Why delink gas prices from oil contracts

The economic recession of 2008 has come out as an eye-opener for the stakeholders in the global energy markets as it caused a visible crack in the historical linkage between the prices of natural gas and that of long-term crude oil contracts. The pattern of movement in gas prices started to diverge markedly from the oil prices with a substantial glut in worldwide natural gas production, driven by technological advancements and rapid growth of unconventional gas resources (shale gas, coalbed methane, etc), especially in the US, coupled with a declining demand (reinforced by worldwide recession). The price of gas declined substantially and eventually increased the competitiveness of the global gas market (especially LNG). The fallout of this persistent glut, IEA predicted in its World Energy Outlook 2009, would eventually be in the form of pressure on long-term gas contracts pricing (usually indexed to price of long-term oil contracts), delinking of gas prices from oil contracts, rise in sale of gas on a spot basis and emergence of a new regional gas demand-supply dynamics through spot price-linkage and integration of regional gas markets in Europe and Asia-Pacific.

The Indian government is currently mulling a rationalisation of domestic natural gas pricing. The rationalisation would serve a dual purpose of delinking price of the crude from the production-sharing contracts between the gas producers and the government, and eliminate the differentials that exist in gas prices from different sources. At this juncture, it needs to be mentioned that the prices of LNG in the Asia-Pacific basin are usually linked to crude oil and hence the prices of LNG that India procures are also linked to that of crude oil. However, given that the natural gas sector is still at its nascent stage and expected to capture a substantial share of India’s future energy mix, it is crucial to dissociate the pricing of the natural gas from the oil price in order to isolate the sector from the increasing oil markets volatility. The move is also rational in view of the perceptible cracks in the international price link between the two resources and the new demand-supply dynamics in the international gas sector. Moreover, although natural gas and crude oil usually come as joint products, their cost of production differs. The energy carriers for oil and gas are different and require completely different sets of infrastructure. Oil is also more amenable to trading than gas. Thus, it may not be appropriate to link the demand-supply dynamics of gas with that of oil either domestically or internationally.

It also needs to be duly recognised that although KG-D6 did help in achieving a surprising boost in GDP, the supply of gas from this source alone may not be enough to meet the growing demand of natural gas by the consuming sectors (especially power and fertilisers). With the LNG markets becoming increasingly competitive internationally, it would also be essential and worthwhile to avail more of that. In other words, a rationalisation of natural gas prices that helps in procuring LNG supplies at competitive rates, without compromising the interests of the main consumers, is clearly important. The government is planning rationalisation through pooling of gas prices from various sources. Currently, India has source-based pricing of natural gas and this varies from less than British thermal unit. Out of nearly 140 mmscmd of gas supplies, about 55 mmscmd is sold under the APM. As for the gas from KG-D6, operated by RIL, the government has fixed a base price of $4.20 per mmBtu and this is capped to a crude oil price of $60 a barrel. Imported gas (in the form of LNG) comes at around $4.50 per mmBtu.

With the heightened concern for climate change and energy security and in view of the barriers that exist in fostering an immediate tectonic shift to renewables, natural gas is viewed as a bridge fuel, both nationally and internationally. Therefore, a shift to uniform stable pricing of natural gas domestically is crucial to justify the incurred investment in the sector. This is also essential to nurture proper growth of a pipeline network so as to make gas easily and adequately accessible to the end-users, and to send a correct signal to the end-users for ensuring more efficient utilisation of gas. Thus, it would really be worth seeing whether the formula for rationalisation that the government is mooting at present actually kills two birds (delinking with crude and removing distortions) with one stone.

Source: Financial Express

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