Indian Gas Sector A Paradigm Shift in Pricing Dynamics

Feb, 2014   |   180  Pages   |   Indian Petro Group   |   Format : PDF

The cabinet committee for economic affairs (CCEA) has approved the Rangarajan Committees proposal to raise the price of natural gas from April 1, 2014. The price of gas is expected to be raised to around $8.4/MMBTU and then revised every quarter thereafter as per the Rangarajan formula. The price of gas is determined by averaging the netback wellhead prices of Indian imports and the gas prices prevailing at global trading hubs of US, UK and Japan.

While upstream oil and gas companies have been demanding a gas price increase for a few years now, the fertilizer and power sectors have voiced serious concerns over any increase in gas price. The upstream companies felt that a low price of gas did not adequately compensate them for the substantial risks involved in exploration activities. Further, the E&P companies argued that offshore exploration and production is significantly costlier than onshore exploration and the low price of gas makes deepwater and ultra-deep water exploration and production unviable. On the other hand, the power and fertilizer sectors are extremely price sensitive and any increase in the price of gas has a big impact on their profit margins. Both these sectors have zero pricing power as the prices of fertilizers and energy are heavily regulated by the government.

The production of gas from RILs KG-D6 block was expected to transform the gas market in India. The gas consumers embarked on an expansion spree encouraged by the prospects of cheap and abundant gas. Although the gas field showed great promise in the initial years of production, production has been on the decline over the last two years and production has decreased to just 14 MMSCMD compared to estimated production of 80 MMSCMD. The gas utilization policy of the government that assigns priority to various sectors for allocation of domestically produced gas resulted in a skewed distribution of gas supply when domestic production declined, benefiting the fertilizer sector at the expense of the power sector. While the supply of gas to the fertilizer sector was not affected due to the decline in domestic production, owing to higher priority, the supply to the power sector reduced substantially leading to an overall drop in gas power plants PLFs across the country. As a result, the power industry in India is facing an extremely tough business environment. The sourcing of fuel, both coal and gas, has become extremely difficult. The power companies are burdened by excessive debts and banks have become weary of lending to the sector.

The decline in domestic production of gas has increased the countrys dependence on imported LNG. The share of LNG in total gas consumption has reached around 30% and has been increasing over the years. There was a huge disparity in prices of domestic gas and LNG. While domestic gas cost consumers around $4.2-5.5/MMBTU, LNG prices were in the range $13-18/MMBTU.

Private gas producers have argued that gas should be sold at a competitively determined arms length price in line with provisions of the production sharing contracts. However, given the large supply-demand mismatch and dependence on imported LNG, competitive bidding for gas results in a price of gas which is almost at parity with imported LNG. GSPC and RIL conducted competitive bidding to sell gas from their Deen Dayal West (DDW) field and Madhya Pradesh CBM block respectively. The bidding resulted in gas prices as high as $12-14/MMBTU. There was however a difference of opinion between the petroleum ministry and the producers over the manner in which the bidding for gas took place. The ministry was of the view that the bidding should have been confined to only power and fertilizer companies, those who were in the priority allocation list.

The power ministry said that power generation from gas power plants would become unviable at a gas price above $5/MMBTU. Gas cannot compete with coal as a source of energy at higher prices due to increased cost of energy generation.

The increase in gas price will have a huge financial impact on the power and fertilizer sector. The impact on the power sector is expected to exceed Rs 46,000 crore per annum and the impact on the fertilizer sector will be more than Rs 17,000 crore per annum, according to some estimates. The government will need to support these two sectors to mitigate the financial impact of the price increase. The government hopes that increased revenue from oil and gas sector in the form of higher profit sharing, royalty and taxes will offset the financial subsidies outgo to the fertilizer and power sectors.

Availability of gas is expected to be a constraint for gas consumers at least for the next three years. The dependence on imported LNG will increase. The high price of gas is likely to hit demand in the power and fertilizer sectors. The rate of capacity addition in these sectors will slow down significantly due to high prices. The CGD sector will emerge as a major consumer of gas and will grow at the fastest pace among gas consumers. Gas is a viable replacement for liquid fuels such as diesel even at higher gas prices/LNG import prices. The CGD sector, refineries and other industrial users are expected to drive the demand for LNG imports.

The gas shortage is expected to ease after 2016-17 as investments in development of new fields and redevelopment of existing fields lead to higher domestic gas production. Imported LNG supplies are also expected to be ramped up with the commissioning of new LNG terminals and expansion of existing terminals. In the meantime, the struggle to source gas will continue and gas consumers will have to bear the burden of higher gas prices.

Chapter 1: Executive Summary 1

Chapter 2: Industry Overview 3
Principal Consumers of Gas 3
Priority Allocation Order for Domestically Produced Gas 4
For APM Gas 4
For Non-APM Gas 4
The Ongoing Struggle for Gas 4
Power Sector 5
Fertilizer Sector 6
Widening Gap Between Supply and Demand 6
The KG-D6 Scenario 7
Import Options with LNG 7
The Gas Pricing Conundrum 8
Rangarajan Committee Recommendations: Recent Developments and Challenges 10
Implications of Current Dynamics 10

Chapter 3: The Current Pricing Paradigm: The Rangarajan Formula 11
Recommendations of the Rangarajan Committee 11
Price calculations based on Rangarajan Committee formula 12
Historical Prices at Global Trading Hubs 15
Gas price for April 2014: $8.4/MMBTU ? 16
Rationale for Gas Price Increase 16
Arms length Gas Price Discovery in India 18
Gas Price Discovery Deen Dayal West (DDW) Gas Field 18
RILs CBM Gas Price Discovery 19

Chapter 4: Impact Analysis of Increase in Gas Price for Fertilizer and Power Sector 20
Power Sector 20
Gas Supply to Power Projects 21
Gas Price Sensitivity of Power Sector 22
Concerns of Power Sector 24
Fertilizer Sector 25
Concerns of Fertilizer Sector 27
Other Non-core Sectors 27
Domestic E&P Sector: How much will it Gain from Price Increase? 27
Govt Exchequer: Higher Revenues from Royalty and increase in tax 28
Price Pooling for Gas 28
The Need for Gas Price Pooling Mechanism 28
Recommendation for Gas Price Pooling by Ministry of Power 29
Critical Issues in Implementation of Gas Pooling 29
Swapping of Gas 29

Chapter 5: LNG Imports 31
Ten Years Supply Trends 32
Imported LNG pricing 33
Pricing formula for RasGas Qatar Contract 33
Pricing formula for Gorgon Gas, Australia Contract 34
GAIL has its own Sources of LNG 34

Chapter 6: Rangarajan Committees Price Formula: Views of different stakeholders 35
Views of the Ministry of Finance 35
Views of the Planning Commission 36
Views of the Ministry of Power 38
Views of the Department of Fertilizer 41
Views of the Department of Chemicals and Petrochemicals 43
Views of Industry Bodies 43
Petroleum Ministrys views 44

Chapter 7: Demand Side Dynamics of Gas 46
Major Consumers of Gas and their share in Gas Basket: The Matrix is Changing Constantly 47
Demand Trends for last 10 years Sector Wise 49
Power Sector (2003-2013) 49
Fertilizer Sector (2003-2013) 50
Other Sectors (2003-2013) 52
Demand Forecasts Sector-Wise (2013-2022) 53
Power Sector (2012-2022) 54
Fertilizer Sector (2012-2022) 55
CGD Sector (2012-22) 56
Overall Natural Gas Demand (2012-2022) 56

Chapter 8: Dynamics of Gas Supply 59
Supply Side Dynamics of Gas: Have Hopes been Belied? 59
Domestic Supply 59
Major Gas Suppliers: Have they Delivered on their Promises? 59
Gas Basins in India 60
Supply Trends (2001-13) 60
Projections (2013-17) 62
Gas Supply from ONGC and OIL 63
The Shale Gas Scenario 63
Imported Supply 64
The US shale Gas Revolution and its Implications for India 65
Major Sources of Indian LNG Imports 66
Long term LNG tie-ups by Indian Companies 67
Concerns of Indian Gas Suppliers 67

Chapter 9: Demand Supply Gap: An Analysis 70
Projected Gas Deficit (2013-2020) 70
Alternative options: Will they help Plug the Gap? 71
LNG Import 71
Shale Gas Prospects in India 72
CBM (A Poor show so far) 72
Failure of KG D6: Huge Price for the Nation 72

Chapter 10: KG-D6: Production Paralysis and its implications 73
Historical Background 73
Production Trends 73
MA Field 73
D1-D3 Fields 74
KG-D6 Financials 75
KG-D6 Projections 76
Technical Challenges 78
Contentious Areas 78
Alteration of Prognosticated Reserves 79
CAG Observations 79
New Discoveries 79

Chapter 11: Gas pricing mechanisms around the world 81
Bilateral Monopoly 82
Netback from final Product 82
Regulated Price (based on cost-of-service) 82
Regulated Price (based on Social and Political Requirements) 82
Below Cost Pricing 82
No Pricing 82
Cost-plus Pricing 83

Chapter 12: Case Studies: Pricing Formations in Foreign Countries 84
North America 84
United Kingdom 85
Continental Europe 86
Russia 86
Asia-Pacific 87
China 87
Gulf Countries 88
Africa 88
Chapter 13: Conclusions 90
Conversions 93
Annexure 1: Crude Oil and Natural Gas Production in India 93
Annexure 2: Trends in Indian Petroleum Industry at a Glance 93
Annexure 3: Reserves of Natural Gas in India (BCM) 95
Annexure 4: State-wise Gross Production of Natural Gas in India (MCM) 95
Annexure 5: State-wise Gross and Net Production of Natural Gas in India (MCM) 96
Annexure 6: State-wise Utilization of Natural Gas in India (MCM) 98
Annexure 7: Industry-wise Offtakes of Natural Gas in India (MCM) 99
Annexure 8: Estimated Total Gas Availability during 12th Plan (MMSCMD, 2012-17) 99
Annexure 9: Compressed Natural Gas (CNG) Activities in India (as on 1.4.2012) 100
Annexure 10: Details of Upcoming Pipelines 101
Annexure 11: LNG imported in the country by various entities during the last three years, foreign exchange spent and the countries from which it is being imported 102
Annexure 124: Natural Gas Demand for 12th & 13th Five Year Plan (MMSCMD) 102
Annexure 13: Total Projected Gas availability during 12th & 13th Plan (MMSCMD) 103
Annexure 14: Revised estimates for domestic gas production (BCM, 2012-17) 103
Annexure 15: World Imports of Natural Gas by Country (MCM) 104
World Imports of Natural Gas by Country (MCM) 105
Annexure 16: Country-wise Estimates of Production of Natural Gas (Million tonnes oil equivalent, Mtoe) 106
Annexure 17: Country - wise Estimates of Consumption of Natural Gas (Mtoe) 108

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