In the important (and controversial) area of prices for natural gas there are relentless efforts by deeply vested interests to obfuscate facts and misinform this impoverished and energy-starved nation about how prices should be set and what they should be. A critique of a recent report by an international agency which was widely reported in the media.
Surya P Sethi (
spsethi09@yahoo.com) is a Former Principal Adviser, Power and Energy, Government of India.
The immediate provocation for this article is a 3 October PTI report which was carried by almost all economic dailies (see, for instance, Economic Times, 3 October, and many other publications on the same day). It is painful to see such an obviously planted infomercial (quoting a report, which is not named, by Standard and Poor’s (S&P) Rating Services), finding easy access to mainstream media in the garb of expert opinion. Even the most rudimentary research or analysis by the editors and economists adorning India’s mainstream media appear not to have been taken.
In repeated op-eds, including a detailed piece carried by EPW in its 8 November 2014 edition, I have explained what is conceptually wrong in the way we are pricing natural gas at the Indian well heads. While the Rangarajan formula compounded its conceptual shortcomings by including an erroneous linkage to liquefied natural gas (LNG) and making a number of simple computational errors, the Narendra Modi government’s formula dropped the LNG linkage, corrected the computational errors and a few of the anomalies while retaining the most important conceptual flaws.
A reiteration of the concerns with the way India prices natural gas at its well heads is warranted by the relentless efforts, by deeply vested interests, to obfuscate facts and misinform this impoverished and energy starved nation about natural gas pricing. Two-thirds of the Indian households depend on food subsidies for survival and the same proportion of households have little or no access to modern commercial energy in any form.
Undeniable Ground Realities
Unlike crude oil, there is no international price for natural gas. Markets for natural gas and LNG are fragmented and not fully fungible. One cannot have a market price without the existence of a fully fungible competitive market. Importantly, LNG and natural gas are two distinctly different commodities, each with its own price dynamics. Finally, prices of natural gas for domestic use are governed by criteria that differ immensely from pricing the same gas for trade across borders either through pipelines or as LNG.
Less than 29% of the global gas production was traded across borders in 2014 with about a third of that being traded as LNG. LNG can be traded more easily, albeit after huge investments in liquefaction, specialised transportation and regasification infrastructure. Given limited LNG infrastructure and trading volume, LNG does not have an international benchmark price. LNG procured from the same source for different markets could vary in price by a factor of two or more. Similarly price of piped natural gas traded across borders is not market determined. The effective price of piped gas is distorted by regional geopolitical premiums or discounts, natural monopoly rents charged by the dedicated transmission network and available LNG options and infrastructure, if any.
North America, dominated by the United States (US), is the only exception wherein a fully fungible energy and natural gas production, transmission, storage and distribution infrastructure exists to sustain a competitive energy and natural gas market that delivers a transparent market determined price for natural gas at the well head as well as the burner tip. However, let me stress that well head prices were regulated even in the US from 1954 to 1993 as the required energy and natural gas market infrastructure was realised. The traditional “cost-of-service” criteria dominated regulation of natural gas well head price for much of this period. Natural inter-state and intra-state monopolies that transmit and distribute natural gas are still regulated strictly and guarantee open access.
Natural gas producers in India do not want the market-driven well head price that natural gas producers get in North America. Not because it is a “gas-surplus” region as the S&P report cited by PTI suggests—this surplus is a recent phenomenon post the shale gas boom. But because well head prices for natural gas in North America have always been very competitive because of informed and transparent price regulation or market competition.
The PTI report essentially suggests that the Government of India’s price setting formula is fine except for the choice of countries that it uses. It suggests using “similar gas-deficient” countries and lists Indonesia and Thailand. Let me first categorically state that no natural gas producer in the world is getting $8–$10 per million British thermal units (MMBTU) at the well-head for natural gas as the PTI report wants the reader to believe.
Next, to put Indonesia and Thailand, in the right perspective, let me say that even in purchasing power parity (PPP) terms, Indonesia’s per capita gross domestic product (GDP) is 80% more than India’s while Thailand’s per capita GDP is about 2.5 times that of India. Thailand’s per capita commercial energy consumption is 3.7 times that of India while Indonesia’s per capita commercial energy consumption is about 40% more than India’s. Most importantly, Indonesia is not a gas-deficient country and actually exported about half of its natural gas production through pipelines and as LNG in 2014. Thailand imported about 20% of its natural gas consumption in 2014 primarily through pipelines. The reader will agree that neither country is quite comparable to India.
Finally, both Indonesia and Thailand together account for only 3.3% of the 2014 world output of natural gas and about 2.7% of world consumption of natural gas. That is hardly a representative sample. And if these two do not yield the price that Indian natural gas producers want, we can selectively keep juggling the countries till we get the desired number. Perfectly scientific methodology as per the S&P/PTI report!
Conceptual Infirmities
The inconvenient truth that I highlighted in the EPW article of 8 November 2014 is that pricing natural gas at the Indian well heads based on an imputed volume weighted well head price for about 65% of the global supply is conceptually wrong. This is so because of (i) the inherent fallacies in estimating a volume-weighted well head price for natural gas from available hub price data and claiming such an imputed number as the surrogate for a global “market price” for natural gas producers when no such global market or price really exists; and (ii) the lack of relevance of such an imputed volume-weighted global well head price (derived from disparate data that includes LNG and piped gas in different proportions across disparate, fragmented and non-fungible markets) to the well head price in India. It is no one’s claim that India could actually acquire natural gas at this imputed artificial price. Quite bizarre and a hitherto unknown methodology coined and used only by India!
Way Forward
India cannot pretend to have a market price for any form of energy without a fully fungible and competitive domestic energy market. A policy to price all primary commercial energy at trade parity could work for crude, petroleum products and even coal (with adjustments for local coal quality and the fact that India is the only country that sells raw-on-mine coal without preparation). For all of these commodities market-driven international price benchmarks are available. Such an approach would fail in the case of natural gas because of the absence of a truly market-based natural gas pricing benchmark outside of North America. Using LNG as a surrogate is problematic as amply demonstrated while rejecting the Rangarajan formula.
However, we could use the trade parity price in terms of the energy content of the fuel domestic natural gas is replacing (excluding LNG) to derive a weighted average well head price payable to Indian well heads. This was the basis for pricing natural gas piped from the former Soviet Union to Western Europe for many years.
Alternatively, we could, like most countries, regulate well head prices of domestic natural gas destined for local consumption. Critics would dub this as a regressive step towards a cost-plus regime. However, as pointed out above, even the US followed this practice for four decades during which the domestic production, transportation, storage and distribution infrastructure grew to support a fully fungible natural gas market. The history of gas price regulation in the US demonstrates that enlightened regulation can deliver the level and fully fungible competitive energy market that everyone desires. The regulatory regime can be responsive to optimal exploitation of domestic energy resources while remaining vigilant towards local demand-supply balance, affordability and energy security concerns.
In closing, let me point out that the Indian Production Sharing Contracts require an arms-length price for natural gas. They do not promise an unregulated market-determined price discovered in a market wherein the demand for energy and energy infrastructure far exceeds the supply/availability. Can the Narendra Modi government deliver an independent, informed, fully enabled and committed energy regulatory regime to India? Only such an empowered and enlightened regulatory regime can best meet the pulls and pushes of various energy sector stakeholders with diametrically opposing interests. Such a regulatory regime for the energy sector is essential to delivering the Modi vision of a cleaner digital India that becomes the location of choice for global producers of goods and services. Most importantly, only such a regulatory regime will seek to know the locus standi of rating agencies like S&P in opining on India’s gas pricing regime.
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