Pricing formula faulty, says S&P's; needs a relook if domestic oil & gas sector has to revive and fuel Make In India

The reduction in prices of CNG (compressed natural gas) and PNG (piped natural gas) with effect from October 1 may have warmed the hearts of the retail consumers, but the picture for the oil and gas industry, led by PSU behemoth ONGC, is far from pretty.

For, on the same day, the government effected a very steep cut of 18%, the steepest in fact, in the prices paid to gas producers on net calorific value (NCV) from $5.18 per mmBtu (million metric British thermal units) to $4.24 mmBtu from October 1, 2015 to March 31, 2016.

Government-controlled gas prices in India are already way below the prices in the Asia-Pacific region countries with comparable levels of development of domestic gas sector. With this steep cut, the price paid for gas in India will be about half of that in Thailand ($8.2) and less than half of Philippines ($11) and Indonesia ($10.5) .

According to a Standard & Poor’s report, also released on October 1, this blow will land rather hard on Indian gas industry’s ability and appetite to make investments in the sector. Particularly so because the industry has been languishing for some years now and has been clamouring for a fair pricing formula that makes developing nearly 10 TCF (trillion cubic feet) of discovered gas reserves viable. A fair pricing formula, the industry has been goading the Ministry of Petroleum and Natural Gas (MoPNG), is essential for it to commit investments for E&P (exploration and production) in deep sea and ultra deep sea waters of the Krishan-Godavari basin to give a boost to domestic production. (Currently India imports nearly 85% of gas consumed.)

While private operators such as Reliance Industries (which is not impacted by this price drop because it is anyway allowed only $4.24 per mmBtu) will withhold investments, PSU major ONGC, which is mandated to develop India’s domestic sector, will have no option but to persist with its Rs 40,000 crore investment in deep sea and ultra deep sea projects. This, says S&P’s, will hurt its profitability even more. That’s not all, the report says this price reduction alone will cost the Government of India about Rs 600 crore in lost royalties and then some more in taxes.

So, what seems to be the problem? If the situation does not help the operators, the government, the end-users (in the long term) and the country, why are we stuck where we are? Why has the industry been handed down a steep cut in prices when it has been arguing for the opposite? Is it to do with the tumbling prices of crude globally? Is the Indian industry making a song and dance of a global industry meltdown? Is it asking to be treated with kid gloves?

Global trends might be the trigger for the instant cut in prices, no doubt, but the problem is more fundamental and uniquely Indian. S&P’s report addressed this unique problem in one telling paragraph. The global scene is what it is for everybody but, it says, Indian industry is saddled with a pricing formula whose very basis is questionable:

“The formula for pricing domestic gas considers prices in gas-surplus geographies such as the U.S. and Canada, which have developed gas transportation infrastructure. Given India’s gas production deficit and emerging gas transport infrastructure, comparing prices in similar geographies will be more relevant, in our opinion. Gas prices in India are lower than in its regional peers as well. For example, natural gas prices in Thailand and Indonesia average US$8-US$10 per mmBtu.”

To be sure, S&P’s is not throwing the baby with the bath water. “We believe the government’s plan to stimulate private sector participation and bring in transparency in gas pricing by introducing formula-driven gas pricing is well intended,’’ it says suggesting, therefore, that the approach for a formula-based pricing is right, but the formula arrived at is not.

The way forward then is clear as daylight. If India has to increase its domestic gas production and reduce imports, this anomaly in pricing must be fixed by basing it on the price movements in gas deficit economies rather than gas surplus ones. Failure to do so will land India in a piquant situation of severely undermining the Prime Minister’s ambitious Make In India mission while at the same time driving investments in foreign countries to the tune of nearly $100 billion.

To understand where this figure is coming from, we just have to take a cursory look at the nine long-term contracts to import LNG (liquified natural gas) that India has recently entered into with various foreign producers. The average price for gas in these contracts is $10 mmBtu. (Remember, for domestic companies this is just $4.24 mmBtu.)

This means, the country will shell out Rs 65,000 crore every year for imports at this price band and will end up paying nearly Rs 14 lakh crore by the time these expensive contracts expire.

Indian oil and gas companies have quacked themselves hoarse that if given a similar price they can develop potential of around 10 TCF of domestic gas reserves valued at Rs. 6.6 lakh crores ($100 billion). But no, they will get just $4.24 because of a pricing formula that pitches gas and gas infrastructure-deficient India with those of gas surplus countries having excellent gas transportation infrastructure.

It is not tough to foresee that if domestic companies (or foreign companies working in India) are paid a similar contractual price of $10, the estimated revenue in the form of royalty, cess, share in profit petroleum and corporate taxes to the Government of India will amount to Rs 2-2.5 lakh crores ($30-40 billion).

What’s more, it will bring in a similar amount in investments into India rather than send our investments into the LNG exporting countries. LNG imports will be replaced by domestically produced gas leading to substantial saving of foreign exchange. This money will remain within the country and spur the Indian banking system. Domestic production of gas will directly increase GDP of the country and will have a multiplier effect in terms of employment generation across the country.

At this price, investment in domestic oil and gas industry will start to flow as all PSU and private players will be encouraged to start developing gas reserves. This will spur activity in the sluggish E&P sector. And correct the imbalance in India’s energy consumption patterns that is badly skewed in favour of imports.

If prices continue to be artificially depressed in India, we will continue to remain dependent on imported energy (LNG) with a foreign exchange outgo that will further increase by $100 billion. This will keep the pressure on the Indian rupee making imports even more costly.

But if India can realise its undeniable potential for domestic production, the kind of savings from reduced imports and add-on revenue, packaged in just one policy decision, can, just for a comparison, give us the money to build public toilets in all of India’s 6,38,000 villages!

There’s a sliver of hope, however. The government has recently allowed a market price for developing 69 smaller oil and gas fields. What it now needs to do is to junk this forced distinction between small and big, domestic and foreign and extend a fair and viable pricing for all.

Because, when domestic companies are subjected to unfair price discriminations, the nation also hurts equally.

(Disclosure: Firstpost is part of Network18 Media & Investment Limited which is owned by Reliance Industries Limited.)