Formulaic solutions to intricate problems can be very handy, often resolving a serious tangle with a few variables carefully crafted into an equation.  

Such cute solutions to complex problems can also raise a storm if the experts start to quibble over the choice of factors and hurl charges of bias and compromised integrity.

The oil and gas industry has seen some of that ferment after Dr C. Rangarajan – an influential advisor to former prime minister Manmohan Singh – slapped together a formula to resolve the battle over gas pricing in the country.

The UPA government put its stamp of approval on the so-called Rangarajan formula last year and rushed to implement it from April1, before being stopped in its tracks by the Election Commission ahead of the general elections.

In the previous fortnight, we wrote a piece on the subject titled Words and Meanings: Double Trouble appearing in our widely-read, free-access column Petro Intelligence. The response was overwhelming but one comment caught our eye.

“It is standard practice for the Government of India to carefully select the chairman of important fact-finding committees to protect its interests – thus B.K. Chaturvedi for Devas-Antrix, V.K. Shunglu for CWG, P.C. Chacko for 2G JPC. Selection of Kelkar for gas/RIL issues was consistent,” wrote a former cabinet secretary.

Dr C. Rangarajan’s name was missing from the list. That made us wonder: did the former bureaucrat really endorse the Rangarajan Committee Report which had recommended a pricing formula that could raise the price of domestic natural gas from the present level of $ 4.2/mmbtu to $ 8/mmbtu, we asked. “Certainly not, it falls in the same category,” he replied.

We have been trying to determine out why the Modi government has shied away from implementing the Rangarajan formula since the Prime Minister is allegedly close to the industrial house that is a significant producer of domestic gas. This allegation was repeatedly made by the Aam Admi Party leader Arvind Kejriwal during the election campaign.

Sources in the BJP say the party was never enamoured by the Rangarajan formula. During the election campaign, the party had made clear that if elected to power, it would not implement the formula without changes. But the party preferred to play down the controversy for strategic reasons. The fact that the BJP would not implement the formula should have been known to domestic players like RIL which has opted to take the matter to arbitration.

Dr C. Rangarjan is an official economist but has never been known to possess an expertise in energy matters. In India, expertise in a relevant area has never been considered important when selecting a person who will head an important committee. The basic qualification is how pliant the worthy is and is he prepared to overcome his qualms over a controversial solution.

On the domestic gas production front, the state-owned ONGC is the largest player. But the public sector enterprise does not have the clout to influence the government on appointments of a chairman and its members to a committee.

For the same reason, Oil India also cannot be considered influential. Who then could have foisted Rangarajan on the Committee? We do not want to speculate about this as it serves no useful purpose at this stage.

It is more important now to consider what precisely is wrong with the Rangarajan formula. There is an accusation that the formula was handed over to the committee by some outside force. We do not subscribe to this view. So, we decided to interact with experts to understand the formula and communicate to the readers their views so that they could judge the issue on its merits.

Let us first acknowledge the fact that India does not have too many experts who understand the arcane subject of gas pricing. But there are some who do and they rank among the best in the world. It is difficult to hunt them down and, having done so, persuade them to talk since they recoil at the thought of publicity.

These experts will, therefore, remain anonymous but their views need to be aired since it brings a certain gravitas to the debate.

Natural gas (dry or one that includes small amounts of natural gas liquids) is not a tradable commodity because it cannot be transported easily like other solid or liquid hydrocarbons. Since it cannot be transported easily, natural gas markets are not fungible and there is no international price of natural gas.

Gas prices can vary by a factor of 10 times or more in different markets worldwide. Natural gas can only be transported through high pressure capital intensive pipelines or by even more capital-intensive liquefaction and transportation in specially designed vessels that carry the liquefied gas at a temperature of about minus 170⁰C. Both options for trading gas are expensive. The FOB prices of LNG in countries rich in natural gas can easily be 2 to 10 times the average well-head producer price of natural gas in that country.

At the broad conceptual level, the Rangarajan Committee wants us to accept that the prices prevailing at international gas hubs and the adjusted net-back prices of LNG imports, as calculated under its methodology, are a measure of the market-driven prices obtained by gas producers worldwide.

But is Rangarajan right? Or, is he taking the whole country for a ride for the benefit of a few?

One of the controversial aspects of the Rangarajan pricing formula is the linkage to the Japan LNG price. The defenders of the formula have gone on record stating that Japan LNG does not significantly impact the overall price determined by the formula. To start with, we decided to focus on this aspect exclusively for this column in our June 25 issue. This does not mean that we consider the linkage to Japan LNG as the most crucial element in the pricing formula. There are far deeper issues which will be taken up in the subsequent column.

According to experts, about 30 per cent of the world gas production is sold outside the borders of the region where it is produced and less than a third of this 30 per cent is sold as LNG. Japanese imports accounted for 36.2 per cent of all LNG trade in 2012 and 11.5 per cent of all gas traded across borders. Japanese imports account for 3.5 per cent of all gas produced in the world.

But in the Rangarajan formula, the impact of the high-priced Japanese imports is way above the weightage it should have got considering that Japan accounts for 3.5 per cent of all gas produced and sold in the world. The reason for this is the fact that the formula doesn’t take into account all the gas consumed in the world. In fact, it leaves out a large chunk of cheap natural gas consumed in Russia, the Middle East, Latin America, Mexico, Africa, Malaysia, Indonesia and Canada. By excluding this large and cheap gas consumption (accounting for almost half of the global consumption), the Japan LNG price punches above its weight in Rangarajan’s formula.

Experts now turn to a far more dangerous aspect of  the  Rangarajan  formula. They say it not only excludes a major part of cheap gas consumed around the world but it also chooses to include the high-priced gas in Europe via the NBP index. NBP prices are weighted by LNG to the extent of 30 per cent. Further, they include the very high pipeline transportation charges of Russian gas sold in Western Europe. And finally, they include the geopolitical premiums that Russia has been arbitrarily imposing on select countries since its breakup.

The result of all this is that in 2012, the NBP price was almost four times the Henry Hub price. Further, the impact of including the NBP price in the formula is greater than the inclusion of the Japanese LNG price as Western Europe, excluding Russia, consumes about five times the gas consumed by Japan.

So, in essence, the Rangarajan formula is weighted by high-priced gas to the extent of over 50 per cent. And the impact of the Japanese LNG price in the Rangarajan formula impact is at least twice its 3.5 per cent share of global output because it leaves out almost half of the world's cheap gas consumption in the regions and countries listed above.

(We welcome reactions from Dr Rangarajan or any other member of the Committee, experts and domestic gas players to make the debate truly meaningful).