
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Indian Gas Sector A Paradigm Shift in Pricing
Dynamics
Pradesh CBM block respectively. The bidding
resulted in gas prices as high as 12-14/MMBTU.
There was however a difference of opinion between
the petroleum  ministry and the producers over
the manner in which the bidding for gas took
place. The ministry was of the view that the
bidding should have been confined to only power
and fertilizer companies, those who were in the
priority allocation list. The power ministry said
that power generation from gas power plants
would become unviable at a gas price above
5/MMBTU.Gas cannot compete with coal as a source
of energy at higher prices due to increased cost
of energy generation. The increase in gas price w
ill have a huge financial impact on the power and
fertilizer sector. The impact on the power sector
is expected to exceed Rs 46,000 crore per annum
and the impact on the fertilizer sector
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Indian Gas Sector A Paradigm Shift in Pricing
Dynamics
will be more than Rs 17,000 crore per annum,
according to some estimates. The government will
need to support these two sectors to mitigate the
financial impact of the price increase. The
government hopes that increased revenue from oil
and gas sector in the form of higher profit
sharing, royalty and taxes will offset the
financial subsidies outgo to the fertilizer and
power sectors. Availability of gas is expected to
be a constraint for gas consumers at least for
the next three years. The dependence on imported
LNG will increase. The high price of gas is
likely to hit demand in the power and fertilizer
sectors. The rate of capacity addition in these
sectors will slow down significantly due to high
prices. The CGD sector will emerge as a major
consumer of gas and will grow at the fastest pace
among gas consumers. Gas is a viable
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Indian Gas Sector A Paradigm Shift in Pricing
Dynamics
replacement for liquid fuels such as diesel even
at higher gas prices/LNG import prices. The CGD
sector, refineries and other industrial users are
expected to drive the demand for LNG imports.
The gas shortage is expected to ease after
2016-17 as investments in development of new
fields and redevelopment of existing fields lead
to higher domestic gas production. Imported LNG
supplies are also expected to be ramped up with
the commissioning of new LNG terminals and
expansion of existing terminals. In the meantime,
the struggle to source gas will continue and gas
consumers will have to bear the burden of higher
gas prices.
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Indian Gas Sector A Paradigm Shift in Pricing
Dynamics
Table of Contents Chapter 1 Executive Summary 1
Chapter 2 Industry Overview 3 Principal
Consumers of Gas 3 Priority Allocation Order for D
omestically Produced Gas 4 For APM Gas 4 For Non-A
PM Gas 4 The Ongoing Struggle for Gas 4 Power Sect
or 5 Fertilizer Sector 6 Widening Gap Between Supp
ly and Demand 6 The KG-D6 Scenario 7 Import Option
s with
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Indian Gas Sector A Paradigm Shift in Pricing
Dynamics
LNG 7 The Gas Pricing Conundrum 8 Rangarajan Commi
ttee Recommendations Recent Developments and
Challenges 10 Implications of Current Dynamics 10
Chapter 3 The Current Pricing Paradigm The
Rangarajan Formula 11 Recommendations of the Ranga
rajan Committee 11 Price calculations based on Ran
garajan Committee formula 12 Historical Prices at
Global
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