A whole lot of gas

No one should be surprised Arvind Kejriwal and crew claim to have found dirty deeds done quite expensively in the natural gas sector in India. This is not because Kejriwal has proven anything. Though his anti-corruption campaign is a necessary shakeup to a complacent elite, when it comes to economics, this self-styled socialist sounds like a cross between Mamata Banerjee and Sitaram Yechury.

There may well be some funny games going in between Reliance and the gas ministry. Kejriwal hasn’t proven anything. But what he has highlighted – as did the comptroller auditor general before him – was that the pricing of natural gas in India is so complicated that it is easy to claim it is derived from corruption. And equally valid to claim it is an honest price, as based on existing government policy, as Reliance claims.

The point is no one can tell.

Natural gas in India doesn’t have a price. It has, at last count, 27 different prices. If one were to include differences created by state or local levies, transport costs, and whatnot I suppose the variations would number in the hundreds.

Gas is priced absurdly in India because it was put together in a time when the market for this fuel was regional if not local. It was derived from a time when domestic production was minimal and imported supplies difficult.

It also reflected a balancing act between commercial and political interests. Electoral compulsions meant gas at low prices for fertilizer and power production. Commercial compulsions required regular and rich profit margins: natural gas is extremely capital intensive with billions needed for infrastructure. This is why 20-year contracts are common in the gas sector. Getting back that sort of investment requires guaranteed supply.

The variation in Indian gas prices is tremendous with many different clusters of gas prices: cooking gas (which is largely imported and the prices are internationally fixed), fertilizer and power (both subsidised), and the prices that are negotiated for much of the gas found by domestic exploration (like KG-D6).

The variation in price is enormous. India imports Russian gas at over $ 10 mmbtu. It is getting the first shiploads of US shale gas at $ 3 mmbtu. The gas used for power and fertilizer is in the $ 6 mmbtu. KG-D6 is presentl $ 4. But what is common in all of these is that the user price is set by the government which makes it inevitably politicized. And it leads any oil and gas firm to turn to pressuring the political leadership to make changes in the prices.

Since politicians will try to make prices as low as possible for their voters, the end result is overly low prices and underinvestment in the Indian gas sector. And Indian gas prices are low. Until 2009, India’s administered price mechanism price for gas was about one-seventh or one-eighth that of the European standards, UK Heren NBP and the EU cif (measured in dollar/oil tonne equivalent). Which is why I am very cautiously sympathetic to the arguments of Reliance and other private producers (though Reliance’s demand for $ 14 mmbtu seems high). Indian gas is still lower then those two standards, but what has become cheaper is Henry Hub.

Henry Hub is the US natural gas benchmark price (like Brent Crude for oil). This used to be about five or six times higher than India’s price. Then shale gas came along and Henry Hub has dropped through the floor. In 2010, it fell below the Indian average price.

In theory, this should provide India an incredible opportunity. India could import US and Canadian gas at $ 2 or 3 mmbtu, driving both Reliance and Russia and Qatar to lower their prices. It could let gas prices in the country be market based. Power, fertilizer and the works could be much cheaper as a consequence.

What’s the catch? The answer goes back to what was said earlier: gas is capital intensive. India simply doesn’t have the infrastructure to import so much gas. It has only two gasification terminals and its pipeline network is primitive. This requires money, and lots of it. But that money will be hard to find if prices are low and the gas market is so politically controlled.

A real gas solution would seek to exploit the present international low prices to keep domestic prices in check, yet provide domestic and international investors sufficient incentive to invest in the needed gas infrastructure. This should produce a virtuous cycle: more investment would mean cheaper gas, would produce more investment. Sadly, neither the government nor Kejriwal nor even Reliance is working to that end.

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