Stepping on the gas with the price hike

Written by Pranav Nambiar | Updated: Jan 2 2014, 07:37am hrs
What would be the implications of the governments nod for notification of the new gas pricing formula

With the government permitting Reliance Industries Ltd (RIL) to price its gas from the KG-D6 basin as per the Rangarajan committee formula, after the companys proposal to provide bank guarantee to cover the disputed shortfall in gas production was accepted by the Cabinet, decks have been cleared for the notification of the new gas prices for the industry starting April 1, 2014. This comes as good news for exploration companies like RIL, Oil India Ltd, Oil and Natural Gas Corporation (ONGC) and Cairn India.

How will the Rangarajan formula change gas prices

India has agreed on a pricing formula for gas supply contracts with producers from April 1, 2014, to replace the present gas prices in the country that range between $4.2 for RILs KG-D6 gas and $5.73 for the Panna-Mukta and Tapti (PMT) gas. The domestic gas prices will be determined on a quarterly basis as an average of three major international hub prices (Henry Hub of the US, National Balancing Point of the UK, and the Japanese Crude Cocktail) and the cost of imported LNG into India. The new formula will be valid for five years and applies only to new contracts or renewals when existing ones expire. For the April to June 2013 quarter, the indicative price based on the formula would be $6.83 per million British thermal units (mmBtu). The Rangarajan committee also mentioned that, after five years, the possibility of pricing based on direct gas-to-gas competition may be assessed.

What impact will the new prices have on oil companies

The gas price hike will not be a magic wand that will make all gas exploration in the country viable. However, it will incentivise companies to undertake more exploration, particularly in the on-land and the shallow-water zones, encouraged by higher returns. RIL officials have clearly stated that some of its future deep-water exploration like the Cauvery basin fields will be viable only at free market prices. ONGC officials also say that some of their deep-water fields will be viable with the Rangarajan pricing mechanism, but this might not be the case with all their upcoming exploration projects in the deep- and ultra deep-water zones. A report by IHS-CERA notes that deep-water and ultra deep-water exploration in India will only be viable at gas prices of over $10/mmBtu.

What impact will the hike have on major gas consumers

The power and fertiliser sectors consume a large chunk of the natural gas in the country. Analysts say the two sectors would be negatively impacted by the new gas prices as it would lead to a sharp increase in the cost of production for these companies and will impose a larger subsidy burden on the government. According to a report of the Standing Committee on Finance, the cost of urea production will increase by R1,384/million tonne with every increase of $1/mmBtu in gas prices, thus increasing the subsidy burden on the government. Therefore, if the gas prices were to rise by $4/mmBtu, then the resultant burden on the exchequer would be around R9,000 crore. Also, every $1 hike in gas price would necessitate a R0.5/unit increase in electricity tariff.

Other industries like the ceramics, petrochemicals, glass, etc, also consume natural gas. While the input costs will go up for these industries, those companies that have replaced more expensive fuels like naptha and diesel with natural gas will still stand to benefit as natural gas will remain competitive even at revised prices.

How does the RIL bank guarantee scheme with the government work

The Cabinet recently cleared the proposal to allow RIL to charge the Rangarajan formula-based price subject to a bank guarantee being furnished by RIL and its partners in the KG-D6 block. RIL and partners have to provide a bank guarantee as the Directorate General of Hydrocarbons (DGH) has alleged that gas production has been deliberately suppressed by the partners so that they can enjoy higher prices at a later date. RIL and its partners in the KG-D6 blockBritish energy giant BP and Canadas Niko Resourceswill have to provide the bank guarantees, which can be encashed by the government in case it is proved that gas was hoarded in the block.

The bank guarantee will be equivalent to the incremental revenue RIL will get from the new gas price. It will cover the difference between the current gas price of $4.2/mmBtu and the new rate as per the Rangarajan committee formula, which will come into effect from April 1. It will be revised on a quarterly basis depending on variation in gas. The bank guarantee that the RIL-BP-Niko Resources consortium will have to furnish is likely to be around $147 million per quarter, assuming that the prices will rise to $8.4/mmBtu and gas production remains at around 11 million metric standard cubic metres per day (mmscmd).

The oil ministry and RIL are currently engaged in arbitration over the governments move to disallow $1.005 billion expenditure made by the company in developing the gas fields because of a sharp fall in output. Oil ministry officials say that the outcome of the arbitration would prove whether the contractor deliberately suppressed gas output or it was a genuine geological surprise.

What next for RIL

RIL will enjoy the new prices on its KG-D6 gas starting April 1, 2014, and simultaneously provide the bank guarantee. Meanwhile, RIL is working with the law ministry to draw up the finer details of the bank guarantee including who will monitor the quarterly provision of bank guarantee and other specific details. The petroleum secretary has stated that they hope to conclude the deal by this month.