Hazy arms-length

Written by Deepak Mahurkar | Updated: Sep 5 2012, 08:43am hrs
Arms-length pricethat is what a gas producer in India is expected to sell gas at, for the benefit of the government and itself. Arriving at such an arms-length price of gas would not be a challenge for a gas producer in a well-networked and market-priced region, say the US or parts of Europe, as is for its Indian counterparts. So how is arms-length price for gas determined Why do Indian gas producers face problems

Put simply, an arms-length price is the price at which two unrelated and non-desperate parties would agree to a transaction. A look at the current gas pricing regime in India reveals that we have a palette of price points depending upon factors like the licensing regime of the source asset and the sector serviced. The price points include government administered prices (for APM gas), alternate fuel-linked prices (Pre-NELP contracts) and arms-length market-determined pricing (in some pre-NELP and all NELP contracts). It is the last one we shall focus on.

Ostensibly, the emphasis is on price discovery through competitive bids from non-affiliates. The contracts (Article 18 of CBM contract and Article 21.6 of NELP PSC) stop short of explaining what exact steps constitute an arms-length gas price discovery process, stating where it ends, and clarifying if the process is to be self-governed and operationalised or will the government expect producers to obtain approvals from the line ministry at all stages. These ambiguities have led to producers being over-cautious by seeking reviews by government, and in turn governments taking required time to accord approvals.

To elaborate, the questions like the following remain unanswered through the contract(i) what minimum number of bidders would be considered sufficient for discovery of arms-length price, (ii) is both priority and non-priority sector representation necessary with bidders; worth highlighting that the precedence of gas allocation to sectors and consequent announcement of priority consumers in those sectors is taken up towards the gas commercialisation phase than before the start of development, however, price discovery is done before or simultaneously,

(iii) is a price formula to be proposed for approval by the government before the price discovery process starts or after; NELP-IX MPSC suggests before but we have cases to cite in which approvals were accorded well after the process,

(iv) what components are permitted in a price formula; are floor prices welcome; why should the formulae of different assets be different, and (v) would bids from consumers not expected to be connected to source in a foreseeable future be included in the process.

Going beyond the price discovery process, although affiliates or conflicted parties are not expected to be a part of the price discovery process, is it expected that gas cannot be sold to such parties at arms-length discovered prices

The lack of accurately and objectively set out parameters or process is leading to government intervention (Articles 21.7 and 18.6 of PSC and CBM contract) as a rule rather than an exception. The fact that cash flow to both central and state governments in natural gas production is linked to gas price/valuation is unfortunately resulting in more objections, explanations, discussions, and consequently delays.

Having taken the underground risk of resources, E&P investors, once successful at establishing economic reserves of hydrocarbon, look for predictable gas prices on a long-term basis. The current uncertainty relating to gas prices both for existing and new discoveries under development causes discomfort to investors and bankers. Producers have called for clarity and flexibility on the price discovery and approval processes.

Finally, a question which is best debated with an open mindisnt the government approving gas formula and price an interested party, albeit with the national interest of reducing subsidy burden Are not actions of price attenuation reducing the benefit both to the government and the producer Is not the end effect the same as that an affiliated party may in some cases cause in price discovery

Shouldnt the government allow free price discovery, let 'economic value of commodity' to reflect in the price of gas and then having accrued the benefit (of taxes and profit petroleum) use that to subsidise the target consumers of end products like urea and power At a time when domestic energy demand grows unabated in the face of limited supply shouldnt E&P companies be incentivised instead of being penalised

With the weakening rupee adding to economic woes of the country, shouldnt correct price signals be sent out to companies which have, leaving out other countries in the world, taken the risk of investing in India

The author is leader, oil & gas, PwC India. Vivek Bhatia and Gaurav Semwal contributed to the article. Views are personal