Come clean on gas pricing

Written by Ashu Sagar | Updated: Mar 5 2014, 10:43am hrs
Why has getting the gas pricing right become so important

The root of this issue has three elements:

India is energy-deficient. Though hydrocarbon derivatives are the most-used fuels in the country, its reserves are not extensive.

The magnitude of risk finance required, technical, skill and manpower constraints necessitate infusion of private capital in the exploration and extraction of hydrocarbons.

The country's terrain does not offer a value preposition for this investment to most of the private upstream energy companies. Even for Indian companies and nationalised oil companies, it makes better economic sense to explore, discover and produce hydrocarbons overseas and import these into India.

India has rightly decided that its sovereignty can be negatively impacted unless a certain proportion of its hydrocarbon-requirement is produced domestically. The energy security policy is, thus, one of the bedrocks of our national economic and security policy.

The second element has necessitated moving away from nationalised oil production to the New Exploration and Licensing Policy (NELP). NELP created a fiscal and contractual regime for private capital to operate in. This meant that the sovereign bound itself under contractual limitations in exercising its powers while guaranteeing certain freedomsamongst which is the freedom to market and price hydrocarbons based on market pricesto the incoming risk-capital providers.

The third element raises the issue of return on risk-capital. The challenging Indian terrain requires risk-mitigation to make it competitive. Some of the mitigation measures considered include 100% FDI, tax benefits, cost recovery, free-market pricing of gas, etc.

Thus, anyone participating in this debate has to answer all the three elements cogently to make a convincing case.

Why not move away from hydrocarbons to alternative sources of energy

Even with the best and latest technology, there is no feasible alternative for substantial replacement of hydrocarbonsat least for the next fifteen years or so. This is without considering the cost of substitutes which could be prohibitive in financial or environmental termsviz. nuclear waste, etc.

Why not have only nationalised companies work in upstream

India was doing this in 80s when it ran into the forex crises. Reserve Replenishment Ratio has to be much higher than what we were managing through intensive and expedited exploration. The countrys economic growth cannot be sustained without growth of energy consumption and therefore local production.

In the 80s and the early-90s, we never found any major oil or gas field in India after Mumbai High. This was despite billions of dollars being spent on exploration. Globally, governments have been de-nationalising the oil and gas sector as the cost of private sector participation to the nation is much lower and more efficient than the cost of nationalised exploration and extraction.

Again, with just a single customer, who was also L-1 bound, the quality and range of oilfield services in India had deteriorated, and fallen way behind global practices. Lack of competition and government-regulated decision-making were additional handicaps. Even today, despite their Maharatna status, major national oil companies, such as ONGC and OIL, are directed to divert their resources to subsidise schemes on downstream products like kerosene, diesel and LPG. Recently, ONGC has been asked to buy Indian Oil Corporation (IOC) shares. Thus, despite their strategic recognition, the focus of using their resources for exploration is already lost.

Apart from imposing such handicaps on public sector companies, the government itself shall also need to provide risk capital. According to the Directorate General of Hydrocarbons (DGH) figures, the expenditure on unsuccessful exploration (on the blocks returned by exploration companies) exceeded $10 billion. The return to exploration companies was zero. This forces the government's handit can either choose to use its resources for assertive action on social issues where private capital is not available, or use the same as risk-capital for exploration and production even though private capital is available.

Why not declare the contracts void

The sovereign has the authority to do so. It will be in the interest of fitness to void a contract if serious fraud is established. However, in the absence of sufficient and valid cause, any cancellation will only make India a pariah in the eyes of commercial organisations worldwide. The implications will not only be for the oil industry, but for all industries. This could deprive successive governments of access to international resources, technologies and skills.

In the event of reneging on the contract, India could find it impossible to attract any contractual investments. It could end up spending extra to get financial institutions' guarantees to back up sovereign commitments

Why offer these benefits to exploring companies

We know that capital shall gravitate to the highest effective rate of return. India has a challenging geology. India's business environment is among the least-friendly ones worldwide. Decision-making is slow, and often populist rather than based on economic rationale. At the same time, more prospective exploration acreages are available worldwide. All countries are vying for private risk-capital. If India does not make its regime competitive and investor-friendly, it is likely to attract very little capital. We have already seen the impact of withdrawal of tax benefits on gasmany blocks were did not receive any bids in the last two rounds NELP.

Why not have a cost-plus regime

For an exploration company, the cost includes the cost of failed exploration as well as successful exploration. India must tackle three issues before taking cost-plus route. Is the government ready to pay more than $10 billion for failed exploration For companies exploring globally, is it willing to include the global exploration costs as well There shall be no incentive for companies to be efficient or effective, if their sins are going to get covered. Our experiments with the cost-plus model in the fertiliser and power sectors are already bearing heavy. Realising the handicaps, the government disbanded the cost-plus regime even for the public sector oil companies way back in 1997-98. But, even if the government is willing to accept the above burdens, it should do it only for future contracts.

The 300-odd existing contracts are on market price. Any change shall be a violation of the contract.

What is the possible impact of sub-market gas pricing

Free and arms-length, competitive market pricing of gas was a contractual commitment of the government. Withdrawal of this in the existing contracts would lead to the following consequences:

The government will be perceived as reneging on the contract, the implications of which are explained above.

The government will not be able to approve production from the gas discoveries already made. It will, therefore, have to import increasingly larger quantities of hydrocarbons from overseas at a much higher cost. There shall be collateral damages like currency depreciation, etc, due to rising CAD. The effective price to be paid by customers shall also go much higher.

Further exploration work in the currently outstanding work with the private sector will stop. It will be a better business case for the companies to return the block and pay the penalty towards incomplete exploration, rather than continue exploration and leave hydrocarbons underground.

The author is secretary-general, AOGO