- Feb 28 2016
On the eve of the budget, the Economic Survey tabled in Parliament trashed the pricing formula approved by the government in October 2014, which, by using prices prevalent in gas surplus economies like the US, Russia and Canada, had succeeded in depressing prices for domestic gas in India to $3.82 per million British thermal unit.
Worse, with the outlook becoming progressively bearish, this is not certain to fall to $3.15 by April. State-owned companies like ONGC do not find the price viable even for their existing fields, let alone the deep water operations.
The Survey recommended that “market-determined arm’s length pricing for domestic gas, with an effective regulator, to provide adequate incentive for investment and also ensure competitiveness and transparency remains the first-best solution that merits consideration”.
The problem is that the recommendation even if accepted may have come far too late. The outlook for gas prices has become even more bearish than for oil. Sanford C. Bernstein, a research firm, reckons global LNG supply will increase by about a third over the next three years, pushing overcapacity to about 10%.
While a few buccaneers may have been quoted that the fall in prices is good for investments because it has been accompanied by a fall in the price of goods and services the truth is far different. The decline in the costs of rigs and services is hardly matched by the collapse in oil prices. If it were, it would not have led to the shelving of $400 billion worth of projects globally – projects that in effect have removed future production of equivalent to $27 billion barrels of oil for the future.
Forget deep water, reports about looming bankruptcies among shale producers are now doing the rounds.
Under the present circumstances it would be facile to hope, let alone raise expectations, that marketing freedom will be the magic mantra that will turn the domestic oil and gas sector around, bringing in investments and technology.
Let us admit that India’s frontier basins as well as marginal fields present unique challenges that make domestic resources difficult to monetize under the best of circumstances. Slowing investments over the last decade have choked off the growth of the nascent domestic services industry so most goods as well as services are still required to be imported. So, even if costs of goods and services were to decline, costs for India will be far higher than comparable projects elsewhere.
Therefore while the grant of marketing freedom and release of control on pricing remain mandatory first conditions – that alone will do little to put the sector on steroids. Admittedly, for no fault of the present government, the move to introduce marketing freedom in a low price scenario carries genuine doubts in investor’s minds over whether the policy will sustain the onslaught of an upturn in prices – should the commodity cycle turn yet again in the future.
Investors cannot forget that market pricing was introduced in Indian policy in the late nineties when oil was $11 a barrel, but given an unceremonious burial once oil prices began crossing $40. Lessons born of this legacy are beyond the control of the government in power. Even if prices are decontrolled today, there persists a serious credibility gap. It will be up to the next commodity cycle to test the strength of the government’s resolve.
At a time when high cost production is being driven out of the market globally, we can expect sizeable Indian reserves with little chance reaching the production stage. In fact there is merit in accepting viability constraints at a time when falling prices of LNG – with further decline being forecast for the future — will automatically cap the price that offshore gas in India can elicit. If the price forecast is not viable, operators will not and should not be pushed to developing reserves.
Thus the following course of action would be preferable:
For one, greater prudence may lie in holding back reserves as long as cheaper gas and oil are available in international markets. Thus even as market-based pricing is allowed, operators should be given sufficient allowance to put unviable domestic development plans on hold rather than rather than forcing investments in higher capex spends that are not justified at prevailing prices.
The merit of this lies in that it would enable the government to retain investors during the downturn at a time when new investors are not easily forthcoming. Licensing and lease terms where necessary should be relaxed to enable this – not for free, but in lieu of definite exploration commitments in acreages held. Depressed rigs and low costs of oil field services are the best time to give a fillip to exploration in times like this.
Second, a parallel strategy should be to encourage domestic companies to use the downturn to aggressively pick up stressed assets and companies abroad, locking reserves as equity oil at a time when valuations are at their lowest. Maximize reserves accretion at the most competitive rates while allowing operators to preserve more expensive domestic resources for exploitation for times when the returns become positive or when dictated by more pressing concerns of energy security should there be supply disruption.
Third, we have seen India successfully re-negotiate its long term LNG supply contract with Rasgas. With Iran opening up, that successful re-negotiation should provide us the cue to negotiate price contracts for gas supplies from that country as well. We need not make these negotiations contingent upon the mode of supply because the modes of supply today are expanding. Even if the Iran-Pakistan-India pipeline remains in doubt, the subsea option (in the medium to long run) as well as options using quick to commission Floating LNG (for the short to medium run) should be actively examined and implemented. The good strategy should be to use quicker FLNG options executed within the next two and a half years while simultaneously working toward serious pipeline options.
In effect if market pricing is implemented, the downturn gives India a golden opportunity to use its unique geo-strategic location between the West Asian and Pacific gas trading routes to develop into the gas trading hub for the region. Once it moves in that direction, it will be the lever that can accelerate the currently fragmented global gas market into an integrated market where gas becomes far more fungible and readily available. India wins.
This commentary originally appeared in The Wire.