Gas pricing muddle gets deeper

A recently commissioned study by GAIL has resurrected the debate on natural gas pricing. The report recommends price pools for the power and fertiliser sectors. But why look at pooled price? Can we have it for the entire sector? Even if we can, should we? If not, what pricing methodology should be adopted, given that largely the end-user industry is policy constrained?

Dual pricing mechanism has being a key characteristic of the Indian gas market; while some sectors purchase gas at highly subsidised rates, others procure it at market determined rates. For instance, 97 per cent of ONGC's total production is sold at a subsidised rate and 3 per cent at a market-determined rate; for OIL the figures are 88 per cent and 12 per cent respectively.

Private players, on the other hand, are largely free to set their price. The end result: disparate price levels leave end-users apprehensive, particularly the power and fertiliser sectors which consume over 50 per cent of the gas. These industries are thus clamouring for pooled pricing; overlooking the larger issue of a sustainable pricing.

Reading through the report it seems that the prescriptions will only aggravate the ailment. To begin with, the concept of pooled prices is devoid of economic logic. One price for the entire sector makes mockery of the concept of plant-level economics.

A flawed concept

While today economics persuades seller and buyer to negotiate and arrive at a price, pooled prices will impede the interplay of price determination. By pooling prices, we are giving significant powers to both the sellers and buyers to abuse the market with higher price trajectory, irrespective of how the pool operator functions.

As an example, from the buyer's perspective, NTPC, with its large consumption base, will lose all incentive to exercise its buying power. Why it should, after all, if the prices eventually are to be pooled for the entire sector? Sellers, on the other hand, would try to jack-up prices; they have every incentive to charge a higher price. Sellers know that by charging higher prices they are not going to affect an individual buyer, as prices eventually will be pooled.

Further, determining and actually implementing pooled pricing would be an uphill task made more difficult by diverse sources of gas with varied cost of production; a fact accepted by the report. Creating detailed guidelines for constitution and operation of a pool, notifying a pool operator and setting in place an institutional mechanism will indeed be demanding.

Though it is intended to be revenue neutral, this could turn out to be the most significant challenge. Existing contractual obligations will add to the confusion; because if implemented, some end-customers will see lower prices, while others will witness higher prices. Though not strictly comparable, how can we disregard the confusion that the March 2007 directive from the Ministry of Petroleum and Natural Gas caused when it directed Petronet LNG to pool the Regasified Liquefied Natural Gas prices and charge uniform pool prices to all existing and new customers?

The move, expectedly, didn't go down well then, and the matter was taken up with the Supreme Court, where it is still pending. Instead of moving away, one gets a feeling that we are entering the pooled price muddle, although through a different route. By adopting the pooled mechanism, we also completely disregard the role competing fuels play in the determination of gas prices. This is especially valid for gas, as it does not have an exclusive market. The role of competing fuels thus becomes imperative for the overall gas penetration.

The right approach

The report accepts that this is a temporary solution till we graduate to a developed state of market. What should be our approach in this interim period given that pooled pricing is weighed down with significant conceptual and operational challenges?

The Indian market is still far from a situation in which gas price is determined through gas-to-gas competition. A cost-based approach is filled with several well-accepted negativities. Thus, the netback pricing approach is the right mechanism for the country given the state of development and more so because the role it emphasises for competing fuels.

This is because the starting point of the netback approach is the determination of the final consumer's willingness to pay, as expressed by the maximum price of gas at which the end-user would be willing to use gas as an alternative to other fuels.

Each sector will thus pay for gas based on the fuel it would replace. Not only will this reflect true demand for gas, it will also result in the optimal utilisation of a scarce resource. It will send the right price signals to each of the end-customers; a key ingredient for sustainable economics.

As the Government acknowledges, the pool of subsidised gas is depleting and the future availability will be a question. Time is thus right to move to a price trajectory which is sustainable to both the producers and consumers in the long run.

Rather than a decree from the Government, price uniformity should be the end result of structural changes in the market. To intervene in the process of structural changes will only take us farther away from the path of a developed gas market.

Whatever pricing methodology the Government will finally adopt, irrespective of the pulls and pressure from various Ministries representing the key end-user industries, it has to incentivise the production and consumption of natural gas by sending the right policy signals. Else, the fallout will be clear — international oil majors will steer clear of the country as an investment destination with its resultant implications. The decision by two major international players to walk off the KG Basin can be cited as an example.

Source: Hindu Business Line

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