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Gas Pricing: Extracting Reason From The Depths


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The key to controlling oil and gas imports is to offer prices that are on par with international prices. Since the oil and gas trade deficit contributes to more than 3/5ths of the trade deficit, our economic health depends on how quickly we can close this wound...

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Gas Pricing: Extracting Reason From The Depths

  1. 1. Gas Pricing: Extracting Reason from the Depths. India, the world's fourth-largest energy consumer, uses coal for nearly 56 percent of its energy needs, while oil accounts for another 26 percent. It aims to double the proportion of gas in its energy mix to 20 percent by 2020. Demand for gas in India's economy far outstrips production, as India's desire to keep prices cheap for the power and fertilizer industries deters investment in costly producing areas and in pipelines and terminals for more expensive LNG. There is a simple lesson to be learnt about oil and gas pricing. The higher the prices the greater the reserves as more become economically viable. The key to controlling oil and gas imports is to offer prices that are on par with international prices. Since the oil and gas trade deficit contributes to more than 3/5ths of the trade deficit, our economic health depends on how quickly we can close this wound. The Narendra Modi government has postponed taking a decision on domestic gas prices as proposed by the Rangarajan Committee by another three months. The Rangarajan formula calls for pricing at an average cost of importing liquefied natural gas (LNG) into India and rates prevailing at international hubs in the US and UK as well as the price of gas imported into Japan, indicating a price of $8.4 per mmBtu. As ONGC and Oil India produce more than 70% of the gas, it is they who benefit most by any price increase. ONGC expects to add about Rs 8000 crore in profits annually and Oil India another Rs.1000 crores thanks to the increase in gas prices. Standard & Poor’s anticipates that the increase in gas prices will significantly improve ONGC's operating profit by about 20 per cent, compared with 5-7 per cent for RIL.
  2. 2. But anything to do with Reliance automatically becomes problematic. Its baggage of perceived wrongdoing, corporate skullduggery and the much-celebrated regime insensitive influence in the halls of government often precludes an objective analysis of any policy issue that concerns it. Consequently the issue relating to the pricing of the gas production from D1 and D3 fields in block KG-D6, India’s first ever deep-water field has become an extremely contentious one. Quite simply the issue is thus. RIL was given the contract to extract gas from the D-6 block from depths of about 3.5 kilometers in the high seas. The extractable reserves were initially estimated to be 11.3 trillion cubic feet (Tcf) of 2P reserves. In the oil terminology 1P means proven reserves, 2P is for proven plus probable, and 3P is for proven, probable and even possible reserves. This was downscaled by the DGH to 10.3 Tcf. Last RIL restated these 2P reserves by 10-15% suggesting they could be 8.5-9 Tcf. Deep depth drilling is a tricky business. Historically, 2P reserves have a strike rate of 50%. The 1P reserves in KG D1 and D3 are just 1.4 Tcf. RIL was expected to drill 50 development wells, but so far has drilled only 18. RIL indicates that it has hit a slew of unforeseen problems with water and sand ingress into the fields, making further drilling commercially unviable and technologically impossible. RIL partners, the oil majors BP and NIKO, too have downgraded the reserves in D-6 by as much as 70% to a mere 2.9 Tcf from the original 10.03 Tcf. It is not exactly uncommon for a producer to downgrade its estimated reserves after drilling a few wells.
  3. 3. ONGC/OIL have done it several times. But they are never held responsible for the so-called under-recovery. Some in the Ministry for Petroleum and Natural Gas (PNG, then dug their heels and insisted on 50 wells. RIL says if the 1P reserves are extremely limited and 2P is tending towards 3P, it would be pointless drilling more wells. It’s akin to drinking from a bottle of juice with more than one straw. In other words, the extractable oil will remain the same despite more wells. Their argument is that if India needs more oil it should discover more fields. And India needs more oil, as of yesterday. In 2007 the PNG ministry appointed Dr. P. Gopalakrishnan, a reservoir management and optimization consultant to look into the reasons for the rise of phase I capital expenditure from $2.47 billion to $5.2 billion. But Dr. Gopalakrishnan too has a past baggage problem. He was responsible for a previous study for upgrading the reserves. That is, according to him, there are more 1P reserves. In his report to the PNG ministry he recommended that RIL be asked to drill more wells. Some of the PNG bureaucrats and others are now holding this report as the gospel. The conflict of interest should be apparent to anyone willing to open his or her eyes. RIL is essentially saying that the initial diagnosis is wrong; the biopsy proves it and so don’t expect us to follow his line of treatment, and at our cost. Now let us look at the macro-economic realities. India had a trade deficit of $191 billion in 2013. Of this $109 billion was due to oil. India imports 82% of its oil needs. Last month the price of the Indian basket of imported oil peaked to $114 a barrel when it was assumed that it would be $104. Every additional dollar adds $1
  4. 4. billion to the oil bill. India is the world’s fourth largest consumer of energy with an oil equivalent of 563.5 million tonnes of oil a year. Its oil demand is growing by 5.1% every year. Clearly there is an urgency to produce more oil and gas domestically. The road to our national salvation means closing in this trade deficit, which means reducing our energy import dependency quite significantly. There are plenty of 2P and 3P reserves in and around India. We have to make those fields viable by higher producer prices. Last year the Government subsidized oil consumption (under- recoveries of petroleum marketing PSU’s) to the extent of Rs.190, 000 crores or close to $30 billion at today’s exchange rates. Fertilizer subsidies and electricity subsidies further ramp up the subsidy bill. The argument many make is that higher indigenous PNG producer prices will mean higher government outflows towards subsidies are nonsensical. For a start they are unmerited subsidies. Then the Government needs to make a call between stimulating higher oil and gas production in India and the sundry desires of citizen consumers for lower prices. Now if the government were to take D6 gas at $4.32/MMBTU and sold it at say $13.60/MMBTU it will gain 85% of the extra $9.28/MMBTU which would mean a yearly gain of over Rs.50, 000 crores to the government. The question is why should the government give this away to big industry when it could do well to use this money to help uplift tens of millions more each year out of their miserable BPL existence? RIL has a point. Why should it be penalized to make other tycoons happy? And we must not also forget that every rupee given as a subsidy on fertilizers, electricity and domestic gas is actually snatched from the poor who benefit little from the State, and ironically enough even less after the so- called reforms.
  5. 5. RIL antagonists on the other hand harp on the sanctity of Production Sharing Contract (PSC). The PSC is a standard oil and gas industry contract and explicitly acknowledges that that reserves and production figures are governed by probability and not certainty. An expectation is very different from a certainty. The KG D6 field was mostly about 8.5-9 Tcf of 2P reserves of which 1P reserves are just 1.3 Tcf. Clearly it is a business of chance. When an estimate is given it cannot be clung to as if it was a guarantee. Only the very naive will give or expect guarantees in the oil business. The Government of India too is not without its credibility problems. It is now increasingly perceived to have become discriminatory and arbitrary. By its pricing policies it clearly discriminates between imported and domestic production. This discrimination has resulted in waning interest for India’s NELP over the last few years with fewer and fewer substantial companies coming to bid for blocks. Oil majors, repeatedly seeing expediency overtake policy, have stayed away as they have become extremely skeptical of the sanctity of contracts signed with the Government. The Modi government needs to set its course and not allow old prejudices and corporate rivalries cloud its judgment of crucial national issues. It has to sustain a policy to increase indigenous PNG production and reduce import dependency. But first it must extract reason from the depths it has been buried into. Mohan Guruswamy Email: 2 July 14