Gas pricing in India

Gas pricing in India - a story of evolution

1. Till 1970's the prices were suggested by expert committes 
2. In early 1970's ONGC set gas prices on a negotiated basis depending on the ability of the player to pay resulting in different prices for different consumer segments.
3. In mid 1970's prices were determined by the producers themselves, based on thermal equivalence of substitute fuels and opportunity cost to the consumer
4. In 1986 govt decided to fix UNIFORM prices year to year basis
5. Policy followed till 1991
6. From 1 Jan  1992, prices of NG were fixed for a period of 4 years to 31 dec 1995 based on the recommendation of the Kelkar committee. 
1. 1992 - 1000 - 1550
2. 1993 - 1000 - 1650
3. 1994 - 1000 - 1750
4. 1995 - 1000 - 1850
7. Post december 1995, price fixed at 1850 and 1000 for north eastern states. 
8. In January 1995, set up shankar committee which suggested that price should be related to the long run average cost cost of prouduction. The price came at Rs. 1854, the committee fixed the price at 1800 with a provision to increase price by 200-250 per scm per year. Government while accepting the numbers, related it to the price parity with fuel oils and annouced the pricing policy as a % of fuel oil. While the prices proposed were the same as suggested by the committee, the principles was changed. 
9. IN 1998-99, price linkage was 65% of the international price basket
10. in 1999-00 price linkage was 75% 
11. in 2000 price linkage was at 75% but the government introduced celings on prices of Rs. 2150, 2850 on a quarterly basis
12. In december 2001,MONPG plans to raise natural gas prices and bring linkage at 100% and double the gas celieing price. 
13. By 2002 the consumer price reached Rs. 2850
14.  Initial proposal was to raise prices  gradually from Jan 2003, but this has been deferred due to assembly elections in gujarat.  Incresased and completely deregulated by october 2003. 

Prices of Natural gas

Prices of natural gas vary widely in india both at the producer level and the consumer level. At the producer level there are 6 different prices prevailing in india depending on the source of the gas. Below is a list of different gas sources

1. KG D6 
2. APM - Others
3. APM - NE
4. PMT
5. LNG- Spot
6. LNG - Long term 

Disparity in the prices that the end consumers pay is dependent on two things 

1. The source from which the gas allocation has happened
2. The sector to which the company belongs

Confused?? as to how the sector to which the company belongs can have different prices, well here it is 

1. The transportation sector and and small consumers (drawing less than 0.05mmscmd) pay Rs.3840/tscm while all other industrial consumers pay Rs. 8675/tscm and the power and fertilizers sector pay Rs. 3200/tscm. These gas prices have been in effect since June 6.2006. The other sector includes customers like petrochemicals, sponge iron and ceramics.

But even after the increase in prices of Natural gas, it remains competitive w.r.t to other fuels as shown in the diagram attached.

Landed price of gas

I always wondered going through the cost of gas that various gas users pay how is it possible that we hear the gas price to be $4.2 per mmbtu (million british thermal units) while the cost reflected in the raw material expenses of fertilizer plants and power plants is above $5.5 onwards. The reason is simple the $4.2 is the well head price of gas i.e. the price of gas at the generation center, but to reach to the end consumer it has to be transported via pipelines, so the company using the gas pays for the transportation cost and also for a marketing cost that is charged by the transporter. Now as the gas passes through various states there are state taxes that come into effect making the landed cost of gas much higher than $4.2/mmbtu.

In india the pipeline transportation companies are reimbursed the transportation charges on a cost plus basis with 12% RoE and the marketing charges are levied on account on large risk like non-payment of bills, billing cost, inventory management and marketing effort that the transportation company undertakes. GAIL for example charges different marketing margins from different players like it charges $0.18/mmbtu on re-gassified LNG, 0.12/mmbtu from PMT fields operated by BG and $0.11/mmbtu for selling gas from Raava fields operated by Cairn India and doesnot levy any margin on the APM gas. Reliance has proposed to levy margins of $0.135/mmbtu.

The transportation cost also vary depending upon the pipeline being used to transport the gas. Reliance gas transportation is estimated to be charging Rs. 16.32/mmbtu for gas delieverd in a zone of 300km from the site of production and Rs. 60/mmbtu for gas delivered beyond 300km for its 1385km kakinada to Baurach pipeline. Gail however charges Rs.28.48/mmbtu. Moreover the producer and consumer prices are applicable for a calorific value of 10000kcal/scm while the transportation charge are for 8500kcal/scm and hence a corresponding adjustment needs to be made in order to make the two comparable

So the price build up is as follows

landfall price in AndraPradesh: $4.2/mmbtu

Transportation cost: $1.33/mmbtu

Marketing margin: $0.135/mmbut

Taxes extra depending on state charges

Landed cost > $5.7/mmbtu

Note: There is a difference between producer price of gas and landfall price of gas, the landfall price of the gas is the sales price of the gas and the cost incurred on bringing the gas onshore from offshore exploration point.

We can take the example of torrent power to understand the same

The landfall price of KG D6 gas at kakinda: 4.2

Marketing margin: 0.135/mmbtu

Transmission cost:0.93

Pricing Mechanism in India

1. The government policy approach on pricing petroleum products since 1970s has moved between cost-based pricing and import parity pricing (IPP). But, since 2004, the government has been setting consumer prices of petrol, diesel, domestic LPG and PDS kerosene on ad hoc basis so as to ensure petroleum price stability in the country in the face of extreme volatility in international oil markets. Yet, each policy regime gave rise to serious imbalances and change was called for. In order to establish a viable and sustainable price system for the petroleum products, it is important to assess the earlier pricing systems and draw some lessons
3. In the past, the first major policy shift in pricing of petroleum products occurred in 1976, when the Government replaced IPP of the 1960s by cost-plus pricing. This came to be known as Administered Pricing Mechanism (APM), which was applied to the entire oil sector. The objective of the government was to shield the Indian economy from the high and volatile oil prices generated by the first Oil Shock in 1973-74. APM ran its course for three decades and was completely abandoned in April 2002. The major weakness of APM was that it did not induce competition in the marketplace, so it did not fulfill the consumer’s interest for better products and services. Nor did it enable domestic oil companies to generate adequate financial resources for project development and capacity addition in this crucial sector
4. The petroleum pricing reforms analysed above, except APM, did not have any mechanism to manage extreme volatility in oil prices. Even the effectiveness of APM as a self balancing mechanism was based on the premise that any increase in the costs of PSU oil companies on account of crude oil production, import, refining and marketing based on the predetermined formula should be fully reflected in the consumer prices
5. During April 2002 to January 2004 oil companies changed the domestic consumer prices of petrol and diesel and domestic LPG based on market factors. However, kerosene price was not changed. As oil prices started moving upward in 2004, the question of smoothing the volatility in international prices assumed importance
6. The period from 2004 to 2008 witnessed three distinct policy phases to address oil price volatility:

• First, the Government devised a price band mechanism in July 2004. The Government gave limited freedom to oil marketing companies to revise retail prices within a band of +/-10% of the mean of rolling average of last 12 months and last 3 months of international C&F prices. In case of international prices breaching this band, the matter would be taken up with Ministry of Finance for modulation in excise duty rates. The above price band was operated only once effective 1st August 2004 when prices of petrol and diesel were increased by Rs.1.10 per litre and Rs.1.42 per litre, respectively. However, as oil prices rose sharply and there was uncertainty in international oil markets, the price band mechanism was abandoned
• In October 2005, the Government constituted the Rangarajan Committee to examine the pricing and taxation of petroleum products with a view to stabilizing their prices and establishing transparent mechanism for autonomous adjustment of prices by the oil companies. The Committee recommended a formula of trade parity pricing (TPP) for petrol and diesel at refinery level as well as at retail level. The formula was a weighted average of import parity and export parity prices, in which the percentage share of import/export of these products provided the weights. The Committee suggested that these TPP prices should serve as indicative ceilings within which the marketing companies would have flexibility to fix the actual retail prices of petrol and diesel. As regards subsidies, the Committee recommended elimination of subsidy on LPG and its restriction of kerosene subsidy to BPL families. (c) The Government implemented switching over to TPP and rationalised taxes on crude oil, petrol and diesel, but could not implement rationalization of subsidies and other changes recommended by the Committee. Even TPP was confined to the refinery level and the retail prices of petrol, diesel, domestic LPG and PDS Kerosene fixed by the Government remained below their TPP levels.

Disadvantages of a cost plus based method

1. Fixed return on investments, no incentive for the business to do better as whatever he does all the cost saving has to be passed on the the consumer and he gets to make only the limited RoE.

2. If you set itemwise limit for each thing, let say you say that the operating cost of a LNG storage facility should be xdollars. But that is given the standard storage method of storing in overhead tankers, now if someone wants to store it in a carven, though the operating costs are higher but the unloading time is greatly reduced. In a cost plus basis for such cases seperate rules have to be created.

The ill effects of subsidy

In India, the government protects the end consumer of sectors like fertilizers and oil and gas from the variations in the prices of end products. The various reasons sighted by the government for controlling the end product prices are as follows

1. To protect poor consumers who do not have access to electricity, so they have to use kerosene for lighting purposes.
2. To provide consumers clean cooking fuel like natural gas, LPG, kerosene to replace use of biomass based fuels such as firewood and dung.
3. Insulate domestic economy from the crude oil price volatility. Full pass through of crude prices may lead to inflation.

The point by point contra logic of the points is as follows

3. Insulate domestic economy from inflation: The consumer has to pay the end prices of various products. Consider for example toothpaste, soaps. Does not HUL, PNG increase the prices of their products when the raw material prices increase. Are not these products used on a daily basis, does not the prices increase in these products passed on to the end consumer. The logic of inflation for petrol prices fails miserably because petrol is a final item of consumption and hence has very few linkages with the the inflation as against diesel which is used in a lot of intermediate stages resulting in higher inflation effects.

1. Kerosene in india is available at very subsidized rate of Rs. 9/liter whereas in the neighboring regions it is available at close to 24/liter leading to black market movement of kerosene from one place to another

2. Kerosene being cheaper is mixed with diesel and is sold in the open market, this puts a huge negative impact on the 23500cr capex that the refineries in India have spent in order to make their fuel euro IV compliant as when diesel is mixed with kersosene the amount of pollution released in the atmosphere is higher.

3. Most of the villages in india have been electrified, so if the intended purpose was to provide electricity then only those villages should be given diesel at cheaper prices which are not electrified.

The burden of diesel price increase on agriculture depends on where it is used. In 2008-09 12% of total diesel went to agriculture. The cost of diesel in agriculture would be accounted for by the government while fixing the MSP for major crops. Therefore any increase in the cost of diesel is taken into account while calculating the MSP. Higher diesel price resulting in higher MSP will increase subsidy in PDS, but it would be much less than the reduction in under-recovery on diesel.

Though the intentions are good and the previous experiment of the government with decontrol of potassium and potash fertilizers resulted in skewing of the NPK ratio from 5.9:2.1:1 to 9.5:2:1 and the government had to immediately give discounts on the prices in order to restore the balance used of fertilizers. Secondly, the vote bank politics comes into the picture if the prices are raised, the ruling party always have the fear of not being voted back to power.

The ill effects of subsidy are as follows

1. The company who sells the products at subsidized price, do not realize the full price at the point of sale, there is a delay in receipt of the balance amount which leads the companies to borrow short term funds from the market in order to fund their working capital requirements thus leading to higher interest costs and hence stretched cash flows. To the extent, the level of self sufficiency in domestic oil production increases, the impact of international oil prices on domestic economy would be reduced. Thus, keeping domestic oil firms viable and in good financial health and providing and environment in which they can grow are also important policy objectives.
2. Inefficient use of the end products: since people donot realize that the actual price of the product is far more than what it is sold at, it promotes inefficient usage. The diesel prices in India are very low which leads to their inefficient usage for example in diesel generation sets.
3. Lowers private sector participation: The artificial prices set by the government does not give a fair playing ground to the private players, who cannot match the low prices and hence does not promote efficiency in the sector as a whole.
4. Subsidy in India is paid out through the government accounts, leading to fiscal burden on the government or the upstream companies in case of the oil and gas sector. In short the cost of financial intervention has to be borne by someone.
5. Even if subsidized products are to be given to the end consumer, you have to give it in limited quantity but consider the case of LPG, which is given in unlimited quanitites to the users. The usage of LPG has grown from 9.3MMT in 2003-04 to 12.3MMT in 2009 out of which sale of subsidized LPG constituted 86.5% of total LPG. Now the intention of giving LPG at discounted rates is to prevent the poor households and make them switch to cleaner fuels but according to NSSO survey, the top 3 declies in the urban areas, comprising some 22 million houselholds use nearly 40% of the LPG and spend less than 5% of their total expenditure. The households get a large part of the subsidy even though they have the capacity to pay for their usage.