The Gas Story

The Central Government took decision to increase the price of natural gas last year. The new price was finally set to take effect from 1st April, 2014. But the matter was finally referred to the Election Commission for approval. The Commission, however, ordered that decision on increase in price should be left to the new government to be formed after the elections. The decision will be favourable for the voters and not-so-favourable for Reliance Industries which is the second largest producer in the country and only significant player in the private sector. About 70 percent production comes from Oil and Natural Gas Corporation (ONGC) while the rest from Reliance. In truth it is Gas that makes the Ambanis one of the top corporate houses of the country, they buy it cheap and sell it dear.

The Gas controversy is rooted in valuation of a scarce natural resource. As there are only two players—ONGC and Reliance, there is no effective competition. Reliance has a virtual monopoly and can seek whatever price it wants. In any case competition will not work because the supplies are scarce.

The Rangaranjan Committee has suggested that price may be fixed by the average of two figures. One, the cost of production of Gas imported by India at the point of production, called 'wellhead'. Two, the average price of natural gas prevailing in the markets of US, UK and Japan. The problem here is twofold. The true cost of production at wellhead is difficult to assess. For example, RIL has claimed that its cost of production is USD 7 per unit (United States Dollars per Million Metric British Thermal Units). At the same time it has entered into long term contracts with Bangladesh to supply Gas at USD 2.34 for the next 17 years. Companies routinely undertake padding to raise the cost of production in the books of accounts.

The second part of the Rangarajan formula is equally slippery. There is a huge difference in prices in US, UK and Japan. On February 28, 2014 the US price was USD 4.6, UK price was USD 6.6 and Japan price was USD 10.9 per unit. US and UK are gas producers. Of the two, the US alone has a multi-producer multi-consumer gas market hence US prices alone can be considered truly market determined. UK is slowly moving towards a competitive market but has not got there yet. Japan, on the other hand, has no gas production to speak of. Japan prices are essentially price at which suppliers are willing to supply. That price is similar to the price at which India is importing Gas presently. So the inclusion of Japan to determine the global average price is unjustified. Even by conservative estimates the price may come to about USD 5 if padding of expenditures removed; and Japan is excluded from the average. The World Bank has projected the global price of Gas to gradually rise from USD 4.2 in 2014 to USD5.7 in 2020. Hence a price of USD 4 as prevailing presently appears not so unreasonable.

The main argument in favour of an increase in price is that it will attract investment in exploration. But investment is coming in within the present pricing system anyways. The area under exploration was only 11 percent of Indian basins before private participation in exploration was opened up. It has increased to 50 percent presently. This indicates that present pricing is attractive enough. The slow pace could be due to red tape and corruption rather than pricing deficit.

Another argument in favour of increase in price is that it will speed up receipts by the government. The agreement with Reliance says that the initial revenues will be allocated to Reliance to recover its investments. After this is done, the revenues will be shared between Reliance and the Government. Argument is that a higher price of gas will enable Reliance to recover its investments soon. The revenue accruing to the Government will start sooner than at present. This argument is valid only if prices are kept at present levels. The argument falls apart if prices are raised by imposition of tax.
[contributed]

Frontier
Vol. 46, No. 40, Apr 13 - 19, 2014