Gas Pricing or Gas Wars?

V Ranganathan, Prof IIMB (Retd)

A recent book ‘Gas Wars’ by journalist Guha Thakurtha has been withdrawn by the publisher after RIL sued the author and publisher for defamation. However, the Government has to now come out with its stand on gas pricing and has a hot potato on its hand. If it goes with Rangarajan Report, and hikes the price of gas to $8.4 per mmbtu, it will be accused of fostering crony capitalism, by giving a largess to private sector and if it opts for the status quo-not so low $.4.2 per mmbtu-price it will be accused of not maintaining the sanctity of contract. What should it do?

Prof. Rangarajan’s gas pricing has been commented upon right from Surya Sethi, former Advisor, Energy, Planning Commission, and an MBA from IIM, and Dr. EAS Sarma, former Secretary, Ministry of Power, and Ministry of Finance, but none of them have attacked the core of the problem, which is how to set the market price of gas when there is no single market price, and who should set it.

Now, for some history. Ministry devised a New Exploration and Licensing Policy (NELP) to attract global explorers to explore for oil and gas in India, which at that time-before Krishna Godavari basin discovery-was considered barren. The public sector, ONGC had been sitting on its ores all these years, without adding a single discovery after Bombay High. So, the Govt. had to give liberal incentives on the one hand to attract private players and introduce competitive bids, on the other, to protect State interest, as far as possible. In the Instant case, of RIL in KG D6 basin, revenue share to the Government was the bid parameter and the revenue share was allowed to vary with the money still to be recovered by the private sector, in different years, called investment multiple. The first half of the story was that RIL gave a schedule of revenue share such that, roughly, till the money recovered by the private sector is 1.5 times the investment ploughed by it, it can take 85% of profit petroleum and give to Government only 15%, but once the number crossed 1.5, the share proportions were reversed, 85% to Government and 15% to Company. That looks fair, but there was scope for gaming, by adding investments and keep the date of reaching 1.5 farther and farther away. That this was indeed happening, was pointed out by none other than Anil Ambani who complained that investment increased 4 fold while output only doubled; this was contrary to the intuition of economies of scale and investment productivity, and suggested that such investments could be fictitious. That is why, the upstream gas regulator, Petroleum Secretary, and the Minister, all had to leave under some cloud; viz. for insufficient diligence to prevent the possibility of private sector to ‘gold plate’.

Now, to the second half of the story on gas pricing: The production Sharing Contract had specified that the prices shall be ‘arms length’, a short hand for prices being market determined. But it did not say when or at what frequency the price will be revised. The other problem was there was really no homogeneous market for gas, unlike oil. There was one price in US, falling with the advent of shale gas; a higher price in Europe with gas price indexed to oil price , and a still higher price in Japan because of transport costs. Rangarajan Committee took the average of the prices the producers in US, UK and suppliers to Japan would get, without the transport cost component. It would be an average of the past one year, and reset every 3 months. For April 2014, this worked out to $8.4, double of the prevailing $4.20. Gas suppliers who were in sellers market were able to get linking gas prices to oil prices, which were increasing, even though gas and oil were neither perfect substitutes nor gas had a homogenous market like that of oil. The recent Russia-China deal has reversed this link of gas price to oil, and has brought it closer to cost of production. The lesson is that there is no one unique and right approach to gas pricing and a lot depends on participants’ bargaining power.

Surya Sethi was cut up that no experts (meaning himself) were not included in the Committee. He also asked ‘why incentive price for an already discovered gas?’. But that was what was pre-agreed in the Production Sharing Contract. He also attacked it as ‘bureaucratically set market price’. He attacked saying that the Committee had set the price of bananas by taking the average prices of apples and oranges. But his remedy was unimaginative; he said it should be cost based, which was a clear violation of PSC and also the principle of incentives. EAS Sarma’s criticisms were also pedestrian and commonplace. He said the price has increased while the world prices are coming down. Surely, if they came down, prices will be reset in future with 1 year lag.

So, where do we go from here? The central question is ‘how to determine the market price’? We have to go from first principles, and agree that market prices must be set by the market, not by Government nor Committees, but by buyers and sellers. So, why should Government take up this task at all? Just leave it to the buyers and the seller, and through better wisdom and by negotiation, they will settle the price themselves! It is to avoid the intractable problem of allowable investments which has been the bone of contention between the representatives of the Government and the private sector in the management committee, Rangarajan had suggested to move away from profit sharing to revenue sharing. But then, this suggestion has since been overturned by the Kelkar Committee, which has opted for Production Sharing instead of revenue sharing.