Pricing domestic natural gas, fuelling right answers

India is searching for a durable domestic natural gas pricing mechanism that can withstand global shocks, keep in check consumer bills and government subsidies, and radically increase the consumption of fuel. The current pricing mechanism had become dysfunctional long before the global price storm lifted domestic rates and forced GoI to set up a committee two months ago to recommend a ‘fair price to the end consumer’.

The price of most domestic gas is currently determined by a formula linked to average rates at international hubs. For gas produced from difficult fields, a ceiling price linked to alternative fuels applies. Both the formula and the ceiling prices have their own challenges:

  • The formula price is not always fair to producers.
  • Both formula and ceiling prices do not fully reach end-users.

State-run ONGC, India’s largest gas producer, has often complained of earning below its cost of production, which it says is about $3.75 per metric million British thermal unit (mmBtu). Prices have stayed below that for six of the eight years of the formula’s existence. Producer’s complaints, however, attracted little government attention.

But now when the pendulum has swung the other way, with record-high prices triggering consumer frustration and expanding fertiliser subsidies, GoI is willing to overhaul the pricing mechanism. The committee would do well to keep in mind that any sustainable price has to be fair to both producers and consumers. The current formula pricing mainly applies to state-run producers’ older fields where output is already declining. And if prices stay low for long, the incentive to invest to extract every molecule possible from the available reserve also reduces.

Increasing output has been a struggle. International Energy Agency (IEA) estimates domestic production in 2030 to stay below that of 2010, and imports to double to meet rising demand. Those who argue against pricing freedom say the domestic market is not mature enough, and would let producers extract unreasonably high prices in a country that imports half of its needs. They support GoI’s intervention to shield consumers. Elevated global prices of the past two years and the extreme volatility have only strengthened their case.

The Asian benchmark for spot LNG was less than $10 per mmBtu for 53 of the 60 months in the five years through 2020. Since January 2021, average monthly prices have varied wildly between $6 and $54. For GoI, higher gas prices could result in increased revenue from higher levies and increased dividends from state-run producers. A significant share of the dividend, however, would leak to other shareholders.

But higher prices would also increase the fertiliser subsidy bill and weaken GoI’s goal of popularising natural gas-powered vehicles. GoI is also sensitive to the fact that billions of dollars of investments going into building gas distribution infrastructure, following the recent rapid award of licences, run the risk of turning bad if CNG prices were to shoot to unsustainable levels. The consequent banking crisis can become a big headache.

City gas distributors have been reluctant to pass on the full benefit of lower domestic gas prices to CNG vehicle drivers, as they enjoy monopoly in their licensed areas and compete with sellers of petrol and diesel, which are relatively expensive due to heavy taxes. City gas firms enjoy three advantages — cheaper domestic gas, lower taxes on CNG and pricing freedom — which show up in strong profit margins.

The return on capital employed for leading city gas distributors such as Indraprastha Gas, Gujarat Gas and Mahanagar Gas was 20-27% in FY2022. By comparison, it was 4.5% for ONGC, and 7-13% for Indian Oil, BPCL and HPCL, which retail petrol and diesel. The regulator’s failure to end the monopoly of dozens of city gas distributors has left their pricing power unchallenged.

Traders buying difficult gas at a ceiling price and selling it further to the end-user at a premium defeats GoI’s purpose of cushioning end consumers. If the trader is an affiliate of the producer, it adds more complexity as the gains of high price ultimately reach the producer, but the government revenues, determined by the

producer price, remain low.

The committee is expected to submit its recommendations to GoI by the end of this month. Whatever its recommendations, one thing is certain: the contest for the depleting pool of price-controlled local gas will

only get intense given the volatility in the global market and expansion of domestic demand.

sanjeev.choudhary@timesgroup.com

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