Dec-2015

Unlike its cousin crude oil, the price of natural gas in India is not market-determined. The domestic
gaUnlike its cousin crude oil, the price of natural gas in India is not market-determined.

The domestic gas price is the weighted average price of four global benchmarks — the US-based
Henry Hub, Canada-based Alberta gas, the UK-based NBP, and Russian gas.

The domestic price is based on the benchmark prices in the prior year and kicks in with a quarter’s
lag. It applies for six months. So, the price applicable from April 1 to September 30, 2015 is based
on benchmark prices from January to December 2014.

The price for November 2014 to March 2015 was $5.61 an mmBtu. As global gas prices have been
slipping over the last year, the domestic price, revised last week, also took a knock down to $5.18
an mmBtu. Interestingly, the pricing guidelines do not take into account the price of gas imported.

Dec-2015
The natural gas pricing scenario in India is complex and heterogeneous in nature. At present, there
are broadly two pricing regimes for gas in the country:
Gas priced under APM (Administrative Price Mechanism)
Non-APM or free market gas.
The price of APM gas is set by the Government. As regards non-APM/free market gas, this could
also be broadly divided into two categories, viz. domestically produced gas from JV fields and
imported LNG.
The pricing of JV gas is governed in terms of the PSC (Production Sharing Contract) provisions.
As regards LNG, while the price of LNG imported under term contracts is governed by the SPA
(Special Purchase Agreement) between the LNG seller and the buyer, the spot cargoes are
purchased on mutually agreeable commercial terms.
In recent times, the APM gas supplies have been declining while non-APM gas saw a dramatic
increase in volume and share. Furthermore, APM gas has been allocated in priority to power
producers and fertilisers, two sectors expected to see their demand increasing over the coming
decade. While the Ministry of Petroleum and Natural Gas has been pushing for higher prices to
limit losses from the PSU, this has met with strong resistance from the Ministry of Power and
Ministry of Chemicals and Fertilisers. The subsidies to fertilisers have already multiplied by five
six times in last few years.
The Reliance Saga in short
To address the supply shortfall of the Natural Gas, the Indian government had passed some reforms
at the end of the 1990s to encourage domestic production and the construction of liquefied natural
gas (LNG) terminals. In particular, the New Exploration Licensing Policy (NELP) opened
Exploration & Production to private and foreign companies. This has been relatively successful:
after stagnating since the early 2000s, Indian gas production had a turning point due to the start of
the Krishna Godavari KG-D6 field in April 2009.
As mentioned above, India has a rather unusual dual gas pricing and supply policy, with APM gas
produced by state-owned companies and non-APM gas from private companies and joint ventures
(JVs). Until May 2010, prices differed widely from around USD 2/MBtu for APM gas to almost
USD 6/MBtu for the most expensive non-APM gas. This wide gap created problems and started
pushing for reforms in gas pricing. Increasing private supply of gas has been indeed a major policy
challenge for the government as the pooling of gas prices was limited by the declining availability
of APM gas.
In the Production sharing contract, the company shared the profits with the government after
deducting the costs and expenses. The profits of the government in this would be a function of the
production. In 2011, a report by Comptroller and Auditor General alleged RIL for the violation of
the terms of its contract in exploring gas fields in the Krishna-Godavari Basin. CAG alleged that
the company used false accounting-methods to show high costs and operating expenses to keep the
profit low. It was also alleged that the company increased the sale price of gas without
Government’s permission from $2.34 mmBtu to $4.2 mmBtu. It was not supposed to do that.

Ashok Chawala Committee

The Ashok Chawla Committee, headed by the former Finance Secretary, had been set up to in early
2011 to suggest transparent and corruption process for allocation of natural resources. Committee
recommendations included adoption of open, transparent and competitive mechanism or allocation
of natural resources and greater disclosure of existing approval process. This committee
recommended competitive bidding route for allocation of coal blocks, switching to open acreage
licensing policy for allocation of oil and gas blocks. This report got lost into oblivion.

Recommendations of C. Rangaranjan Panel

The panel chaired by the Prime Minister’s economic adviser C. Rangaranjan recommended that
the domestic gas price be indexed with international prices, implying that the present practice of
the administered price mechanism be scrapped. At the same time, it has proposed scrap the existing
production sharing formula for hydrocarbon excavation too, and replacing it with the sharing of
revenue between the contractor and the government.
Thus, we see that the recommendations are of great implications. If the government accepts the
recommendations, it will bring paradigm shift in the in the pricing of gas. The committee says that
the new gas price should be calculated on the basis of an average of prices at exporting countries
and at prices at international hubs such as the US’s Henry hub, the UK’s National Balancing Point
and Japan’s custom cleared rate.
Here are some recommendations of note:
The price will be administered as per a set formula under which various components will be
assigned different weightage
The committee has recommended the sharing of the overall revenue of the contractor with the
government, without setting off any costs.
The new mechanism will replace the current fiscal model for PSCs signed under the New
Exploration Licensing Policy of 1999. The existing norms allow a company to recover all its capital
invested in exploration and production of the gas, after which the profits are shared with the Union
government under an agreed formula.
The panel has now proposed that under the new mechanism, the government’s share in the
contractor’s revenue will be determine through a competitive bid process for future PSCs. The
bidder will offer different percentage revenue shares for different levels of production and price
levels.
An extended tax holiday of 10 years, as against seven years, is proposed for blocks having a
substantial portion involving drilling offshore at a depth of more than 1,500m, since the cost of a
single well can be as high as $150 million.
The following table summarizes the different in the existing system

Gas pricing in India

There are multiple pricing regimes existing in the country for
Natural gas supplies. Further, there is differential pricing existing
for different sectors. Policy makers have been considering various
aspects to look at the pricing of natural gas.

There are multiple pricing regimes existing in the

country for Natural gas supplies. This could be
broadly divided into three categories:
•APM Gas
•Non APM Gas
•LNG
Further, there is differential pricing existing for
different sectors. Subsidized sectors such as power
and fertilizer get relatively less prices as compared
to other sectors. Also, region specific pricing exists
in the country with North Eastern states getting gas
at relatively cheaper prices as compared to other
parts of the country. Pricing of major share of gas
supplies in the Indian market is controlled and is
not market driven as government approval is
required before changing the price. Controlled
pricing may result in disincentivizing investments in
the sector in terms of limited participation from
foreign players, who have access to technology,
much required in deep-water E&P activities.
Also, controlled pricing hampers the
competitiveness of consuming sectors (power/
fertilizer/ domestic) to compete with global energy
markets as it leads to low investments in energy
efficiency on the demand side. Policy makers have
been considering various aspects to look at the
pricing of natural gas. Some of the deliberations
done by the government of India on pricing include:
•Pooled Pricing of Gas: As multiple pricing regimes
exist in the country, pooling of gas from different
sources has been deliberated by the policy makers.
A sectoral pool was being considered with separate
pools of power and fertilizer customers. Separate
pools were considered in view of avoiding cross
subsidies between the customer groups and related
administrative issues arising.
•Rangarajan Committee recommendations on
Pricing: The committee has suggested a uniform
gas-pricing, at ‘unbiased arms-length’. The formula
of domestic gas pricing should be 12-month trailing
average of volume-weighted average at well-head
(on net-back basis) for gas imports and volume-
weighted average of US Henry Hub, UK NBP and
Japanese Crude Cocktail prices. Gas prices are
expected to increase based on the suggested
framework by Rangarajan committee.

2014
The gas pricing issue between the government of India and Reliance Industries, brought into the
public debate by Arvind Kejriwal, the former chief minister of Delhi, reveals how difficult it is to
develop a fair pricing architecture for vital energy resources like gas.

At the heart of the issue is a long-known dilemma for policy makers: whether to link gas prices to
an ‘assessed’ price, determined by our government or private Indian participants, or link it to an
international market-based price.

India currently uses both methods. The Administered Pricing Mechanism (APM) price set by
government for gas and used by the power and fertilizer sectors, is an example of the ‘assessed’
price, while the price that Indian companies pay for imported gas is an example of the market-
linked price.

Unfortunately, neither model accurately reflects the physical market – the actual demand and
supply – for natural gas in India.

That’s because the ‘assessed’ prices carry distortions within. The ‘assessed’ APM price set by the
government is deliberately kept low for the poor who benefit from the subsidized rates. Such
assessments have been based on a complex ‘cost-plus’ method that adds the cost of raw material,
production, distribution, and marketing. Private companies have also ‘assessed’ prices in the past
when bidding for government gas exploration tenders or seeking buyers for the gas produced. [1]
This has ultimately also proved unsustainable.
There are two problems with this method: one, there’s no way of verifying appropriateness or
accuracy, because the price-setting processes are opaque. Two, it creates an opportunity for state
– or private owner – intervention at every level, as also for corruption, since the assessments are
subjective.

The other method is to link India’s natural gas prices to the international market, more specifically
to the benchmarks of the U.S., UK, Japan, and those of countries such as Qatar and Australia. The
US and UK benchmarks – the Henry Hub and National Balancing Point respectively – are
determined by their local gas exchanges, whose prices include not just the cost of raw material,
production, distribution and marketing, but also the sophisticated inputs from the financial
markets such as volume, speculation, hedging, currency risks, geopolitical developments. The
Japan benchmark -Japan Custom Cleared or JCC – is based on international crude prices. Our
own gas import contracts such as those with Qatar and Australia are based on JCC.

Although this is a transparent process, the market-linked international price comes with its own
limitations for India. Since the gas rates partially depend on crude prices, they become directly
affected by the volatility of the global crude oil markets. And if the prices are denominated in
dollars, a weakening rupee will cause a loss for the Indian consumer. [2]

These limitations with the international market-linked prices, coupled with our own inefficient
domestic assessments now under scrutiny for corruption, makes price assessment in India sub-
optimal at best.

The RIL KG-D6 gas pricing is an interesting case study of how pricing has oscillated between the
two models. The price of $2.34/mmbtu proposed by Mukesh Ambani’s Reliance Industries in 2006
to sell gas to brother Anil Ambani’s Reliance Natural Resources Limited (RNRL), was not accepted
by the government even though it was the same price that RIL had used to win a bid NTPC had
initiated earlier. [3] The government claimed that the price was not an ‘arms length’ price for
RNRL. [4]

To make it fair, the pricing was then linked to the international price of crude oil. This resulted in
the revised price of $4.2 per mbtu for RIL, and was eventually accepted by New Delhi in 2007. [5]

Since then India has moved to an international market-linked pricing model for gas which is linked
to average gas prices in the markets of the U.S., UK etc, for our private and public sector players.
This was done based on the recommendations of a 2012 committee headed by C. Rangarajan, the
Chairman of the Prime Minister’s Economic Advisory Council. The aim is to incentivise domestic
exploration and pricing with even better transparency. [6] This new pricing is to go into effect for
all new contracts, starting April 2014. [7]

Phase Report Pricing and Profit Sharing Models

Pre 1999 Pre-NELP Assessed Pricing: Administered Price set by government(e.g.

PMT gas to Power sector)Market-linked Pricing: Linked to
global crude oil prices(e.g. Panna-Mukta Tapti gas to
GAIL)Profit Sharing: Royalty + Tax only
 1999-2012 NELP Assessed Pricing: Through competitive ‘arms length’
bidding(e.g. RIL gas to NTPC). Also, administered prices
continue.Market-linked Pricing: Linked to global crude oil
prices(e.g. RIL gas to RNRL or gas imported from Qatar)Profit
Sharing: Royalty + Tax + portion of profits (after cost is
recovered by producer)

Rangarajan Final Assessed Pricing: <Discontinued> Market-linked

Committee Report Pricing: Linked to international ‘exchange’ traded prices in US,
2012 UK, Japan and import prices from Qatar, Nigeria, etc.Profit
Sharing: portion of revenues (from the start)

Kelkar Preliminary Assessed Pricing: <Likely to remain discontinued>Market-

Committee Report linked Pricing: Recommendations due for linking to
2013 marketProfit Sharing: Royalty + Tax + portion of profits
(after cost is recovered by producer)

*NELP – National Exploration and Licensing Policy

Coincidentally, RIL’s KG-D6 contract is also due for a pre-scheduled revision in the same month –
April 2014. [8] If the norms are used, Reliance too will benefit and sell its gas for about
$8.4/mmbtu. [9]

It is this price increase that the Standing Committee on Finance and the Aam Aadmi Party have
opposed. Both are demanding that RIL be persuaded to produce the gas and sell the gas at the pre-
revised rate. [10]

The Rangarajan Committee also recommended that profit-sharing contracts be amended to

a revenue-share model at the start of production, to prevent inflation of exploration costs and a
loss of subsequent income for the government. By this measure, RIL will get $8 per mmbtu – twice
the current rate.

To add to the confusion, a new committee formed in early 2013 under Vijay Kelkar has already
dismissed the Rangarajan Committee’s conclusions about profit-sharing and is likely to overturn
the recommendations when it submits its final report later in 2014. [11]

Such is the prevarication and uncertainty of doing business in India. Worse, without incentivising
business into domestic gas production, we will continue to be dependent on imports.

It is imperative then, for India to find a solution that reflects our own business and market realities
as also the consumer’s purchasing abilities. Now is the right time, with a new government due in
Delhi in May, to design and implement a policy architecture that reflects our particular economic
make-up.

An optimal answer is to develop our own price assessment architecture, much as the West has. For
instance, the U.S. has its own oil and gas production, as also the related structures – the West Texas
Instrument benchmark for oil and the Henry Hub for gas – which reflects its own domestic market
and exports. This would also mean developing a price assessment process based in rupees which
has so far not been comprehensively tested or widely encouraged.
This level of sophistication, however, is difficult for India to achieve on its own because our gas
exploration, transportation and the supporting financial markets remain under-developed.
Transnational gas pipelines initiatives such as TAPI (Turkmenistan-Afghanistan-Pakistan-India)
that could have helped in developing an alternative price signal for India, have only progressed at
snail’s pace.

Even the advanced economies of Japan, Korea and China have had difficulty in developing in a gas
pricing architecture domestically, relying instead on a simple, market-linked rate pegged to global
crude oil prices – as India has also attempted to do. Despite Asia being the fastest-growing natural
gas market in the world [12] more than 80% natural gas traded in Asia is linked to global oil prices.
[13] The region lacks the unity and therefore the heft to negotiate jointly for a competitive rate,
thereby paying the higher “Asian Premium” [14] for its energy.

Some efforts are being made in the region. In 2010, China launched a market for spot trading of
LNG for domestic use. The volume and usage has gradually increased, indicating market-rate
commitment. [15] Japan is expected to launch a Futures market for gas in April 2014.

India can take the lead in a regional initiative to develop a pricing architecture with other
consuming nations, and thereby leverage our massive annual imports of oil and gas (Asia alone
accounts for 70% of the world’s liquefied natural gas market). A small step has been taken. In
September 2013, India and Japan – both heavily energy import-dependent – signed an agreement
to work towards “rationalizing of LNG prices in Asia Pacific” and “towards the development of a
market environment that would enable effective, stable and globally competitive LNG
procurement” – a sort of Henry Hub benchmark appropriate for large consuming nations [16]. It
will encourage the development of a price assessment process based in rupees – a concept so far
not comprehensively tested.

If successful, such an initiative can expand to include the other large importers such as Korea and
China which are struggling with the same issues.

Till then though, we will muddle along with sub-optimal solutions.