Towards rationalised pricing

However, the demand for gas was substantially higher at 279 mmscmd for 2011, whereas consumption was about 180 mmscmd in FY11. So the current import of LNG would be about 45-50 mmscmd.

Because of the availability-demand gap and the ?differential pricing regimes?, the government has marked out priority and non-priority sectors for NG. The priority sectors comprise fertiliser and power, which have regulated pricing and where feedstock costs cannot pass through. The non-priority sectors include petrochemicals, refineries, sponge iron plants, etc., where feedstock costs can be passed through. The power sector is currently the largest consumer (39%) followed by fertiliser (26%), and city gas distribution (7%).

Each of these sectors have an impact on the economy in terms of inflation, investment climate, currency value, RBI and government policy. So it is imperative that the Indian gas market has a ?rationalised? gas pricing mechanism to encourage efficient consumption and development of natural gas infrastructure.

World pricing

Globally there are several pricing models. In the USA, gas prices are set by the fundamentals of supply and demand. The discovery of shale gas, etc. has led to the North American prices settling at low levels of $4-4.5/million British thermal units (mmBtu), which has even dropped to $2.5/mmBtu recently.

In Europe, long-term take-or-pay contracts guarantee a minimum purchase of gas indexed to oil prices as the customary method for buying and selling gas and is currently between $10 and $12/mmBtu.

In Asia, gas is mainly bought and sold at prices set by contracts linked directly to oil prices. The Asia Pacific LNG prices has risen to as high as $14/mmBtu after the March 2011 Tsunami in Japan.

Pricing in India

There are broadly three pricing regimes for gas in India?gas priced under the Administered Pricing Mechanism (nominated blocks), gas priced under NELP, and imported gas. The price of APM gas is set by the government. Pricing of non-APM gas falls into either of the remaining categories, namely, domestically produced gas from New Exploration Licensing Policy/joint venture fields, and imported LNG. The pricing of JV gas is governed by the terms of the production sharing contract (PSC), negotiated between the government and the producer. The price of LNG imported under term contracts is governed by the sale & purchase agreement (SPA) between the LNG seller and the buyer, while spot cargoes are bought on mutually agreed commercial terms. Currently there is a large price differential between domestic and imported gas, where domestic gas is priced at $4.2 to 5.5/mmBtu+pipeline charges+taxes, while imported R-LNG spot prices are at $10 to 14/mmBtu+pipeline charges+taxes.

The three broad price segments existing in the market (based on sector usage) are: up to $10/mmBtu for power (CCGT), fertiliser (gas) and steel; up to $14 for fertilisers (naphtha), fertilisers (FO), industrial, city gas distribution (CGD), power (CCHP), power (peaking), petrochemicals & refining; and up to $18/mmBtu for power (naphtha), captive power and refining (naphtha). However, specific pricing may differ based on the pipeline charges and state taxes.

The pricing issue in India has always been complex. This is compounded by two situations?firstly, the fact that APM gas supplies have been declining while non-APM gas supplies have seen an increase, and secondly, most gas-consuming sectors have a far reaching impact on national economic drivers & indicators. Hence, the pricing of NG would need to balance supply and demand dynamics?from the supply side, gas prices need to be high enough to attract upstream investments and cover production costs, i.e. market pricing, while on the demand side consumer competitiveness has to be maintained.

For the fertiliser industry, increasing the gas prices would require increasing the subsidies, especially considering fertiliser producers are not allowed to pass through feedstock costs.

So considering that each consuming sector has its own intrinsic market dynamic, a suitable pricing mechanism that would rationalise the overall consumption cost of NG has to be evolved. A single NG price for the Indian market would benefit consumers, develop the NG market and attract long-gestation investments. Gas ?price pooling? (either based on cost pooling or bid-based pooling) or ?discovered pricing? are possible pricing methodologies to bring in price stability at the consumer level.

Pooling of NG resources and supplies would appear a workable solution to ensure rationalised ?price discovery?, including convergence of APM and non-APM pricing. But this requires substantial policy intervention. A study conducted for GAIL by Mercados EMI examined various pooled pricing options:

Option A: General cost-based pool covering all consuming sectors and all suppliers, excluding those of spot LNG.

Option B: Limited sectoral pool arrangement covering the price-sensitive power and fertiliser sectors, which are heavily subsidised, subjected to heavy regulations.

Option C: Competitive markets based on auction pools on the lines already established for the power sector.

Option B was considered most suitable by the ?inter-ministerial committee on policy for pooling of natural gas prices? . This leaves room for an alternate market to develop for other industries and even for customers of the power and fertiliser sectors who may not wish to be a part of the pool.

For other large consuming sectors?sponge iron, petrochemicals and CGD?pooling can be done at the gas supplier?s level rather than the consumer level. Currently, the gas consumers source gas from various sources and pool it at the individual company level. Hence, the alternative market for consumers in the non-power/fertiliser sectors would facilitate price discovery for new gas supplies.

Pooling of transportation costs is generally not recommended as this tends to distort the basic economic price signals derived from the location of the customer vis-?-vis the resource. However, given India?s geographical spread and the need to have equitable distribution of growth, pooling of transportation costs might be recommended.

Both price discovery and pooled price methods would pre-suppose requisite storage and distribution infrastructure across the country to enable efficient last mile pricing.

Most upstream companies have reservations on price discovery under pooling as the pools do not have any control over international LNG prices. Pooling would imply domestic prices at much lower levels than imported LNG, which would be detrimental to the interest of domestic upstream producers and indigenous development of NG. This argument also puts the brakes to allocation of APM gas to the pool sectors i.e. power & fertilisers.An inherent feature of the pooling mechanism would be that all customers of a segment would be supplied gas through a pooling mechanism at a common price irrespective of the rate at which gas is contracted.

In the Indian context, this would lead to issues of taxation, as the common pooled price may be higher than the contracted price for some and lower for others. Also, differences in value added tax (VAT) applicability (some states allow VAT credit against the final product while others do not) and VAT rates (vary from 12% to 26%) further complicates the issue.While the government is looking towards increasing domestic pricing of NG from $4.2 to $5.5/mmBtu, it may not necessarily result in a ?rationalised? pricing mechanism that balances demand and supply dynamics.

Also, variation in taxation among states, modifications in business processes to accommodate a NG pooling mechanism and the legislative & administrative structures required for a smooth functioning of this mechanism would need resolution at the outset. Considering these, a rationalised gas price discovery model is still a long way off.

The author is senior director, Deloitte Touche Tohmatsu India. Alaric Diniz, senior manager, and Shantanu Sinha, deputy manager, also contributed to the article