Following the downward revision in the price of domestic gas by 18% to US$ 2.5 per million British thermal unit [mBtu] – on gross calorific value [GCV] basis – from October 1, 2016, the two public sector undertakings [PSUs] in the upstream oil & gas segment viz., Oil and Natural Gas Corporation [ONGC] and Oil India Limited [OIL] have raised a big hue and cry about its likely impact on continued viability of their operations.
The ONGC/OIL duo have contended that the revised price at US$ 2.78 per mBtu on net calorific value [NCV] basis [corresponding to US$ 2.5 per mBtu on GCV] is even lower than their cost of production at US$ 3.59 per mBtu and US$ 3.06 per mBtu respectively. They have argued that there should be a ‘floor’ below which the price should not be allowed to go. The demand is seriously flawed.
Under the new guidelines for pricing of domestic gas in vogue from November 1, 2014, the price is based on a weighted average of prices at 4 global locations viz., Henry Hub [USA], NBP [National Balancing Point] [UK], AGR [Alberta Gas Reference] [Canada] and Russian price for a full year three months prior to the effective date for revision. Effective November 1, 2014, the price was US$ 5.61 per mBtu.
The price is revised bi-annually [once in 6 months]. Thus far, there have been 4 such revisions [all downward] viz., April 1, 2015 [US$ 5.18 per mBtu]; October 1, 2015 [US$ 4.24 per mBtu]; April 1, 2016 [US$ 3.39 per mBtu and October 1, 2016 [US$ 2.78 per mBtu]. The current price is half of the level that prevailed effective November 1, 2014 at US$ 5.61 per mBtu.
The reduction is the outcome of persisting global surplus resulting from a surge in supplies [from North America, Australia and middle-east] on one hand and decrease in demand especially from China and Japan on the other. A sharp drop in the international price of crude oil [to which gas price is linked in most contracts] beginning June, 2014 through the whole of 2015 has also played a role.
The guidelines were introduced in response to a clamor among exploration and production companies [ONGC/OIL included] that the government should debunk the archaic system of administered pricing and move towards market based mechanism. Modi – dispensation did precisely that by adopting a formula-based approach.
This was based on recommendations of a committee of secretaries [CoS] [September, 2014] which rejected the competitive bidding route arguing that the market for gas in India is in a nascent stage and considering that the demand is far in excess of supply, this would lead to exploitation of consumers. On the other hand, linkage with prices at mentioned locations which also happen to be major international trading hubs would free pricing from such an aberration.
Moreover, the formula-driven pricing has the advantage of a ‘neutral’ stance between producers and consumers as well as among various producers/consumers. In a scenario of increasing price, E&P companies stand to gain though consumers lose whereas, under a decreasing price scenario, producers lose but consumers stand to gain. Within each class [read, producers or consumers], an efficient entity is capable of extracting the best under any scenario.
Such a dispensation provides a ‘stable’ and ‘conducive’ policy environment for E&P companies to take investment decisions based on their assessment of how prices will move in the relevant jurisdictions. Any attempt to tinker with it purportedly to accommodate the concerns of particular sectors [or companies] at any given point of time will rob it of this vitality and robustness; hence, it should not even be under consideration.
Notwithstanding the above, ONGC/OIL should note that during first one and a half year under new pricing regime, the price allowed was significantly higher than their cost [as stated by them]. During last six months April 1 – September 30, 2016 also, at US$ 3.39 per mBtu, it was slightly lower than the cost for ONGC US$ 3.59 per mBtu and still higher than OIL US$ 3.06 per mBtu. It is only from October 1, 2016 that the price dipped below cost.
Here again, a deeper probe would show that even now, the PSUs may not be at a loss. The price [US$ 2.78 per mBtu] is applicable to supplies mostly from fields that are over three decades old wherein the initial investments have already been amortized. True, companies are also investing to sustain recovery from those fields. Against that, cost of equipment and services globally have also plummeted; that should help in drastically lowering cost of their operations.
It also needs to be ascertained as to how these undertakings are accounting for investment made in development of newly discovered fields. If, they are including this too for arriving at the cost [such capital spend can only be amortized from future supplies as and when these flow from those fields] then, this will ‘artificially’ boost the cost thereby giving a misleading picture.
Even so, for extracting gas from deep water & ultra-deep water and high pressure–high temperature [HPHT] areas [e.g. KG-DWN-98/2 of ONGC], in March, 2016, the government issued guidelines to give an incentive price using a formula based on price of alternate fuels. That price effective from October 1, 2016 is US$ 5.3 per mBtu – almost double the normal price.
Therefore, neither on principle nor in terms of underlying facts, there is any case for deviating from formula-based approach. E&P companies need to focus on increasing return by maximizing production and reducing cost. By doing so, they will also be showing care for user industries like fertilizers and power which consume nearly 75% of gas but cannot afford to pay more due to majority of their consumers [farmers and households] being poor.
It is good that the minister for petroleum and natural gas [MPNG], Dharmendra Pradhan has categorically rejected the demand made by ONGC/OIL. The government should stick to its stance and not buckle under pressure which will only mount in days to come.