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The vexed pricing issue must be resolved if energy security is to be achieved by 2030

It’s a perplexing paradox: on the one hand, India is going through its toughest period of short supply in energy, and on the other there are rich, abundant resources lying unused. Both corporate consumers and the general public know how the shoe pinches: until these issues are sorted out, they will continue to pay a steep price for petrol, diesel and gas.

Today, India consumes 700 million tonne of oil equivalent of energy in different forms, one-third of which is imported. Demand for oil and natural gas alone is expected to triple in the next two decades to make India one of the most import-dependent nations in the world. Which is why, every time there is news of unrest in Iraq or any other oil-producing nation, everybody gets the jitters.

Officials and industry experts believe that if India is serious about its target of energy security by 2030, the new government at the Centre will have to tackle the challenges in the areas of domestic production of oil and gas by linking the price to market on priority basis.

Some of the tangles which the new government must prioritise in the next few months are:

n A re-look at the new exploration licensing policy (NELP) by reviewing the production sharing contracts (PSC)

n Unlocking the potential in the alternative fuel segments

n Creation of energy corridors

n Deregulation of diesel in the short term and the LPG and kerosene in the long term

n Phasing out of fuel subsidies that burden the government and cause higher interest burden on the oil marketing companies (OMCs)

n Upgradation of public sector refining companies to make them efficient and competitive.

Much more complicated are issues in the upstream sector (exploration, extraction) and downstream sector (refining).

In the upstream sector, the major issue riling explorers and the contractors is the pricing of natural gas. The price of natural gas late last year was doubled to $8.4 per million metric British thermal unit (mmBtu) from the current $4.2 per mmBtu to cater to the demands of upstream explorers, who found difficult to recover the cost of production. However, the revised gas price was not notified by the government and was deferred for revision post the general elections. Sources close to the government state the NDA government is expected to review the prices again after disbanding all previous groups of ministers and empowered group of ministers (GOMs and eGOMs) to whom the buck had been passed.

It is well known by now that companies are unwilling to explore the blocks awarded under nine rounds of NELP since 1999 — due to pricing related and other contractual obligations. Statistics prove that out of 174 blocks awarded, only 63 blocks are in operation at present. There could be no more glaring proof of the previous government’s inability to persuade — or relent to the demands of — operators for an early resolution of the gas price issue. Companies believe the current price of gas makes it unviable for them to recover even the cost of production, forget any returns.

PSCs are the root of a major tussle between the government and private oil and gas explorer Reliance Industries. RIL discovered the largest oil and gas reserves in the Krishna-Godavari D6 block awarded under NELP I in 1999. Production from the KG-D6 block has fallen from its promised peak target of 80 mmscmd to 12 mmscmd currently on technical issues. This had led to a raging controversy over recovery of capital expenditure under the PSCs. The government claims the production was not achieved since RIL failed to drill targeted number of wells under the contract; RIL claimed it was pointless to drill where there was no reserve. There were also reports of RIL gold-plating the expenditure figures which the company claimed was due to increased cost of services and raw material. The issue is under arbitration (See Page 10)

FC Weekend independently verified from government sources that the petroleum ministry is planning to overhaul PSCs and the existing norms for NELP. The existing PSCs allowed contractors to recover the cost of exploration first and then pay royalty to the government. While the norms for new contracts under review are expected to allow the government to receive revenues from the day the block starts production.

The 10th round of auction with around 46 blocks on offer covering 166,053 sq km has been put on the backburner until PSC norms are overhauled. These blocks comprise 17 inland, 15 shallow water and 14 deepwater blocks. It would also be the second highest after NELP-VI in which 52 blocks were offered. Those on offer now are across 13 basins with nine blocks in the Cambay basin, seven in Mumbai High and five in the Andamans.

JC Chaturvedi, executive director, new and marginal fields of ONGC, said the new government, as a priority will have to take stock of what is so wrong with the NELP auctioning process that it failed to elicit a good response from the foreign companies in the last couple of auctions. “Earlier developers were allowed to recover the cost of exploration first before paying the government the royalty. However, what we have witnessed is that complete recovery is not allowed on some pretext to some companies. This is not business-like and has spoiled the sentiment amongst the foreign explorers as well. The production sharing rule has to be relooked,” said the ONGC official.

Experts point out that the investments made by companies are with a view to making profits and not for charity. The lack of exploration activity due to abscence of proper policy on PSC and also due to unrevised gas prices would not help the government either.

Criticising the delay in notifying the revised gas prices, Essar Oil MD LK Gupta said that unlike other countries, India has not allowed the price of gas to be market linked, which has affected the growth and development of the sector, forcing power capacity to lie idle and increasing the cost of production for fertiliser and pertrochemical companies. This is highly illogical since oil prices are market linked. “If the price is allowed to be market linked, the inappropriate dependence on costly imported liquefied natural gas could be curtailed. It would also allow explorers to look at high cost exploration activities in their blocks that would promise handsome returns to the E&P companies,” said Gupta.

India is currently importing around 40 per cent of its gas requirement from abroad at a price that is four to five times the domestic gas price. It is believed if the gas price is doubled to $8.4 per mmBtu, India’s major pipeline and gas distribution company GAIL, that also sources natural gas from abroad to sell through its LNG terminals, would take a hit of around Rs 800-1,000 crore on its bottomline.

The cost of production of gas in Qatar, the biggest supplier of gas to India is not more than $2-$3 per mmBtu depending on the Henry Hub price. Even if additional supply costs are included, the landed cost for Indian companies should not be more than $6 per mmBtu, while Indian consumers are getting the gas at an average rate of $14-$15 per mmBtu.

RK Goel, former director finance of GAIL, says the Modi government is pro-poor and would try to strike a balance between market linked pricing and subsidies for important products. “The most justifiable price for natural gas would be around $6 per mmBtu and it is more likely the new government would revise the price to $6 instead of $8.4 per mmBtu for the explorers,” he said.

The point has been countered by explorers like ONGC and RIL who believe that at existing prices and in some blocks, even the price of $8.4 would not let companies recover the cost of production.

Chaturvedi of ONGC said that better sense prevailed when the government allowed public sector upstream companies ONGC and OIL to charge market-linked price for gas produced from marginal fields that produce less than 100,000 standard cubic meters of gas (scmd). Government fixed the base price at $5 for the issue to go through a tender. “One would be surprised to know that we fetched $11.10 per mmBtu from a Gujarat-based company for 21,000 scm/day of gas, with a condition that if government revises price upwards of Rs 11.10, the sourcing company would pay the equivalent of the revised price by the government,” Chaturvedi added.

The companies also counter the general belief that they are deliberately sitting on blocks and not producing. There is lot of gas produced during production of oil that has to be flared up since selling it is commercially unviable. “We have surplus production of gas in Tripura and in Rajasthan. However, we do not have the infrastructure to supply the gas to remote locations in West Bengal and other states. To set up a straight pipeline from Tripura to West Bengal we have to pass through Bangladesh, which refused us the permission to set up the pipeline. On the contrary, Myanmar allowed China to set up a pipeline to draw gas. These are geo-political challenges that one has to face apart from policy-related issues that need to be taken up by the government on priority basis,” said the ONGC official.

Any decision to hike the price of gas is also going to impact the profits of gas-based power plants as they would not be able to sell at higher tariffs and would not be able to meet their cost of production, unlike the fertiliser companies where the higher cost is passed on. Rajeev Mathur, GAIL’s executive director, marketing said if the price of gas is hiked to $8.4 it would impact the bottomline of the company by around Rs 800-1,000 crore in the short term.

According to ratings agency Crisil, the increase in gas price to $8.4 per mmBtu would help the bottomline of upstream companies to grow by Rs 11,000-11,500 crore in 2014-15. The combined effect of lower under-recoveries and the gas price hike is expected to lift the profits of upstream companies by about Rs 21,500-23,000 crore in 2014-15.

It would also impact the profits of the downstream companies such as HPCL, Indian Oil and BPCL by 26-28 per cent to Rs 16,100-16,400 crore in 2014-15 and by another 4-6 per cent to Rs 16,800-17,100 crore in 2015-16. OMCs shared Rs 2,100 crore under-recoveries in 2013-14. “We have assumed they will not share any under-recovery burden in 2014-15 and 2015-16 due to significant decline in overall under recovery burden going forward. Over the next two years, as gross refining margins (GRMs) of OMCs are expected to remain similar to 2013-14 levels of $3-$4 per barrel, the improvement in profitability will largely be on account of the decline in under-recoveries,” said Crisil in a report.

B Mukherjee, former director finance of HPCL believes a lot would depend on the complete deregulation of the diesel price. It should finally mean less interference from the government. “If the price of crude moves upwards and rupee depreciates further from the current level the under recoveries for the marketing companies could again move up from zero deficit. It needs to be ensured that government finds ways to completely de-regulate diesel prices to improve efficiency in the PSU marketing companies by reducing the burden of high cost debt,” said Mukherjee.

India’s annual energy import bill, according to a Godman Sachs report, already high as $120 billion, could jump to $230 billion by FY23. India’s net energy imports make up 6.3 per cent of GDP. Measures like switching from oil to natural gas and improving conservation can reduce energy imports of the country significantly, it said.

Moreover, the reduction in energy imports as a share of GDP could improve India’s current account on a structural basis, which in turn could be positive for the rupee over the medium term.

There is also a view that the new government should introduce product-focused schemes in proper manner as three more refineries are coming up in Saudi Arabia and UAE, which would create surplus capacity in the West Asia. These countries would then export to neighbouring countries, becoming India’s direct competitors.

A senior official from Reliance Industries, refinery division said, “It should be government’s agenda to increase the product focus scheme in areas such as East Africa, Australia and Singapore, instead of West African regions of Algeria, Libya and Mexico which do not really need petroleum products since they have surplus production themselves.”

There also has to be special emphasis on upgrading old and small PSU refineries to increase their efficiency and help them compete with private sector companies. There has been some movement in this direction with expansion of Paradip, Bina, Panipat and Kochi refineries, which have replicated the model of the RIL and Essar refineries with higher complexities.

Deep Mukherjee, senior director at India Ratings & Research believes, “While the current policy of blanket subsidy is unsustainable, it is inconceivable that fuel-related subsidies would vanish. However, there may be a strong argument to rationalise it and direct the subsidy to the economically weaker strata in the society. Direct cash transfer may be one of the more efficient methods to benefit identified genuine households in such category.”

There are also arguments in favour of complete deregulation, stating the government will have to come out with a notification assuring there would be no more interference and the revised prices will not be reviewed retrospectively. These steps would win investors’ confidence and help the sector grow.



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