COMMENTARY

The international price of natural gas on a heating value basis, including transportation costs, has always been significantly lower when compared with petroleum products. For the last decade, it has been nearly half. In almost every application, natural gas can substitute petroleum products. However, the success of natural gas in substituting petroleum products in the transport sector has been somewhat less effective. Some countries with an abundance of natural gas like Russia have as much as 50% share of natural gas in the commercial energy basket as compared to the world average of about 25%.

Finally, the availability of natural gas is widespread geographically or less concentrated geographically than crude oil and thus enhancing energy security and market stability. This will become an issue of growing importance for India.

‘Gas Short’ Policy

The present policy approach for gas seems to be derived from a mindset that India is relatively “gas short” and this scarcity is attempted to be met through rationing or, in other words, allocating available gas through quantitative allocation with its consequent under-pricing. Ironically, this approach only reinforces the shortage phenomenon as this discourages supply and enhances demand as prices are not allowed to play their full role. This policy which creates “rent” in the gas markets gets reinforced through “political economy” factors as a number of important players share these rents.

The other conceptual shortcoming of the present framework is that when people think about gas, it is thought of as something distinct from crude oil, while in reality both being hydrocarbons, are close substitutes. The fact that they are close substitutes is vividly reflected by how closely they are tracked in terms of prices in the international markets. For instance, if you look at the international liquefied natural gas (LNG) prices or the Henry Hub price for domestic gas in the United States, both track very closely the corresponding crude oil prices. Yet another shortcoming in the approach is forgetting Prime Minister Rajiv Gandhi’s insight in the 1980s that we have to think long term and that is of even greater relevance to

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natural gas. As buyers and sellers usually adopt long-term contracts, our own policies need to be stable and the authorities should always honour explicit or implicit commitments as this reduces policy uncertainties and encourages buyers and sellers to enter into long-term commitments. The importance of this issue to the development of gas sector cannot be overemphasised. In describing in this manner the present policy framework, I may be criticised for being less than fair to extant policies, but I would submit that I may be closer to the evolving state of affairs in this sector.

Uncertainty and Variance

The current procedure for determination of gas pricing being somewhat nontransparent, there is an element of uncertainty and enormous variance in gas p rices in the same markets in India. For i nstance, both in Gujarat and Andhra Pradesh, amongst consumers, the gas prices vary by almost 200%. Such price variation and non-transparency in price determination ironically discourages a nchor customers such as the fertiliser and power sectors, creating further difficulties for making any large investments required for laying the pipeline infrastructure. In other words, the present pricing policy framework is not leading to more rapid development of the natural gas sector in India – whether in terms of c reating supply or demand. This is unfortunate as with better policies for the s ector, one can foresee a reduction in total imports of hydrocarbons in the Indian economy and enhancement of the country’s energy security.

How do we achieve this paradigm shift? Most important, policymakers will have to change their perspectives or their mindset by recognising three important factors. First, both oil and gas being hydrocarbons are close substitutes and these markets move in tandem internationally where the infrastructure for gas is well developed. Second, although oil and gas are both hydrocarbons, one is liquid and the other gaseous and therefore require different logistics in terms of supply infrastructure. Hence, these two e nergy infrastructures create different market structures, an issue which has

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some regulatory impli cations that are d iscussed later in this article.

Gas Abundant

The third factor is that India is potentially a “gas abundant” country. It is “abundant” compared to the availability of oil and compared to the present projections of demand for gas in the next 20 years. Given the right incentives for producers, it is possible to foresee India to achieve over a decade or so gas output level of more than 500 mmscmd from the current supply level of 120 mmscmd. These supply projections may be somewhat speculative, but I would argue these are not without basis.

A number of knowledgeable experts think it is possible to argue that from the current gas reserves of 30 trillion cubic feet (tcf), the reserves can be increased to more than 120 tcf within the next decade. This is based on likely reserves in the eastern deep waters that are estimated between 70 and 90 tcf and the coal bed methane (CBM) gas reserves that are estimated to be 10-15 tcf and the west coast gas reserves also estimated at 10-15 tcf. With these reserves, India can sustain production of even more than 500 mmscmd for 15 years or so. I have not added to these reserves either the shale gas reserves or the gas supply possibilities from in situ gasification of the country’s deep coal reserves.

The new technology of horizontal drilling makes it possible to access shale gas. For instance, in the US, in a decade or so, the share of shale gas increased by 20%. Indian geologists also estimate the presence of shale gas in Gujarat and Assam. All these potentially large gas reserves can become a reality only if we allow incentives to producers. This requires that our exploration contracts should have transparency and complete stability.

Need for Transparency

In recent years, there have been instances of unilateral deviations from the stated policy and practices regarding the Production Sharing Contracts (PSCs) and this needs to be eschewed if we want to make any radical gains in finding new gas which is indeed there to tap. Exploration and production of hydrocarbons is inherently hugely risky and such policy instability

COMMENTARY

makes it even riskier, thus discouraging the oil companies. In addition to transparency in the contracts, we should give freedom to producers to market their gas provided the price determination is at arm’s length and on a transparent basis, which avoids transfer pricing or deliberate under-pricing. This would mean, inter alia, long-term prices to be linked to international crude oil prices providing transparency like in our LNG contracts.

What I am arguing is for further liberalisation of gas markets in India. This will require an improved regulatory regime. One possible regulatory model to strengthen gas markets in India is the recent A ustralian Natural Gas Act, 2008, which has very detailed provisions for pricing, production pipelines, operations including the tariffs and safety, etc. We can also learn from the Office of Gas and Electricity Regulator of Australia (OFGAR) about enforcement of competition policies to curb potential abuse arising out of possible monopolistic power. With such incentives and regulatory approach, we will find that a number of oil companies will be forthcoming to invest in our gas sector along with new technologies and i mproved oil field practices.

To achieve such an outcome, I should re-emphasise the importance of having an upstream and gas regulatory agency which is fair, transparent and technically at par with the best oil companies of the world.

As mentioned, natural gas is different than oil because of its transportation requirements. Large pipelines are required to transport gas and once such pipelines are created, the market structure can become locally monopolistic. To create competitive national gas market, we require national gas pipeline grid, what I call the “NATGAS” grid. But working of this NATGAS grid will have to be supervised by a regulator for ensuring transparency, competition and safety. This interstate network has to work as a common carrier and all interstate pipelines would be built either through public sector or private sector companies where construction, sizing, routing and pricing will be done on open tender basis in consultation with the regulator.

Crown Capacity

One possible way of promoting gas markets could be that even where the cross-country or interstate pipelines are under the private sector, 25-30% of capacity of such pipelines can be “crown” capacity, which can be either on “carried interest” or “participating interest” basis and such capacity will be available to any buyer or supplier of gas with the toll charges, which are determined by the regulator. This will enable the development of the gas market in India where third party suppliers and buyers can use the common carrier. Given the multiple sources of gas such as ONGC, Reliance, GSPC Cairn or other operators and multiple sources of import like Petronet LNG, Shell, GAIL, or the new ones, under a new policy approach, India’s gas market will become competitive like the one obtaining in the US or Europe giving consumers choice as well as supply stability. This way, gas prices all over India will converge barring inherent transportation costs, a tendency that is already observed in the US gas market which is fully liberalised. This will also vastly improve the bargaining power of India in organising large-scale gas imports whether in the form of LNG or gas through pipelines.

The new gas policy can bring large b enefits to the Indian economy due to a number of positive outcomes. First, it will increase energy security by enhancing sharply the supply of natural gas from home or domestic sources. Second, it will reduce imports of crude oil and thus bring in considerable macroeconomic benefits. Third, it will lead to investment in power and fertiliser sectors thus benefiting agriculture as well as Indian industry. Fourth, by reducing the cost of power and fertilisers, it will improve all-round competitiveness of Indian industry and agriculture. Also, gas being a more environmental friendly fuel, it will enable us to meet our national goals of sustainable development by reducing pollution. It will also lead to better price discovery and greater choice for consumers.

We will see that the long-term contractual gas prices will be aligned to international crude oil prices in a transparent manner and one can foresee spot market prices such as our own “Kakinada hub” price emerging and providing transparency to gas prices nationwide. Such augmented supply of domestic gas can be further

s upplemented with LNG imports as well as import of gas through international pipelines from Iran or Myanmar. This will increase the system stability as well as give impetus to the growth of the neighbourhood region whether Gulf or east Asia. Finally, one of the most important benefits of this policy approach is it will help us to eliminate the humongous levels of subsidies the country is incurring on the nitrogenous fertilisers and LPG. Such an elimination of subsidies will provide fiscal space to the central government to increase investments in areas such as environmental protection and for the reduction of public debt.

Benefits of a New Gas Policy

There is a final point and this relates to the possibility of the new gas policy i ncreasing fiscal space to the state g overnments as well. As our increased gas resources are going to come from

o ffshore, it is going to create literally tens of thousands of crores of “resource rent” in the form of profit gas and royalty. This resource rent from offshore hydrocarbon resources while belonging to the Union of India could be shared with all the states of the union. Already, the central government shares the profit petroleum or profit gas and royalty from the onshore fields under the NELP with a state where oil or gas is being p roduced. By sharing the offshore profit gas and royalty, a considerable amount of resources will become available to all the states of the union for i ncreasing the supplies of critically short public goods in important fields such as health, education, water and urban i nfrastructure.

In conclusion, with these second g eneration reforms of the hydrocarbon sector, we can change the energy base of our economy and this will give allround benefits to the economy. Given our h uman capital, natural resources e ndowment and the new technologies, it is possible to achieve this with a new a pproach or with what I call “Towards a New Natural Gas Policy”. I am mindful that I have only outlined an approach and many improvements may be n ecessary for the implementation of these proposals.

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