Why India must develop its gas trading hub
The announcement of policy intentions for setting up of a trading hub to set Indian gas benchmark would provide a fillip to the upstream activities.
Thanks to our endeavour to attract investment and technology in exploration and production activities in the oil and gas sector, along with the consultations with various stakeholders, a need for a price discovery mechanism for natural gas that provides for market-based guidance emerged. This also perfectly fits into our ambitions to increase the share of natural gas in India’s primary energy basket— that currently stands at 6.5%, and falls way behind the global average of 24%—besides enhancing domestic production of natural gas. Currently, the domestic natural gas price is set by the government on a biannual basis, and is the weighted average price of four global gas benchmarks with a time lag of 15 months. Interestingly, for a country that imports almost 45% of its natural gas consumption, domestic pricing considers imported gas prices with a long lag, and is enough of a dampener.
The announcement of policy intentions for setting up of a trading hub to set Indian gas benchmark would provide a fillip to the upstream activities. Several gas-dependent countries in Asia are now a part of this marathon for setting up of trading hubs, led by Japan and China. It requires policy efforts on various fronts that would set the right environment for a trading hub to seamlessly operate. In this respect, it would be worthwhile to explore the journey of the most successful and largest natural gas markets in the world, i.e., the US.
Unbundling the merchant and transport functions of the pipelines by Federal regulations in the 1980s provided the much needed start to the development of natural gas markets in the US. In 1989, wellhead prices were completely de-regulated, allowing markets to determine the price of gas, and delivered significant gains to the consumers in the form of lower prices and better access. The open non-discriminatory access to transportation played a major role in integrating the regional wellhead prices into a national competitive market for natural gas. Further, the mandatory disclosure of available capacity and capacity-release programmes enabled the market participants to sell unused capacity to each other, creating a secondary market for natural gas.
In the early days, gas trading by buyers and sellers was done over the telephone and fax, as in the developing bond markets. Nevertheless, since 1994, electronic trading began to dominate the markets, leading to a surge in volumes traded from a mere 13 Bcf in 1994 to 1545 Bcf in 1998—a growth of 112 times. The migration of transactions to electronic markets led to a surge in the velocity of trading, as products became standardised, indicating that arbitragers had umpteen opportunities to arbitrage geographies and time to render price discovery more efficient. It also transformed the business of energy companies, which shifted a greater portion of their portfolios to a more flexible, short-term electronic transactions.
The wholesale gas markets in the US is currently fully liberalised and very competitive, backed by a collegium of numerous electronic platforms and systems such as Streamline and WebICE, that can handle market transactions from the time traders enter a buy or sell position through matching and credit checking, and gas delivery at the marketing hub. In a natural gas hub, producers can sell gas to marketers, local distribution companies and end-users at the market price, and, in turn, the local distribution companies (LDCs) have the flexibility of buying it on demand basis apart from any long-term contracts they may have. Thus, flexibility and openness in trades, eventually moved transactions from wellheads to the market centres, where natural gas is traded mostly for immediate or near-term delivery.
Being the largest producer and consumer of natural gas in the world, the US has more than 50 active spot market centres or hubs, where prices are discovered in a continuum. The most active and publicised market centre is the Henry Hub, which has an extensive receipt, storage and delivery capability, besides being the delivery point for NYMEX. It illustrates that liberalising gas prices brought about development of markets and enhances choices for transactions. The Federal Energy Regulatory Commission (FERC) through various regulations governs the operations of such spot trading platforms. The natural gas trade is subjected to a code of conduct that addresses price reporting and record retention requirements.
The FERC also overlooks the pipeline capacity release programmes. According to parts 284B or 284G of the FERC regulations, it is mandatory for an inter-state pipeline offering transportation services to have a mechanism within its tariff that allows release of capacity to the pipelines for re-sale by the pipeline. Moreover, under the NGA’s market manipulation clause, the FERC ensures fair prices for transmission and trades of natural gas, and through periodic regulatory changes safeguards trades via market-driven prices rather than cost-of-service bases prices. Typically, the main players in the spot market involve the producers of natural gas, pipeline companies, gas distribution companies, independent marketers and companies which are large users of natural gas. Actively traded spot markets, along with storage facilities and independent pipelines, in turn, support the financial markets, which helps in efficient discovery of commodity price, reflecting the fundamentals of the commodity at any given time and geography.
While India pushes for the development of its natural gas economy for greener and economic fuel causes, developing a market for transparent price discovery remains the key. The Petroleum and Natural Gas Regulatory Board (PNGRB)—that oversees policies relating to natural gas in India, including its distribution—shall by way of a separate set of regulations ensure a well-coordinated functioning of markets and related ecosystem entities in a fair and smooth manner. In addition to ending the end-user clause that forms a mandatory part of the sale agreements in the Indian market, the regulations should also enable development of short-term markets that provides opportunities for financial market players to arbitrage the temporal and spatial differences and, thereby, support towards efficient and transparent price discovery mechanism. A vibrant trading hub, including for LNG, would help in better integration of the domestic markets with the global ones, at a time when various major gas economies in Asia are vying for a global trading hub of their own.