OPINION: Natural gas exchange and growth of India’s gas sector
For increasing the share of natural gas and to have a well-functioning gas market, tough decisions would have to be taken.
New Delhi: In June 2020, the announcement that a natural gas exchange would start functioning in India took us by surprise. The Government had announced its desire to set-up the exchange earlier and work on the regulatory design had been underway for more than two years. At the time of the announcement, the regulator had not published draft guidelines for setting up the exchange. Soon enough the exchange was indeed inaugurated on June 15, 2020., and has been operating thereafter. There are two primary drivers for setting up a natural gas exchange in India. The primary driver is the aspiration of the Indian policy makers to increase the share of natural gas in India’s primary mix from 6% to 15%. Due to past policies and formulae, India has multiple prices for natural gas (different for domestic and imported gas), even though the commodity is the same. Long term investment decisions underpinned on usage of natural gas, necessitates that there is one market-determined price for gas. There is a history of gas-based power plants and gas-based steellants, becoming financially unviable with changes in availability of domestically produced gas. Therefore, for India to move towards higher gas usage, a spot-market for natural gas with the ability to hedge risks through derivatives is imperative. The second driver relates to incentivising domestic natural gas production. After the Supreme Court ruled in May 2010 that natural gas prices should be subject to Government control, the Indian upstream sector has been pushing for market determined prices, which was also the intent of the NELP contracts. Thereafter, under the HELP policy, the Government has reverted to providing pricing freedom. Price discovery through an exchange is a good transparent way of determining market prices. While these are still early days, the data suggests that volumes traded on the exchange are very limited. After the gas exchange started functioning, PNGRB issued draft guidelines for public comment. Most comments made by interested parties were on areas covered by the regulations e.g., settlement, margins for the exchange, capital requirements, etc. PNGRB has now finalised the regulations that would govern the natural gas exchange. However, policy makers would need to address some larger issues to make gas trading a success in India. One question is whether the exchange would impact the pricing of domestically produced natural gas. Currently, domestically produced gas is priced based on a formula which essentially determines the Indian gas price based on prices in gas surplus countries such as USA, UK, Russia and Canada. This provided an independent bench-mark to determine domestic gas which are reset every 6 months. However, since most of the benchmark countries have an oversupply of gas, this has ensured that India’s domestically produced gas is available for a low price (the recent price revision effective October 1, 2020 is at an all-time low of USD 1.79/mmbtu). The current domestic gas price formula does not address the investment & cost requirements to maintain and improve domestic production, as the Indian geology is higher risk with higher extraction costs for new discoveries . There is also the dichotomy of a large variance between domestic and imported gas prices. Imported gas is more expensive due to the capital-intensive LNG value-chain (liquefaction, shipping, re-gas etc).
Domestic gas currently accounts for approximately 50% of gas consumption in India. Further, through the gas-allocation policy, the Government has prioritised sectors such as fertilisers and city gas. Given that domestically produced gas is cheaper than imported gas, there has been a queue of players wanting to source domestic gas. The Gas Exchange has a better probability of functioning like a perfectly competitive market only when there are large number of buyers and sellers. Besides giving depth, inclusion of domestic gas on the exchange will reduce also price volatility and reduce the demands on the Government to allocate cheaper gas. However, changing the basis for pricing of domestically-produced gas is not without its challenges. PSCs may need to be amended. Anybody who stands to lose i.e., beneficiaries of the gas allocation policy could protest and even litigate. Then there is the issue of the subsidy-bill of the Government. It will not be an easy decision. Also, sufficient pipeline network capacity and pipeline access needs to provided to buyers and sellers of gas on a non-discretionary basis. The gas-trading guidelines do provide for the buyer or the exchange to have a gas transportation agreement. However, the larger question is whether carriage and selling of gas should be totally separated or pipelines should continue to operate on the basis of third-party access for part of the pipeline capacity. Separation of transportation and marketing has worked very well in the largest gas market – USA. For India to increase the share of gas in its primary energy mix, new pipelines would be required. Pure transportation pipelines i.e., where the transporter cannot be a seller of gas may require financial support from the Government. The volumes to underpin the development of new pipelines are not there, when investment decisions are made. It is a chicken and egg story between demand and supply. Therefore, in the past, building of pipeline infrastructure has been incentivised by allowing the pipeline companies to also sell gas. Without bundling transportation and selling gas, the gas volumes may not justify the investment decision. Consequently, incentivisation for building new pipelines may be at variance vis-à-vis an effective exchange for natural gas for which total unbundling would be the preferred option. Finally, natural gas is outside the purview of GST and is subject to state VAT. If India wants an integrated gas-based economy, then natural gas must be brought under the purview of GST. GST was implemented by the Centre agreeing to underwrite an annual 14% growth in the State Government’s tax revenues subsumed by GST. Even before the onset of COVID, Government was unable to bring natural gas under GST. Collapse in the revenues of both the State and the Central Governments and the issue of compensation of states for shortfall in GST revenues will complicate things. For increasing the share of natural gas and to have a well-functioning gas market, tough decisions would have to be taken. Policy makers will be tested as serious reform is never easy. Reform is more than being administratively efficient. Trade-offs would need to be evaluated. However, as Ralph Waldo Emerson said “What lies behind us and what lies ahead of us are tiny matters compared to what lies within us.” We hope that the inherent strengths of the Indian policy making will overcome these challenges.
[This piece was authored by Rajnish Gupta, Associate Partner, Tax and Economic Policy, EY India]