The Hindu Business Line : Should the government set the price for gas at all?

The government should not interfere in the market-based price discovery process for the KG Basin gas but it should ensure transparency in the same. It is hoped that the Group of Ministers discussing the issue will not hesitate to ask Reliance Industries to call for fresh bids given that the earlier process was not transparent, says RAGHUVIR SRINIVASAN.

Policy for Reliance’s KG Basin gas still in the pipeline.

Much before it fires the burners at power plants, gas from the Krishna Godavari Basin has ignited a major controversy over its value and has all the interested parties in a bind. The discussions and debate of the last month and more over the issue have churned up quite a few important questions such as whether the formula followed by Reliance Industries to price the gas was a fair one; did Reliance follow a transparent bidding process to discover the price; is there any ot her methodology to arrive at a fair price, and so on.

Pricing and allocation

While these are all important questions for sure, the most important one of them all is this: Should the government intervene in the pricing or allocation of the gas produced under legally binding production-sharing contracts signed by it with producers?

This question ought to be uppermost on the agenda when the Empowered Group of Ministers (EGoM) sits down to discuss the issue, yet again, today. The simple answer to the question is that the government cannot and should not intervene in either fixing the price or in deciding on the allocation of the available gas to different industries. Pricing is an issue that should be left to the seller and the buyer to negotiate and arrive at and there ought to be no place for the government in this, at least this is what conventional economic theory says. It is a different matter that in India, the government has traditionally meddled with the petroleum industry and continues to do so.

Role of the government

Economic theory apart, the Production Sharing Contract (PSC) that the government has signed with gas producers under the New Exploration Licensing Policy (NELP) clearly defines the role of the government as merely “approver” of the discovered price.

Article 21.6.3 of the PSC states: “… the formula or basis on which the prices shall be determined… shall be approved by the government prior to the sale of natural gas to the consumers/buyers. For granting this app roval, government shall take into account the prevailing policy, if any, on pricing of natural gas including any linkages with traded fuels, and it may delegate or assign this function to a regulatory authority as and when such an authority is in existence.”

Before approving the price, the government is required to determine whether the gas has been “valued on the basis of competitive arms length sales in the region for similar sales under similar conditions”. It is to satisfy this condition that Reliance Industries submitted its pricing plan to the government for approval. What should have been a routine approval has now snowballed into a major controversy, thanks to the numerous vested interests and lobbies that are traditionally at play in the petroleum and natural gas industry.

Anyway, the PSC certainly does not bestow power on the government to either administer the selling price or tell gas producers who they should sell to and how much. Indeed, operational and pricing freedom was one of the selling points of the NELP when it was launched and continues to be so. There is no reason why an exploration company — domestic or multinational — should invest millions of dollars in the high-risk exploration activity when it is not assured of an economic return on the investment. Gas should be priced at its economic value, which is a function of the demand and supply equation, if the industry is to develop and meet the country’s energy needs.

Those demanding government intervention largely are from the fertiliser and power industries, the biggest potential users of gas. The fertiliser industry would want gas at administered prices of under $4 per million metric British thermal unit (MMBTU) if that were possible, but as the report of Economic Advisory Council to the Prime Minister, which went into the subject, says even at a delivered price of $5.5-6 per MMBTU, there will be significant savings in fertiliser subsidies for the government. This is because the industry’s current alternative, naphtha, is priced at $18 per MMBTU and is also known for extreme price volatility.

Users from the power sector also do not have much reason to grumble because Reliance’s discovered price of $4.33 per MMBTU net of transportation costs, marketing margins and taxes, translates to a generation cost of Rs 2.50-2.80 per unit which is higher than domestic coal-based power of Rs 2-2.34 per unit but lower than power from imported coal which is estimated to cost between Rs 2.75 and Rs 2.90 per unit. These are numbers worked out by the Economic Advisory Council.

So, there is clearly no case here for government intervention in pricing or allocation at all. If the government still desires to ensure “cheap” gas for fertiliser companies, then it should consider a change in policy to taking its share of profit petroleum in kind (gas) which it can allocate to its chosen users. The PSC in its current form envisages the government taking its share of profit petroleum in cash.

Reliance should call for bids

At its meeting today, the EGoM will also have to decide on some specific points raised by the Economic Advisory Council relating to Reliance’s formula and its bidding process. The Council has suggested that the formula be calculated in dollars and converted to rupees at the prevailing exchange rate; this should be the easier of the issues to decide upon. The more difficult, albeit important, one will be whether Reliance should be asked to call for bids again because the Council feels that the earlier process was not transparent.

Reliance had not publicised its bidding and restricted its bidders to those from power and fertiliser industries with demand of at least 1 million standard cubic metres per day (mmscmd) of gas. Besides, it had not declared the amount of gas that it planned to put up for sale while calling for the bids. These, the Council felt, hampered “true price discovery”.

It is difficult not to agree with the Council on this; the company certainly ought to have followed a more transparent process and there was no need to hurry through with it when gas production was more than a year away (at that point in time).

Setting a precedent

The Reliance KG Basin price discovery process will be a precedent for others such as Gujarat State Petroleum Corporation and Oil and Natural Gas Corporation which have also discovered gas and are in the process of monetising it. Therefore, utmost care has to be devoted to make the Reliance case as transparent as possible.

The EGoM should direct Reliance to call for bids again from all buyers in need of gas and ask the company to disclose the total quantum of gas that is available for sale. This is also important because the company has projected two different figures for its gas production; to the government it has projected a peak production of 80 mmmscmd while to the Bombay High Court, where it is fighting a case filed by the Anil Ambani group, it has projected availability upto 40 mmscmd only.

The company says calling bids again could cause a delay in its production from the KG Basin by a year. Even taking the company’s statement at face value, a delay cannot be sufficient justification for condoning a non-transparent price discovery process.

The gas is not going to go away in a year and if anything, Reliance could get a better price when it calls for fresh bids.

Regulation of natural gas production and pricing is still a virgin territory in India where every stakeholder, including the government, is on the learning curve. Given the millions of dollars being sunk into the industry and the huge demand-supply gap for gas, it is important that the right precedents and conventions are set. The EGoM deliberations today assume crucial proportions due to this.

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