Gas pricing must be determined by market bids, not government committees

A Committee of Ministers fixed the price of natural gas in 2009-14 at $4.2/unit. The Rangarajan Committee has suggested a new pricing formula, accepted by the government, that from 2014 could raise the price to $8.4/unit (though the petroleum minister thinks it will be closer to $ 6.8/unit). Those favouring the change say it is necessary to attract future investment in the sector. Those opposed say this is a ploy to hugely increase the profits of Mukesh Ambani from the KG gas field. Which of the two is right?

Actually, neither.

The decision to fix the gas price at $4.2/unit from 2009 was an outrageous, arbitrary violation of the bidding conditions of exploration contracts in the New Exploration Licensing Policy of the late 1990s.

Credibility Loss

The Rangarajan Committee’s new formula from 2014 onward is maybe less arbitrary, but still violates the original exploration condition, that the contractor would be free of price control. Only in India is the “market price” decided not by the market itself, but by Committees of Ministers or Rangarajan Committees!

Many Indian analysts mistakenly view the gas price controversy as one of Mukesh-versus-Anil Ambani, or NTPC-versus-Mukesh, or government-versus-Mukesh. Wrong, wrong and wrong again. The real issue is the violation of NELP contract conditions, because of which India’s global image is mud. It is viewed as a rascally state that changes the rules of the game at will, ignoring contractual obligations.

Huge energy imports are the main cause of India’s gigantic trade deficit. It badly needs the best technology and global investors to discover oil and gas. Very few will come unless India proves it honours its promises. The losses India suffers today from poor credibility greatly exceed any losses of Anil Ambani or NTPC.

Shares & Prices

Globally, oil companies sometimes sell oil at a discount to favoured partners. To prevent such transfer pricing, NELP empowered the government to certify that all “market prices” were arms-length prices, discovered by competitive bidding. This power of certification has been twisted by the government to impose price control. That has shocked investors globally.

Back in 2007, Reliance floated tenders and established a high market price. Instead of accepting this, a Committee of Ministers decided to find the “true” market price, and decided on $4.2/unit. After legal battles, the Supreme Court held that the government had the final say on prices. This hit the NTPC and Anil Ambani, who claimed contractual rights to supply at just $2.34/unit. The petroleum ministry defended the increase by arguing that the government itself would be the biggest gainer, not Mukesh.

How so? NELP entitled oil producers to first recover costs in the form of cost oil/gas. Next, the remaining profit oil/gas would be divided between the contractor and government on a sliding scale. Mukesh initially got 90 per cent of the profit oil/gas, declining in stages to just 15 per cent after recovering 2.5 times costs. The government’s share shot up to 85 per cent.

The petroleum ministry said that after the increase in price from $2.34/unit to $4.2/unit, Mukesh would recover his costs and high profit share from a much smaller quantity of gas. So, the government would reach its 85 per cent share of profit gas at a much earlier stage of production. Hence, the government would end up with a much bigger share of total gas reserves. Mukesh would be a big initial gainer, but a far bigger long-term gainer would be the government.

If that was true at $4.2/unit, it should be even truer at $6.8 – 8.4/unit. Mukesh’s entitlements will be achieved much faster, after the production of a much smaller proportion of reserves. The government’s share should rise sharply. Why has the petroleum ministry, which made this argument in 2007, not done so today?

It should tell us how the shares of Mukesh and the government in total reserves will change with higher prices. It should also estimate immediate gains to all gas producers, of whom the ONGC is easily the biggest. Windfall ONGC gains will suffice to subsidise gas to power or fertiliser plants.

Revert to Market Bids

The ONGC and GSPC have also struck gas in the KG basin. Both say it’s uneconomic to produce from these fields unless the price exceeds $7.5/unit. Meanwhile consumers are lapping up imported gas at $13/unit. Bidding for coal-bed methane has established prices of $11-12.unit. This further highlights the case for free pricing.

Separately, Reliance is accused of exaggerating (gold-plating) its costs to get a bigger share of oil. If there is evidence, Reliance should be prosecuted. If not, the mud-slinging should stop. But what matters most is the larger principle of having prices determined by market bids, not governments.

In our era of unstable coalitions, investors need the confidence that every new minister or government will not change the pricing formula. That means ending price controls and reverting to market bids.

One thought on “Gas pricing must be determined by market bids, not government committees

  • 2014.Dec.26 at 16:04
    Permalink

    Let the price of oil and cooking gas which are below subsidy levels(there is no more need for subsidy as the international commercial prices are lower than subsidy levels), the benefits of which let it be passed on directly to the common man and let the bank account and aadhar card and other such harassment of the common man by the government be removed else let the government be removed and voted out forever.

    Natural Gas Price 3.15 USD/mmBTU (2.58 EUR/mmBTU) 24 Dec 2014, which is very much lower than what is set by government of India reported the paragraph below.( International price of gas gathered from www dot infomine dot com)

    The government has reworked the gas pricing formula approved by the previous Congress-led government and restricted the rise in local gas prices to $5.61 per mmBtu from Nov. 1. The prices will be revised after every six months. (price of gas gathered about the present government in India 2014 from in dot reuters dot com). Let every citizen of India know that International prices are now below subsidy prices.

    Reply

What do you think?