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Two more reports…
Two reports discussing policy reforms for natural gas have recently been
submitted. While it is still early days, the recommendations call for stopping
preferential supplies to merchant power, city gas players and other non-core
sectors. Pooling of natural gas supplies for fertiliser and regulated power players
will also improve the affordability LNG – a positive for P-LNG and transmitters like
Gail, GSPL. It is as yet unclear how this will impact domestic gas prices but we are
encouraged by the recommendations to move towards a free-market. Every
US$1/mmbtu change in prices impacts EPS of Reliance, ONGC, OIL by 4-6%.
CANR – withdraw allocations to merchant power developers
q The Committee on Allocation of Natural Resources (CANR) was set up by the Group
of Ministers (GoM) headed by the FM to consider measures to tackle corruption.
q The CANR report, yet to be accepted by the GoM, enunciates principles for future
natural gas supplies without affecting the current gas utilisation policies.
q The committee recommended that fertiliser players continue to be supplied
domestic gas as per government’s current policies in the short term (3-5 years).
q While it recognises the need to efficiently utilise power capacities in light of the
sharp rise expected, it has advocated that domestic gas allocations be allowed only
to producers that submit to regulated tariffs and not to merchant power developers.
q Indeed it recommends an immediate change even for existing supplies here with
the cognizance of the EGOM on natural gas allocations and indicates that such
developers as well as city gas players be grouped with other users who should
procure their future requirement at market determined prices.
Gas price pooling – make LNG affordable
q Separately, an inter-ministerial panel set up to formulate policy on pooling of
natural gas prices has recommended pooling domestic gas and LNG for supplying to
power and fertiliser sector consumers at a blended average price.
q It recognises that fertiliser will take precedence in domestic supplies followed by
power but notes that proportion of LNG in the respective pools will rise nonetheless.
q The committee also proposes to cap use in city gas to 6mmscmd (similar to current
levels) and notes that incremental supplies here and to other non core sectors
(refiners, petrochems, steel) should be predominantly fed from imported LNG.
q It also argues for reversion to postalised (or equalised) tariffs from the current
zone-based tariffs for gas transmission and to simplify state taxes on natural gas.
Early days yet but P-LNG, Gail, GSPL will gain
q It is still early days for the committee reports – especially the one on pooling for
gas supplies which appears to be facing resistance from several quarters.
q Pooling may also conflict with existing contracts and vitiate the NELP auction
process for gas pricing while the recommendations for equalised transmission tariffs
is at variance to current the downstream regulator PNGRB’s regulations.
q Nonetheless, prima-facie, the recommendations will increase the cost of sourcing
gas for city gas players like Indraprastha Gas. Similarly, existing merchant power
developers and those with significant expansion plans will face headwinds.
q Pooling of supplies for fertiliser, regulated power will also improve affordability of
LNG – a positive for P-LNG where rising prices could become a growth headwind.
q Transmitters like Gail and GSPL will benefit too if this improves LNG imports.
Impact on pricing is uncertain but eventual free market
q It is as yet unclear how the recommendations will impact domestic gas prices.
q For example, the pooling report notes that gas-pools may weaken the negotiating
hand of Indian LNG buyers in the global market while increasing the temptation to
keep prices from domestic producers – both unintended consequences.
q Nonetheless, while we see little scope for any upward revision of Reliance KG-D6
prices (and concomitantly that for ONGC and Oil India) before Mar-14, we are
encouraged by the recommendations of both reports to underscore an eventual
transition to a free market where global gas prices play an important role.
q Every US$1/mmbtu increase in gas prices lifts the EPS of Reliance, ONGC and OIL
by 4-6% and cuts Gail’s EPS by 7-8% (lower margins in LPG and polymer).
Key recommendations on natural gas of the Committee on
Allocation of Natural Gas and comments from Ministry
CANR recommendation: The demand for gas for fertilisers arises on account of the
cost and efficiency advantages that it lends to urea production. However, in the
Committee's view, the slant or bias in favour of urea may be corrected through
extension of the nutrient based subsidy scheme, which has been announced in the
Budget for 2011-12. This, along with sourcing of urea from other jurisdictions where
gas is available at a cheaper price (e.g., middle East and African countries) is likely to
reduce the demand for gas for domestic urea production. However, keeping the critical
importance of fertiliser availability for food security of the country, it would be
necessary to ensure that domestic urea capacities continue to obtain natural gas, as
per their requirements, which can be assessed on rational and transparent basis.
Moreover, till such time that there is need to subsidise urea and the scheme for direct
delivery of subsidies to the users (i.e., farmers) does not actually get operationalised -
a time horizon of 3-5 years can be earmarked for this purpose - natural gas should be
supplied to the fertiliser sector, on the basis of formula/principle as approved by
Government.
Comments of Petroleum Ministry: The Committee has recommended that domestic
urea capacities should continue to off-take natural gas as per their requirements. Till
such time that urea prices are not decontrolled or the scheme for direct delivery of the
subsidies to the user does not get operationalised, natural gas should be supplied to
the fertiliser sector on the basis of formula/principle approved by the Government. This
is in line with present Gas Allocation Policy.
CANR recommendation: New and existing gas fired power capacity should preferably
be used only for intermediate or peaking power. A specific procurement contracts for
such power along with a time of day tariff mechanism is expected to be shortly in
place, given current regulatory developments in the electricity sector. However,
keeping in mind the need to develop power capacities in the country expeditiously and
bring down both the peak and energy deficits, there would be a need to ensure that
the power sector demand for gas (for peak/intermediate capacities, up to a plant load
factor (PLF) as specified) is met in full, till the end of the XII Five year plan period. In
view of the fact that distribution sector reforms are critical and need to be started
expeditiously and to encourage time of the day tariff mechanisms, the price of the gas
should be determined through a market mechanism, without there being any need to
provide any input subsidies. However, since this segment is receiving the benefit of an
earmarked supply, it is important to ensure that the benefit is passed on to the
consumers of electricity. Hence, the Committee is of the opinion that the bidders in
this market should be limited to such state-owned or private plants as are willing to
subject themselves to regulated tariffs, i.e., merchant power plants would not be
entitled to the benefit of earmarked supply. Since the price of imported LNG would act
as a cap, it is expected that the power produced through market sourcing of gas would
be in the range where it can eminently be absorbed for peaking/intermediate load
applications.
Comments of Petroleum Ministry: i) The present gas allocation policy allows supply
of domestic gas to power plants for operating at 75% PLF in Andhra Pradesh and 70%
PLF in other parts of the country. For new power plants, the policy is that domestic gas
would be allotted subject to availability once the power plant has been completed
ii) On the recommendations that new and existing gas based power capacities should
preferably be used for intermediate and peaking power and the demand for gas for
such capacities is met in full till the end of 12th Five Year Plan period, the views of
MoPNG are that 16,000 MW of gas based power capacity exists in the country as on
date. 5000 to 6000 MW additional capacity is expected to be operational over the next
two years. It would be necessary to optimally utilize the existing gas based capacity.
Setting up of power plants only for peaking or intermediate use would require
distribution reforms and time of day tariff regulations. Views of Ministry of Power may
also be taken on the recommendation.
iii) MoPNG is in agreement that the price of gas should be determined through market
mechanism and gas for power plants should be made available only to such State
owned or private plants that are willing to subject themselves to regulated tariffs i.e.
merchant power plants would not be eligible for earmarked domestic gas supply.
However, implementation of the decision would require approval of the Empowered
Group of Ministers (EGoM).
Comments of Steel Ministry: Gas based sponge iron sector has been allotted natural
gas for their existing capacities, based on the premise that the use natural gas as
feedstock and not as a fuel and also as they were set up as coast based plants on the:
presumption that they will get cheaper and continued supply of natural gas. However,
recently, due to dwindling supply of natural gas from KG-D6 fields, MoPNG has given
directions to give priority to supply of natural gas only to' fertilizers and power sector
(including merchant power plants) and making cuts in supply to other sectors including
gas based sponge iron. As recommended by the Committee no preference should be
given to merchant power plants over gas based sponge iron plants in the matter of
supply of natural gas and the supply gas based sponge iron plants be made as per
allocation made to them and the contractual obligations.
CANR recommendation: In view of the strategic needs of the country, the
Committee thinks that gas should increasingly be viewed as a substitute for oil, and
used as industrial fuel and for cooking, transport and other such applications if in these
sectors, the use of gas is competitive vis-à-vis other competing Petroleum, Oil and
Lubricants (POL) based fuels without compromising Government revenue through
taxes on liquid fuels. Thus, these uses should also be allowed to procure their
requirements through the market, at a market determined price. Government may
review taxation on piped gas/CNG (compressed natural gas) beyond threshold usage.
Merchant power plants can compete with such uses for their gas requirements.
Comments of Petroleum Ministry: If domestic gas is competitively priced and the
price of domestic gas reflects the energy equivalence in terms of alternate fuels
obtained from crude or liquefied natural gas (LNG), domestic gas can be supplied to all
sectors as substitute for industrial fuel even if the output prices of such sectors are
decontrolled. This would, however, be subject to availability of gas after meeting the
requirement of priority sectors where output prices are controlled and also revenue
implications as the present taxation regime on gas is much lower compared to liquid
fuels.
CANR recommendation: However, the aforesaid allocation and pricing
recommendations would only be applicable to future discoveries and contracts of gas.
The existing contracts should be maintained. The existing contracted supplies can
continue to be earmarked for various sectors, through the EGoM, as per extant
practice; and, at the price discovered and approved by Government. However, the
Committee would request the EGoM to revisit the earmarked allocation of gas for such
power plants as are not willing to subject themselves to regulated tariffs. The EGoM
can continue to allocate gas to the specific fertiliser units on the basis of the
recommendations of the concerned administrative Ministries/Departments.
Comments of Petroleum Ministry: MoPNG is in agreement with the
recommendations.
CANR recommendation: The freedom which currently exists in the New Exploration
Licensing Policy (NELP) provisions for contractors to determine the prices of their gas
produce should be employed to move towards free pricing of gas from NELP fields. The
price discovery in respect of other sectors, besides fertilisers, for future supplies of
gas, should, in the Committee's view, be on the basis of a market mechanism, either
through an exchange or through bilateral contracts. This will ensure a continuing
incentive to the contractors to produce and bring more and more gas in the market.
However, the existing price contracts should be preserved in their present form. The
subsidies, wherever required, should be transferred directly to the end consumer; or,
otherwise met transparently through a budgetary mechanism.
Comments of Petroleum Ministry: NELP contracts provide for the Contractor to
determine the market price of gas on the basis of competition and arms length sales
and the price basis/price formula shall be approved by the Government in a region for
similar sales under similar conditions. Thus the NELP contract already provide for
market related pricing of gas. The present contracts do not envisage sale of gas
through an exchange. Whether direct transfer of subsidies to the end consumers
through a budgetary mechanism would be possible in the power sector, needs to be
separately examined by the Ministry of Power/Ministry of Finance.
CANR recommendation: A competitive gas market (on the sellers' side) should be
ensured by development of a natural gas trading platform (exchange) which allows
producers to effect market discovery of gas prices and sell gas competitively to other
sectors, besides fertilisers. The exchange or bilateral arrangements, however, should
ensure that power sector demand is met in full over the medium term (i.e., till 2016-
17) horizon. Gas markets can also develop through creation of independent marketers
in the form of aggregators and shippers. The existing linkage between transporters and
marketers has potential for conflict of interest and does not bode well for development
of a healthy gas market. To encourage the development of such a market, Government
can take and then auction, in small lots, a part of its profit petroleum in kind under the
PSC contracts. The development of a market for natural gas can be subject to the
regulatory oversight of the downstream regulator.
Comments of Petroleum Ministry: MoPNG is in agreement with the development of
natural gas trading platform to effect market discovery of gas prices except for
fertilisers. This would require differential pricing of gas. The present decision of the
EGoM is that gas be supplied to all sectors at the same price. In a condition of scarcity
exchange traded domestic gas prices would tend towards LNG prices. This may make
the gas unaffordable for some sectors like power. It may not be possible for
Government to auction its share of profit petroleum as the Contractor would demand
equal price for his gas. The present gas market is an emerging market with few
players and oversight by downstream regulator may not be appropriate at this stage.
CANR recommendation: It should be easy to buy, sell and use the commodity being
traded. For gas, this means a good nation-wide transportation and distribution
infrastructure, which is currently missing. Without such infrastructure, a national gas
market will not exist. The Committee's opinion is that the most critical need in the
medium term, therefore, is the rapid development of a national gas grid and gas
distribution infrastructure. While Petroleum and Natural Gas Regulatory Board (PNGRB)
has begun this process, it would be good to expedite this. Of course, it goes without
saying that such infrastructure development should be undertaken in a fully
transparent manner and can be expected to synchronize with upstream gas availability
or LNG terminals.
Comments of Petroleum Ministry: MoPNG is in agreement with the
recommendation that development of gas transportation infrastructure should be
synchronised with upstream gas availability and LNG terminals.
CANR recommendation: Open access and affiliate code regulations that have been
created by the PNGRB should be enforced. To further encourage competition, it may
also be considered whether the percentage of capacity that must be reserved for open
access should be increased. It should be noted that in well-developed gas markets
such as the US, the entire pipeline capacity is reserved for open access - that is,
transportation is completely unbundled from marketing (OECD 2000).
Comments of Petroleum Ministry: The stage of development of Indian markets is
very different from USA markets. Higher capacity and open access increase the risk of
the entity laying the pipeline as there is no firm commitment on transportation.
CANR recommendation: The Committee recommends that as gas markets become
increasingly competitive and supply improves, Government and regulatory agencies
should gradually withdraw from their roles in deciding price and allocation. Instead,
they should ensure that markets remain competitive and consumer interests are
protected.
Comments of Petroleum Ministry: Agreed
CANR recommendation: The idea of pooling of gas prices for selected sectors can be
further examined vis-à-vis the relative advantages of pooling being coordinated at the
unit level, along with development of sufficient infrastructure (in the form of gas
pipelines and re-gasification terminals).
Comments of Petroleum Ministry: Agreed
Key recommendations of the Inter-Ministerial panel on
pooling of natural gas prices
q It is important to note Indian gas market needs a rational gas pricing mechanism to
encourage efficient consumption and development of natural gas infrastructure,
while preserving the incentives to gas suppliers. Gas price pooling (either based on
cost pooling or bid based pooling) is desirable for all the sectors consuming gas in
order to bring in price stability at the individual consumer level. However, based on
the analysis conducted by the consultant that Power and Fertilizer being the most
vulnerable sectors, it is imperative for the Power and Fertilizer sectors to have a
stable (within a range) gas price.
q Accordingly the following are recommended:
1. Price pools should be formed for power and fertilizer customers. We
recommend separate pools for the two sectors to avoid cross subsidies between
the customer groups and administration issues that a combined pool would
present;
2. The pools should be notified consequent to a policy issued by the GoI. The
notification should spell out the guidelines for pool operation in sufficient detail,
and should also provide for tenure for the pool. The pool can be disbanded or
extended upon a specific review on completion of the term. Considering the
market realities the consultant recommended a 4-5 year term for the pool;
3. The policy should notify a pool operator. We believe that GAIL as an existing
operator of the pipeline system (and also with prior experience of pooling of
RLNG) would be well placed to operate the pool. However the pool operation
would have to be done on an arms length basis with suitable functional
separation within the organization. The design of the pool should be undertaken
on the basis of minimization of structures, costs and complexities;
4. A detailed set of pool rules should be drawn up and such rules should be
notified by the GoI after due consultation. The limits of operations of the pool
should be clearly set out, including the range of acceptable pool prices and
corresponding quantities to be introduced. Detailed operating codes would also
need to be drawn up;
5. All existing contracts for the sectors identified for pooling should be modified or
novated to the pool as per the pool rules. This would require the pool operator
to develop standard contracts;
6. The pool should feature the necessary institutional structures and governance
arrangements discussed earlier in this report. A separate analysis of these
arrangements is suggested consequent to acceptance of the recommendations
of this report;
q As mentioned, the pools are recommended for the power and fertilizer industries
only. This leaves adequate room for an alternate market to develop for other
industries and even for customers of the power and fertilizer sector (particularly the
former), who may not wish to be a part of the pool. This would facilitate price
discovery for new gas supplies, and the pooling arrangements would not be a
limiting factor for development of the industry beyond the limits that the pool can
serve within its rules. This would also provide comfort to new gas suppliers who
wish to supply to such industries.
q It is important to note that the benefits of cost pooling are not necessarily
restricted to the power and fertilizer sectors only. However the benefits of central
pooling in the other sectors on the lines proposed is more complex on account of
the large number of consumers with small volumes, since this would militate
against the objective of keeping the pool administration set up and costs to a
minimum. For the other sectors such as sponge iron, petrochemicals, CGD and
other small customers pooling can be done at the gas supplier's level. In the
present scenario the gas consumers source gas from various sources and pool it at
the individual company level. Our analysis shows that in the international markets
such as Italy and France where mostly the supply is based on contracts the gas
supply company pools the gas from various sources and supplies it to the
customers at a common price to all the end consumers. As we have mentioned in
the report, we do not recommend pooling of transportation costs since this distorts
the basic economic price signals derived from the location of the customer vis a vis
the resource. However we do recommend the development of a robust gas
transportation system across the country based on a policy or legislative mandate.
In the initial years when the utilization is low on such pipelines, the policy
framework should place limits on the pipeline charges. Deficits if any can be made
good through mechanisms like Access Deficit Charges (ADC) as prevalent in the
telecommunications sector.
q Finally we recommend the creation of a roadmap for migration to competitive
wholesale markets for gas, which would typically be through bid based pools, and
feature a large number of independent shippers. It is important to note that such
mechanisms could coexist with cost based pools and also long term contracts for
gas supply. This would result in the emergence of a vibrant gas market that could
attract new gas suppliers willing to supply for various contract tenures, and would
provide a strong signal for emergence of gas trading hubs at key dispatch/
aggregation points in the country.
Critical issues that have emerged related to Inter-
Ministerial panel’s recommendation on pooling of gas prices
q Variations in taxation among the states
The rates of VAT vary among the states from 12% to 26%. Some of the states have
also allowed VAT credit against the final product while some do not. An inherent
feature of the pooling would be that all the customers would be supplied gas through a
pooling mechanism at a common price irrespective of the rate at which gas is
contracted. This would lead to the issues of taxation as the common pooled price may
be higher than the contracted price for some and lower for others. The states are not
bound to levy VAT on common pooled price. It might be difficult to account for the
variations in taxes through the pooling mechanism. In case an effort is made to pool
the taxes, then some states may increase the VAT rates and this may lead to export of
state taxes and may lead to legal complications.
Since, there is no physical pooling of gas and the actual delivery of gas may be
different than pooled gas. Also, transportation charges would follow the contractual
path, while the physical path may be different. Swapping of gas, which is inherent in
gas pooling, would also require a clear taxation regime. To remove these anomalies
natural gas may be included in GST regime or be conferred 'Declared Good' status.
q Creation of an Overarching Pool
In the present system, the producer gives the gas to a marketer or enters into a GSPA
directly. With the pooling mechanism, there may be no direct relationship between the
producer/marketer and the customer regarding the quantity of gas supplied as well as
the price. The pool will have to decide whether to make any gas a part of pooled price
or not. It will need to be worked out how GSPA/GTAs between the producer/
marketer/ transporter and the consumer will be operated. Future GSPA/GTAs may
have to be modified to accommodate the pooling concept.
q Concern Over Price Discovery
In their comments on the report of the consultant, most of the upstream companies
have expressed reservations on the price discovery mechanism as it would operate in
the pooling scenario. The pools do not have any control over the international LNG
price and to get the benefit would like to keep the domestic prices at much lower levels
than the LNG. This would be detrimental to the interest of upstream producers and
indigenous development. Since, the customers will not be getting the gas at the
contracted price with the producer, producer will not be able to discover the price of
gas supplied to fertilizer and power sectors through bidding and it would be only the
pool which will be able to discover the price.
q Pooling of Transportation Tariff
The transportation tariff cumulates as gas moves from one trunk pipeline to the next.
The transportation tariff for a customer in a state like Punjab for the KG Basin gas
could be more than 70% of the producer price of the gas. It has been suggested by
some consumers especially fertilizer sector that transportation tariff should also be
pooled. Pooling transportation tariff would have to involve transporters also in the
pooling mechanism, making it further complicated.
q Legal Challenge
The directive for pooling of LNG prices by Petronet LNG in 2007 was challenged by
several Gujarat customers. Though Gujarat high court decided in favor of pooling 2:1,
the appeal is pending in Supreme Court. In view of the complex issues involved in
pooling of all existing gases as well as future domestic gas and LNG for creation of two
sectoral pools, it is for consideration whether an Inter-Ministerial group involving
Ministry of Finance, Planning Commission, Ministry of Power and Deptt. Of Fertilizers
may be formed and chaired by Addl. Secretary, MoPNG to resolve the inter-ministerial
issues and also devise pool operating guidelines.
q Imports of LNG only at reasonable price
The same would be facilitated if LNG imports are made for upcoming power/ fertilizer
plants. In order to maintain that the prices are at a reasonable level, a high
empowered committee can be formed comprising of high level officials from GAIL,
MOP&NG and other administrative Ministries.
q How convergence of price pooling and NELP could be achieved
Under the present contract, flexibility is given for discovery of prices through market
route which would be approved by GOI. Since the pooling proposed is at consumer
level, the prices payable to producers would remain unaffected and would be governed
by provisions of PSC/NELP contracts. The prices of consumers for core sectors would
only be dictated by the pooling mechanism.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Two more reports…
Two reports discussing policy reforms for natural gas have recently been
submitted. While it is still early days, the recommendations call for stopping
preferential supplies to merchant power, city gas players and other non-core
sectors. Pooling of natural gas supplies for fertiliser and regulated power players
will also improve the affordability LNG – a positive for P-LNG and transmitters like
Gail, GSPL. It is as yet unclear how this will impact domestic gas prices but we are
encouraged by the recommendations to move towards a free-market. Every
US$1/mmbtu change in prices impacts EPS of Reliance, ONGC, OIL by 4-6%.
CANR – withdraw allocations to merchant power developers
q The Committee on Allocation of Natural Resources (CANR) was set up by the Group
of Ministers (GoM) headed by the FM to consider measures to tackle corruption.
q The CANR report, yet to be accepted by the GoM, enunciates principles for future
natural gas supplies without affecting the current gas utilisation policies.
q The committee recommended that fertiliser players continue to be supplied
domestic gas as per government’s current policies in the short term (3-5 years).
q While it recognises the need to efficiently utilise power capacities in light of the
sharp rise expected, it has advocated that domestic gas allocations be allowed only
to producers that submit to regulated tariffs and not to merchant power developers.
q Indeed it recommends an immediate change even for existing supplies here with
the cognizance of the EGOM on natural gas allocations and indicates that such
developers as well as city gas players be grouped with other users who should
procure their future requirement at market determined prices.
Gas price pooling – make LNG affordable
q Separately, an inter-ministerial panel set up to formulate policy on pooling of
natural gas prices has recommended pooling domestic gas and LNG for supplying to
power and fertiliser sector consumers at a blended average price.
q It recognises that fertiliser will take precedence in domestic supplies followed by
power but notes that proportion of LNG in the respective pools will rise nonetheless.
q The committee also proposes to cap use in city gas to 6mmscmd (similar to current
levels) and notes that incremental supplies here and to other non core sectors
(refiners, petrochems, steel) should be predominantly fed from imported LNG.
q It also argues for reversion to postalised (or equalised) tariffs from the current
zone-based tariffs for gas transmission and to simplify state taxes on natural gas.
Early days yet but P-LNG, Gail, GSPL will gain
q It is still early days for the committee reports – especially the one on pooling for
gas supplies which appears to be facing resistance from several quarters.
q Pooling may also conflict with existing contracts and vitiate the NELP auction
process for gas pricing while the recommendations for equalised transmission tariffs
is at variance to current the downstream regulator PNGRB’s regulations.
q Nonetheless, prima-facie, the recommendations will increase the cost of sourcing
gas for city gas players like Indraprastha Gas. Similarly, existing merchant power
developers and those with significant expansion plans will face headwinds.
q Pooling of supplies for fertiliser, regulated power will also improve affordability of
LNG – a positive for P-LNG where rising prices could become a growth headwind.
q Transmitters like Gail and GSPL will benefit too if this improves LNG imports.
Impact on pricing is uncertain but eventual free market
q It is as yet unclear how the recommendations will impact domestic gas prices.
q For example, the pooling report notes that gas-pools may weaken the negotiating
hand of Indian LNG buyers in the global market while increasing the temptation to
keep prices from domestic producers – both unintended consequences.
q Nonetheless, while we see little scope for any upward revision of Reliance KG-D6
prices (and concomitantly that for ONGC and Oil India) before Mar-14, we are
encouraged by the recommendations of both reports to underscore an eventual
transition to a free market where global gas prices play an important role.
q Every US$1/mmbtu increase in gas prices lifts the EPS of Reliance, ONGC and OIL
by 4-6% and cuts Gail’s EPS by 7-8% (lower margins in LPG and polymer).
Key recommendations on natural gas of the Committee on
Allocation of Natural Gas and comments from Ministry
CANR recommendation: The demand for gas for fertilisers arises on account of the
cost and efficiency advantages that it lends to urea production. However, in the
Committee's view, the slant or bias in favour of urea may be corrected through
extension of the nutrient based subsidy scheme, which has been announced in the
Budget for 2011-12. This, along with sourcing of urea from other jurisdictions where
gas is available at a cheaper price (e.g., middle East and African countries) is likely to
reduce the demand for gas for domestic urea production. However, keeping the critical
importance of fertiliser availability for food security of the country, it would be
necessary to ensure that domestic urea capacities continue to obtain natural gas, as
per their requirements, which can be assessed on rational and transparent basis.
Moreover, till such time that there is need to subsidise urea and the scheme for direct
delivery of subsidies to the users (i.e., farmers) does not actually get operationalised -
a time horizon of 3-5 years can be earmarked for this purpose - natural gas should be
supplied to the fertiliser sector, on the basis of formula/principle as approved by
Government.
Comments of Petroleum Ministry: The Committee has recommended that domestic
urea capacities should continue to off-take natural gas as per their requirements. Till
such time that urea prices are not decontrolled or the scheme for direct delivery of the
subsidies to the user does not get operationalised, natural gas should be supplied to
the fertiliser sector on the basis of formula/principle approved by the Government. This
is in line with present Gas Allocation Policy.
CANR recommendation: New and existing gas fired power capacity should preferably
be used only for intermediate or peaking power. A specific procurement contracts for
such power along with a time of day tariff mechanism is expected to be shortly in
place, given current regulatory developments in the electricity sector. However,
keeping in mind the need to develop power capacities in the country expeditiously and
bring down both the peak and energy deficits, there would be a need to ensure that
the power sector demand for gas (for peak/intermediate capacities, up to a plant load
factor (PLF) as specified) is met in full, till the end of the XII Five year plan period. In
view of the fact that distribution sector reforms are critical and need to be started
expeditiously and to encourage time of the day tariff mechanisms, the price of the gas
should be determined through a market mechanism, without there being any need to
provide any input subsidies. However, since this segment is receiving the benefit of an
earmarked supply, it is important to ensure that the benefit is passed on to the
consumers of electricity. Hence, the Committee is of the opinion that the bidders in
this market should be limited to such state-owned or private plants as are willing to
subject themselves to regulated tariffs, i.e., merchant power plants would not be
entitled to the benefit of earmarked supply. Since the price of imported LNG would act
as a cap, it is expected that the power produced through market sourcing of gas would
be in the range where it can eminently be absorbed for peaking/intermediate load
applications.
Comments of Petroleum Ministry: i) The present gas allocation policy allows supply
of domestic gas to power plants for operating at 75% PLF in Andhra Pradesh and 70%
PLF in other parts of the country. For new power plants, the policy is that domestic gas
would be allotted subject to availability once the power plant has been completed
ii) On the recommendations that new and existing gas based power capacities should
preferably be used for intermediate and peaking power and the demand for gas for
such capacities is met in full till the end of 12th Five Year Plan period, the views of
MoPNG are that 16,000 MW of gas based power capacity exists in the country as on
date. 5000 to 6000 MW additional capacity is expected to be operational over the next
two years. It would be necessary to optimally utilize the existing gas based capacity.
Setting up of power plants only for peaking or intermediate use would require
distribution reforms and time of day tariff regulations. Views of Ministry of Power may
also be taken on the recommendation.
iii) MoPNG is in agreement that the price of gas should be determined through market
mechanism and gas for power plants should be made available only to such State
owned or private plants that are willing to subject themselves to regulated tariffs i.e.
merchant power plants would not be eligible for earmarked domestic gas supply.
However, implementation of the decision would require approval of the Empowered
Group of Ministers (EGoM).
Comments of Steel Ministry: Gas based sponge iron sector has been allotted natural
gas for their existing capacities, based on the premise that the use natural gas as
feedstock and not as a fuel and also as they were set up as coast based plants on the:
presumption that they will get cheaper and continued supply of natural gas. However,
recently, due to dwindling supply of natural gas from KG-D6 fields, MoPNG has given
directions to give priority to supply of natural gas only to' fertilizers and power sector
(including merchant power plants) and making cuts in supply to other sectors including
gas based sponge iron. As recommended by the Committee no preference should be
given to merchant power plants over gas based sponge iron plants in the matter of
supply of natural gas and the supply gas based sponge iron plants be made as per
allocation made to them and the contractual obligations.
CANR recommendation: In view of the strategic needs of the country, the
Committee thinks that gas should increasingly be viewed as a substitute for oil, and
used as industrial fuel and for cooking, transport and other such applications if in these
sectors, the use of gas is competitive vis-à-vis other competing Petroleum, Oil and
Lubricants (POL) based fuels without compromising Government revenue through
taxes on liquid fuels. Thus, these uses should also be allowed to procure their
requirements through the market, at a market determined price. Government may
review taxation on piped gas/CNG (compressed natural gas) beyond threshold usage.
Merchant power plants can compete with such uses for their gas requirements.
Comments of Petroleum Ministry: If domestic gas is competitively priced and the
price of domestic gas reflects the energy equivalence in terms of alternate fuels
obtained from crude or liquefied natural gas (LNG), domestic gas can be supplied to all
sectors as substitute for industrial fuel even if the output prices of such sectors are
decontrolled. This would, however, be subject to availability of gas after meeting the
requirement of priority sectors where output prices are controlled and also revenue
implications as the present taxation regime on gas is much lower compared to liquid
fuels.
CANR recommendation: However, the aforesaid allocation and pricing
recommendations would only be applicable to future discoveries and contracts of gas.
The existing contracts should be maintained. The existing contracted supplies can
continue to be earmarked for various sectors, through the EGoM, as per extant
practice; and, at the price discovered and approved by Government. However, the
Committee would request the EGoM to revisit the earmarked allocation of gas for such
power plants as are not willing to subject themselves to regulated tariffs. The EGoM
can continue to allocate gas to the specific fertiliser units on the basis of the
recommendations of the concerned administrative Ministries/Departments.
Comments of Petroleum Ministry: MoPNG is in agreement with the
recommendations.
CANR recommendation: The freedom which currently exists in the New Exploration
Licensing Policy (NELP) provisions for contractors to determine the prices of their gas
produce should be employed to move towards free pricing of gas from NELP fields. The
price discovery in respect of other sectors, besides fertilisers, for future supplies of
gas, should, in the Committee's view, be on the basis of a market mechanism, either
through an exchange or through bilateral contracts. This will ensure a continuing
incentive to the contractors to produce and bring more and more gas in the market.
However, the existing price contracts should be preserved in their present form. The
subsidies, wherever required, should be transferred directly to the end consumer; or,
otherwise met transparently through a budgetary mechanism.
Comments of Petroleum Ministry: NELP contracts provide for the Contractor to
determine the market price of gas on the basis of competition and arms length sales
and the price basis/price formula shall be approved by the Government in a region for
similar sales under similar conditions. Thus the NELP contract already provide for
market related pricing of gas. The present contracts do not envisage sale of gas
through an exchange. Whether direct transfer of subsidies to the end consumers
through a budgetary mechanism would be possible in the power sector, needs to be
separately examined by the Ministry of Power/Ministry of Finance.
CANR recommendation: A competitive gas market (on the sellers' side) should be
ensured by development of a natural gas trading platform (exchange) which allows
producers to effect market discovery of gas prices and sell gas competitively to other
sectors, besides fertilisers. The exchange or bilateral arrangements, however, should
ensure that power sector demand is met in full over the medium term (i.e., till 2016-
17) horizon. Gas markets can also develop through creation of independent marketers
in the form of aggregators and shippers. The existing linkage between transporters and
marketers has potential for conflict of interest and does not bode well for development
of a healthy gas market. To encourage the development of such a market, Government
can take and then auction, in small lots, a part of its profit petroleum in kind under the
PSC contracts. The development of a market for natural gas can be subject to the
regulatory oversight of the downstream regulator.
Comments of Petroleum Ministry: MoPNG is in agreement with the development of
natural gas trading platform to effect market discovery of gas prices except for
fertilisers. This would require differential pricing of gas. The present decision of the
EGoM is that gas be supplied to all sectors at the same price. In a condition of scarcity
exchange traded domestic gas prices would tend towards LNG prices. This may make
the gas unaffordable for some sectors like power. It may not be possible for
Government to auction its share of profit petroleum as the Contractor would demand
equal price for his gas. The present gas market is an emerging market with few
players and oversight by downstream regulator may not be appropriate at this stage.
CANR recommendation: It should be easy to buy, sell and use the commodity being
traded. For gas, this means a good nation-wide transportation and distribution
infrastructure, which is currently missing. Without such infrastructure, a national gas
market will not exist. The Committee's opinion is that the most critical need in the
medium term, therefore, is the rapid development of a national gas grid and gas
distribution infrastructure. While Petroleum and Natural Gas Regulatory Board (PNGRB)
has begun this process, it would be good to expedite this. Of course, it goes without
saying that such infrastructure development should be undertaken in a fully
transparent manner and can be expected to synchronize with upstream gas availability
or LNG terminals.
Comments of Petroleum Ministry: MoPNG is in agreement with the
recommendation that development of gas transportation infrastructure should be
synchronised with upstream gas availability and LNG terminals.
CANR recommendation: Open access and affiliate code regulations that have been
created by the PNGRB should be enforced. To further encourage competition, it may
also be considered whether the percentage of capacity that must be reserved for open
access should be increased. It should be noted that in well-developed gas markets
such as the US, the entire pipeline capacity is reserved for open access - that is,
transportation is completely unbundled from marketing (OECD 2000).
Comments of Petroleum Ministry: The stage of development of Indian markets is
very different from USA markets. Higher capacity and open access increase the risk of
the entity laying the pipeline as there is no firm commitment on transportation.
CANR recommendation: The Committee recommends that as gas markets become
increasingly competitive and supply improves, Government and regulatory agencies
should gradually withdraw from their roles in deciding price and allocation. Instead,
they should ensure that markets remain competitive and consumer interests are
protected.
Comments of Petroleum Ministry: Agreed
CANR recommendation: The idea of pooling of gas prices for selected sectors can be
further examined vis-à-vis the relative advantages of pooling being coordinated at the
unit level, along with development of sufficient infrastructure (in the form of gas
pipelines and re-gasification terminals).
Comments of Petroleum Ministry: Agreed
Key recommendations of the Inter-Ministerial panel on
pooling of natural gas prices
q It is important to note Indian gas market needs a rational gas pricing mechanism to
encourage efficient consumption and development of natural gas infrastructure,
while preserving the incentives to gas suppliers. Gas price pooling (either based on
cost pooling or bid based pooling) is desirable for all the sectors consuming gas in
order to bring in price stability at the individual consumer level. However, based on
the analysis conducted by the consultant that Power and Fertilizer being the most
vulnerable sectors, it is imperative for the Power and Fertilizer sectors to have a
stable (within a range) gas price.
q Accordingly the following are recommended:
1. Price pools should be formed for power and fertilizer customers. We
recommend separate pools for the two sectors to avoid cross subsidies between
the customer groups and administration issues that a combined pool would
present;
2. The pools should be notified consequent to a policy issued by the GoI. The
notification should spell out the guidelines for pool operation in sufficient detail,
and should also provide for tenure for the pool. The pool can be disbanded or
extended upon a specific review on completion of the term. Considering the
market realities the consultant recommended a 4-5 year term for the pool;
3. The policy should notify a pool operator. We believe that GAIL as an existing
operator of the pipeline system (and also with prior experience of pooling of
RLNG) would be well placed to operate the pool. However the pool operation
would have to be done on an arms length basis with suitable functional
separation within the organization. The design of the pool should be undertaken
on the basis of minimization of structures, costs and complexities;
4. A detailed set of pool rules should be drawn up and such rules should be
notified by the GoI after due consultation. The limits of operations of the pool
should be clearly set out, including the range of acceptable pool prices and
corresponding quantities to be introduced. Detailed operating codes would also
need to be drawn up;
5. All existing contracts for the sectors identified for pooling should be modified or
novated to the pool as per the pool rules. This would require the pool operator
to develop standard contracts;
6. The pool should feature the necessary institutional structures and governance
arrangements discussed earlier in this report. A separate analysis of these
arrangements is suggested consequent to acceptance of the recommendations
of this report;
q As mentioned, the pools are recommended for the power and fertilizer industries
only. This leaves adequate room for an alternate market to develop for other
industries and even for customers of the power and fertilizer sector (particularly the
former), who may not wish to be a part of the pool. This would facilitate price
discovery for new gas supplies, and the pooling arrangements would not be a
limiting factor for development of the industry beyond the limits that the pool can
serve within its rules. This would also provide comfort to new gas suppliers who
wish to supply to such industries.
q It is important to note that the benefits of cost pooling are not necessarily
restricted to the power and fertilizer sectors only. However the benefits of central
pooling in the other sectors on the lines proposed is more complex on account of
the large number of consumers with small volumes, since this would militate
against the objective of keeping the pool administration set up and costs to a
minimum. For the other sectors such as sponge iron, petrochemicals, CGD and
other small customers pooling can be done at the gas supplier's level. In the
present scenario the gas consumers source gas from various sources and pool it at
the individual company level. Our analysis shows that in the international markets
such as Italy and France where mostly the supply is based on contracts the gas
supply company pools the gas from various sources and supplies it to the
customers at a common price to all the end consumers. As we have mentioned in
the report, we do not recommend pooling of transportation costs since this distorts
the basic economic price signals derived from the location of the customer vis a vis
the resource. However we do recommend the development of a robust gas
transportation system across the country based on a policy or legislative mandate.
In the initial years when the utilization is low on such pipelines, the policy
framework should place limits on the pipeline charges. Deficits if any can be made
good through mechanisms like Access Deficit Charges (ADC) as prevalent in the
telecommunications sector.
q Finally we recommend the creation of a roadmap for migration to competitive
wholesale markets for gas, which would typically be through bid based pools, and
feature a large number of independent shippers. It is important to note that such
mechanisms could coexist with cost based pools and also long term contracts for
gas supply. This would result in the emergence of a vibrant gas market that could
attract new gas suppliers willing to supply for various contract tenures, and would
provide a strong signal for emergence of gas trading hubs at key dispatch/
aggregation points in the country.
Critical issues that have emerged related to Inter-
Ministerial panel’s recommendation on pooling of gas prices
q Variations in taxation among the states
The rates of VAT vary among the states from 12% to 26%. Some of the states have
also allowed VAT credit against the final product while some do not. An inherent
feature of the pooling would be that all the customers would be supplied gas through a
pooling mechanism at a common price irrespective of the rate at which gas is
contracted. This would lead to the issues of taxation as the common pooled price may
be higher than the contracted price for some and lower for others. The states are not
bound to levy VAT on common pooled price. It might be difficult to account for the
variations in taxes through the pooling mechanism. In case an effort is made to pool
the taxes, then some states may increase the VAT rates and this may lead to export of
state taxes and may lead to legal complications.
Since, there is no physical pooling of gas and the actual delivery of gas may be
different than pooled gas. Also, transportation charges would follow the contractual
path, while the physical path may be different. Swapping of gas, which is inherent in
gas pooling, would also require a clear taxation regime. To remove these anomalies
natural gas may be included in GST regime or be conferred 'Declared Good' status.
q Creation of an Overarching Pool
In the present system, the producer gives the gas to a marketer or enters into a GSPA
directly. With the pooling mechanism, there may be no direct relationship between the
producer/marketer and the customer regarding the quantity of gas supplied as well as
the price. The pool will have to decide whether to make any gas a part of pooled price
or not. It will need to be worked out how GSPA/GTAs between the producer/
marketer/ transporter and the consumer will be operated. Future GSPA/GTAs may
have to be modified to accommodate the pooling concept.
q Concern Over Price Discovery
In their comments on the report of the consultant, most of the upstream companies
have expressed reservations on the price discovery mechanism as it would operate in
the pooling scenario. The pools do not have any control over the international LNG
price and to get the benefit would like to keep the domestic prices at much lower levels
than the LNG. This would be detrimental to the interest of upstream producers and
indigenous development. Since, the customers will not be getting the gas at the
contracted price with the producer, producer will not be able to discover the price of
gas supplied to fertilizer and power sectors through bidding and it would be only the
pool which will be able to discover the price.
q Pooling of Transportation Tariff
The transportation tariff cumulates as gas moves from one trunk pipeline to the next.
The transportation tariff for a customer in a state like Punjab for the KG Basin gas
could be more than 70% of the producer price of the gas. It has been suggested by
some consumers especially fertilizer sector that transportation tariff should also be
pooled. Pooling transportation tariff would have to involve transporters also in the
pooling mechanism, making it further complicated.
q Legal Challenge
The directive for pooling of LNG prices by Petronet LNG in 2007 was challenged by
several Gujarat customers. Though Gujarat high court decided in favor of pooling 2:1,
the appeal is pending in Supreme Court. In view of the complex issues involved in
pooling of all existing gases as well as future domestic gas and LNG for creation of two
sectoral pools, it is for consideration whether an Inter-Ministerial group involving
Ministry of Finance, Planning Commission, Ministry of Power and Deptt. Of Fertilizers
may be formed and chaired by Addl. Secretary, MoPNG to resolve the inter-ministerial
issues and also devise pool operating guidelines.
q Imports of LNG only at reasonable price
The same would be facilitated if LNG imports are made for upcoming power/ fertilizer
plants. In order to maintain that the prices are at a reasonable level, a high
empowered committee can be formed comprising of high level officials from GAIL,
MOP&NG and other administrative Ministries.
q How convergence of price pooling and NELP could be achieved
Under the present contract, flexibility is given for discovery of prices through market
route which would be approved by GOI. Since the pooling proposed is at consumer
level, the prices payable to producers would remain unaffected and would be governed
by provisions of PSC/NELP contracts. The prices of consumers for core sectors would
only be dictated by the pooling mechanism.
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