The new Narendra Modi government in New Delhi prolonged the suspense this week over what tack it will take on the controversial domestic gas pricing issue.
It had been expected to signal which way it is inclined ahead of a September 30 deadline to announce its final decision on gas prices.
Instead, it invited “recommendations” from the private and state-owned gas producers. Curiously, no formal opinions were sought from the fertilizer and power sector consumers.
Having revoked the previous government’s ruling to scrap a $4.20/MMBtu five-year-old cap on wellhead gas prices and peg them to international markets, the Modi government essentially staked its claim to go back to the drawing board on an issue that is already getting long in the tooth.
It has three options now: The first is to leave the cap at $4.20. This is the weakest of possible choices and which promises to have domestic gas producers up in arms, turn away foreign E+P companies and call into question the lofty epithets of “reform-minded” and “business-friendly” that have been blithely pinned on Mr. Modi and his government.
The second option is to agree with the Rangarajan Committee’s recommendation and rubber-stamp the complex formula adopted by the previous administration.
This would raise prices to as high as $8/MMBtu by tying them to international pipeline and LNG benchmarks in the US, Europe, the Middle East and Japan.
A contrived “theoretical free market” price, this one is over-engineered and begs the question why an average of US Henry Hub, the UK National Balancing Point and the LNG value realized by exporters to Northeast Asia and India should represent the economics of gas production and marketing in India.
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The third option is to take the golden middle-of-the-road approach — something that sits well with various ancient Asian philosophies. Buddha described it as a path to liberation, according to Wikipedia, although clearly he was not envisioning modern-day markets.
For gas, the middle ground would mean a price of around $6/MMBtu, partial relief to producers as well as consumers, partial reforms, likely moderate development of the country’s gas reserves, and base case demand growth for the relatively cleaner fuel.
The number could just be handed down as a new cap for an interim period (five years again would be too long to stand still) or reverse-engineered from a formula that pegs it to free overseas markets. If the latter, this is a prime chance for the government to simplify the formula and make it more logical.
Linking it to the FOB netback values achieved by major LNG suppliers in the Asia-Pacific — Australia and Qatar — would make sense.
That is because the alternative as well as the supplement to India’s own gas production is LNG imports. The netbacks to Australia and the Middle East from delivered ex-ship spot prices being paid by the Japanese and Indian spot LNG importers as assessed by Platts are currently around $11.50/MMBtu.
Why not also use term LNG prices? Possible, but they are linked to crude oil and thus disconnected from the dynamics of gas markets.
There is no transparency on India’s term import pricing, but the levels are estimated to be in the vicinity of $11-12/MMBtu. However, they will swing up the next time North Sea crude rallies.
So instead, India could use a monthly spot LNG market average (previous three- and six-month averages are terrible lags to inject into a formula when there is all the freedom in the world to craft it) and divide it by two, with a pledge to whittle away the denominator over coming years. Et voila!