Review Rangarajan formula on gas pricing: A heavy price to pay

Written by Ashu Sagar | Updated: Jul 15 2014, 17:29pm hrs
While there is much debate on natural gas pricing and an appropriate formula to arrive at it, the need of the hour is to quickly fill up the void that exists today in the production sharing contracts under which private- and public-sector oil companies produce gas. Arriving at a market-determined price would help continue sales, carry out approved development and make existing and likely discoveries attractive for exploration companies. In 2012, the Rangarajan committee came up with a formula to raise prices. However, sellers considered the Rangarajan formula price as a low one that did not reflect the true market price. Buyers considered it to be too high. Following the controversy, the new government announced in June that it will review the formula.

Does the Rangarajan formula fix a high price for gas

The Rangarajan price is a proxy for the average global price. Being the global average, it is neither high nor low. The gas prices vary from low in the energy-rich countries to high in those that are energy-deficient. In some places, gas is an economically negative nuisance and is burnt to make the production of oil viable. It is available for sale at near-zero price if you bear the expenses to evacuate and transport it. However, it is a difficult material to transport.

Gas markets can be stranded with expensive and complex transport issues. There is no single global price as yet, though one is likely to emerge with increasing liquified natural gas trade.

Why is a review of the formula unwarranted at this juncture

A meaningful review has to consider many complex factors. These include contractual issues with producers; demand-supply balance, artificially controlled by the government at the moment; the budget deficit, because any replacement price impacts areas like agriculture and power where the government has social obligations and subsidies that are linked to the budget.

During the period of the review, the contractual rights of the oil producers will remain violated. Further development of gas fields shall stop and the new bidding rounds will go abegging as already seen in the last couple of NELP rounds. Already, nearly 100 discoveries remain undeveloped for want of commercial price. A complete and proper review at this stage is impracticable. Any APM-like decision shall have all the above negative implications and some more. The negative perception about Indias reliability for doing business shall impact areas beyond oil and gas.

Did the inclusion of Japanese prices set the Rangarajan formula-based price too high

The inclusion of the Japanese LNG prices does move the Rangarajan price up (though marginally, as it has just 3% weight) while the inclusion of Henry Hub Index (the US) moves the prices down (substantially, as the weight assigned to this is 21%).

Indian producers have strong objections to the Rangarajan formula using the Henry Hub price in its caluclations. The US economy is not really energy deficientproduction there carries very less geological risks. Hence, commercial exploration services are cheaper; the gas is wet and therefore a by-product of the profits made on oil sales, and the leases, being on private land, could be very short-term; thus, any product left underground is lost to the existing producer forever after the term lapses. Thus, it is not reflective of Indian exploration in any way and should not be used. Producers also have objections to the Rangarajan formulas liquefaction cost, of $2.5/$3.5, as these numbers are much higher than actual costs in most cases today, leading to lower netbacks.

Is it possible to shift to a rupee-based pricing for gas in place of a dollar-based one

The oil & gas market is huge as both are traded globally. Thus, the prices are denominated in dollars, irrespective of the country involved. Many other commodities, currencies and activities move in tandem with the oil prices. More important, all services and goods used in oil industry move with these prices and are quoted in dollars. Thus, a few years ago, when oil prices suddenly shot up, the cost of drilling a well almost doubled, whether it was in Gulf of Mexico or the KG basin.

For the same reason, all contracts are designated in dollars, and the gas and oil prices need to be worked out in this currency only. One cannot have revenues in rupees and costs in dollarsit would be logically inconsistent as one set of variable would carry exchange rate risks and the other would not.

Designated price in any other currency shall ultimately be converted in dollar terms, and shall be error-prone. Both oil prices and exchange rates fluctuate and it is nearly impossible to have data of all the items simultaneously to get any semblance of accuracy and objectivity. The designation of price in PSC is in dollars. It creates a contractual obligation to observe it.

What would be the impact of a gas price hike on the user industries

The impact on user industries is being exaggerated. Even after the price increase, the cost/BTU of domestic natural gas shall be barely half of the fuel it is replacing. User industries need to acknowledge this reduction of costs as well. The user industries that are not subject to price-control have no problem. Their bids for new gas are close to double the Rangarajan price since that is the replacement cost and is near the real market price.

The industry where the fuel is a pass-through (power) is not affected. It is the governments obligation to supply power at a socially acceptable rate that is under stress. It is likely that much more reduction in price can be achieved by reducing losses, or directly subsidising the deserving users, or by refining billing slabs. The government now needs to take call on the choice between political expediency and continuing with energy deficit or strict implementation efficiency measures. The other industry (fertiliser) is already subsidised. This subsidy and the actual Budget Deficit are being reduced by allocating gas to fertiliser on priority. Increased price does not really affect the industry.

Is the delay in gas price hike justified What would be the impact on gas producing companies

The effect of the delay is very damaging. In a nutshell, we can write off more private investments and developments in the near future.

Is it possible to fix a lower price than what Rangarajan panel has suggested

Yes, it is even possible to go as low as $1/mmBtu, through a Sovereign fiat. Any price is possible in the APM. It needs to be a conscious decision after considering all the implications. With the drying up of further investments in oil and gasand perhaps, even in other natural resourcesthe relevant question is whether the decision shall bring investors back to India, or shall it cause our energy costs to soar and to add to the fragility of supply.

The author is secretary general, AOGO