The Labyrinth Of gas pricing & usage

A jumbo group of ministers (GoM) has been set up to look at various contentious issues relating to the supply and pricing of natural gas. The Cabinet secretary submitted a report last fortnight after elaborate presentations were made by various stakeholders in the sector, including the producers and consumers of gas. The report is based on detailed presentations made to a committee of secretaries (CoS) set up for the purpose.

Some of the broad conclusions made by the Cabinet secretary’s report will probably be studied in greater detail by GoM. Of course, much of the controversial aspects of policy flows from the massive gas find by RIL in the KG basin. The key issue is how such gas, which is to come on stream by mid-2008, is to be priced and allocated to key domestic sectors such as power and fertiliser, which consume over 75% of the current gas production.

At a broader level, the report appears to endorse that pricing of all gas produced under the ‘National Exploration Licensing Policy’ framework must be market-determined. It also emphasises that legal sanctity of the production-sharing contract (PSC) the government signed with RIL must be maintained so that no signal of a reversal is sent to foreign investors. By doing so, the credibility of the system is retained.

After all, exploring gas is a risky proposition, and unless entrepreneurs are incentivised to explore gas, there is no point fighting over how it should be allocated. There is a clear hierarchy of issues here. The policy must first address how best an incentive mechanism be put in place to explore gas, and then the issue of marketing and allocation to the fertiliser and power sectors can be examined.

In keeping with this, the Cabinet secretary’s report endorses the sanctity of the government’s PSC with RIL. But, at the same time, the report appears to assert the sovereign right of the government to come up with a natural gas pricing policy and a natural gas utilisation policy. These two policies will balance the needs of the producers and consumers. The report is very clear that the government will not fix any price. That has to be left to the market.

The report asserts that the government can prioritise allocations through the natural gas utilisation policy without violating the letter and spirit of PSC with RIL. But PSC will be subject to the broader policies on gas pricing and allocation. The report also concludes that RIL formula for gas pricing — based on RIL inviting quotations from a limited set of gas consumers in the power and fertiliser sectors — should be taken up only after the new gas pricing and allocation policies are put in place.

In this context, it has suggested it may not be prudent for the government to approve any pricing formula put forth by RIL unless all court cases involving RIL and RNRL of the Anil Ambani group are resolved. This raises the all-important question of whether critical government policy implementation must await pronouncements by courts which may take years to materialise. The Cabinet secretary has chosen to play safe in this regard. GoM will, most likely, be forced to take a view on this aspect.

Two other critical issues raised by the Cabinet secretary will have an impact on the way RIL arrives at the cost and pricing of gas in the future. The Cabinet secretary’s report says, prima facie, the formula proposed by RIL to arrive at the market price/valuation of gas suffers from several infirmities.

The price discovery process employed by RIL cannot be considered totally transparent on three counts. One, there is single seller and multiple buyers with stranded assets which results in demand for gas far exceeding supply. Two, these are short-duration contracts where pricing may not reflect long-term trends. Based on the advice by the Planning Commission, CoS feels gas prices should not be linked to Brent crude and instead be indexed to a basket of traded fuels, including furnace oil, which is far lass volatile.

It is true that short-duration contracts do not reflect long-term price trends, but the point about demand far exceeding supply cannot be held against any private entrepreneur because that is the nature of the industry. Gas is a scarce commodity globally, and far less explored than the liquid forms of petroleum.

The report suggests capital expenditure is a very critical component in the pricing of gas and determining the government’s share of profit. Therefore, a strict monitoring of costing is required. Currently, this is done by the government nominee on the management committee where RIL representatives are also present. It argues for further improving the accountability of government representatives who study the costing aspects.

The report advocates an audit by Comptroller and Auditor General (CAG), or other reputed international agencies, familiar with the industry. The involvement of CAG in the costing of gas will add a completely new dimension to the controversy.

Finally, the report recommends the petroleum ministry must arrive at a broader gas pricing and allocation policy in consultation with the ministries of power, fertiliser and the Planning Commission. It also says PM’s Economic Advisory Council may also be consulted.

GoM will now take up all the issues raised by the Cabinet secretary, and will have to take a call on many recommendations made by the CoS that have the potential to interminably delay RIL’s schedule to come on stream by mid-2008. For instance, CoS suggestion that the government may not take a call on RIL’s price formula until court cases are settled is a sure recipe for delays.

Other procedural recommendations like improving the accountability of the costing committee by bringing in either CAG, or a reputed international expert, could delay matters, though they would bring more transparency.