New gas price formula a mixed bag

New gas price formula a mixed bag

The Union government has announced several measures:

i)Most important was the much-awaited new gas price formula for undeveloped discoveries in difficult

offshore areas.

ii)The government also cleared a new hydrocarbon exploration licensing policy (HELP), providing for

uniform licence for all hydrocarbons with a shift to revenue sharing models (from existing profit sharing


iii) It also announced an extension policy for 28 medium/small fields. These decisions were long pending,

and their formal announcement is certainly positive. However, in our view, these changes will not make

investment in upstream E&P (which have suffered for last several years) enticing enough to attract new

investments, particularly in the current low oil/gas price environment. The fact that these moves are not

enticing was also reflected in the muted stock reaction (RIL down 3%, ONGC and OIL flat vs. Sensex

down 0.7%).

New gas price formula not very enticing at low oil prices

After a long delay, the government finally announced the new gas price formula applicable for

discoveries in difficult areas (like high pressure-high temperature fields, deep-water and ultra-deep

water blocks). Based on the first 9MFY16 average price, the likely price of $8/mmbtu is attractive, but on

our estimate based on recent 2-month prices, the likely price of about $4/mmbtu is not enticing enough

to attract new investments.

A positive is that the new price will also be applicable to existing discoveries (where commercial

production has not commenced as on 1 January 2016), provided contractors withdraw any ongoing

litigation on gas prices.

A negative is that the government has sought to restrain ‘marketing freedom’ by putting a cap on gas

prices. The ceiling is based on lowest of (i) imported fuel oil price; (ii) weighted average price of

substitute fuels (0.3x coal + 0.4x fuel oil + 0.3x naphtha); and (iii) LNG import price.

On our estimate, the weighted average price will largely determine the price cap. And 30% weight to

imported coal will tend to keep the ceiling down. We don’t see much logic in this weighted average

formula, except that perhaps the government wanted to keep prices lower for consumers.

In our view, coal competes with gas mainly for power generation and it is nearly always cheaper than

gas. Purely on the price of power produced, gas cannot compete with coal, particularly for base-load

generation. However, for peak generation needs, gas-based generation is more suitable.

Similarly, gas is an environmentally greener fuel versus both fuel oil and naphtha. Also, as India is a large

net exporter for fuel oil and naphtha, the linkage to import parity price of fuel oil does not seem very

reasonable to us.

As the realised price is higher, few operators may choose to develop existing discoveries. We do not

expect existing litigation on gas prices to be withdrawn.

Uniform licensing a positive, but revenue sharing not so

The key features of new HELP are: (i) uniform licence for all forms of hydrocarbon; (ii) move to open

acreage licensing; (iii) move to a revenue sharing model (from prevailing investment multiple, and cost

recovery/production linked models); and (iv) marketing and pricing freedom. HELP also seeks to provide

a graded system of royalty rates for offshore areas (royalty rates to decrease from shallow to deep

water areas) to recognising higher risk in deeper areas. Also, similar to earlier NELP (new exploration

licensing policy) the cess (on oil production) and import duty (on capital imports) will not be applicable.

In our view, adoption of a uniform licensing policy is a positive move, and will allow companies to

simultaneously explore conventional and unconventional resources (such as coal bed methane, shale oil

& gas, tight gas and gas hydrates).

However, in our view, a move to revenue sharing is somewhat backward. The E&P business has

significant upfront risks that are mainly taken by contractors. Thus, production sharing contracts (PSCs)

should provide for the recovery of investments first before any profit sharing with the government. The

legacy PSCs provided such incentives, and hence attracted significant investments in several NELP

rounds. However, in recent years the implementation of profit sharing PSCs saw many conflicts between

contractors and the government. Revenue sharing will certainly ease administration. However, in our

view, it will make new investment less attractive for contractors, particularly in the current low oil price


Seeking 10% profit share may be imprudent in the current environment

The decision for a blanket extension of existing PSCs for 28 medium/size fields is certainly a positive

move. However, in our view, the government seeking 10% higher profit share (from normal sharing

calculated as per existing PSC provision) may not be a prudent move, especially in the current low oil

price environment. As such, these are marginal fields, and some may become even less attractive if the

government profit share increases.


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