The
barbs have started to fly and reputations are being torn to shreds as
the debate over the hugely contentious gas pricing formula comes to a
boil with the Narendra Modi government trying to work its way out of a
sordid mess created by the Manmohan Singh-led UPA regime.
The first part of our investigative piece on the Rangarajan committee’s
vexed gas pricing formula appeared in our previous issue titled Warped Formula: Tilting The Scales.
This is the second part which has been prepared by distilling the wisdom
of a coven of petroleum industry experts. They have slammed the formula
for its questionable assumptions about the way natural gas prices in
India should be determined and the dodgy variables and weightages that
the Rangarajan committee worked into its formula.
But it goes even beyond that. Until now, Rangarajan’s integrity was
always above reproach. That is no longer the case with the experts
starting to question his motivations. Worse, the charge that’s hanging
in the air is that the chief of the former Prime Minister’s council of
economic advisors had pre-judged the issue when the gas pricing mandate
was given to him.
The
experts sent in their comments on the gas pricing issue in writing. As
this piece deals with a subject of immense national importance, we would
prefer to identify the experts we interacted with. They are: K.K.
Kapoor, former CMD of GAIL who officiated for a while as the CMD of
ONGC; Ravinder Kumar, former president of RIL and a petroleum trading
expert; J.K. Jain, former director (finance) of GAIL, P. Balakrishna, a
Delhi-based independent consultant, and a senior official of the
Planning Commission who did not want to be identified.
The bulk of this piece, however, is based on an interaction with Dr
Surya P. Sethi, whom we regard as India’s foremost energy expert. He was
principal advisor to India’s Planning Commission. Sethi has a deep
knowledge of international oil and gas markets and has a reputation of
being an independent thinker and not a lobbyist – which makes him
eminently qualified to dissect the Rangarajan formula.
Kapoor says the Rangarajan Committee is guilty of mixing up two entirely different scenarios:
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Where the resource (gas) is owned by a country and the producer sells it within that country, and
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Where the resource (gas) is owned by one country and it is sold to
another country either through a long distance pipeline or after
liquefaction, ocean transportation etc.
“The price applicable in case II is not relevant. The Rangarajan
committee has erred and mixed up these two cases,” argues Kapoor.
Ravinder
Kumar says the committee discussed the pricing basis and mechanisms in
different parts of the world, but then went on to recommend a unique
formula based on international prices of two international markets — the
US and the UK — and the modified price of LNG in Japan. Thus, the
inherent assumption in this formula is that (a) Natural gas is internationally tradable, and (b) LNG prices are directly linked to the natural gas price.
He argues that both the assumptions are completely wrong. Natural gas
can be transported through pipelines and, thus, can be traded only in
the region. A simple comparison of LNG and natural gas prices in the US
clearly shows that there is no relationship between LNG and NG prices.
If that is correct, Ravinder Kumar wonders why the committee chose to
recommend the linking of Indian NG prices with LNG prices in Japan.
“There is no international price for the Natural Gas produced in India
and sold in India through the pipeline network. Such gas is not
internationally traded and should not be compared with LNG prices,
whether prevailing in India or elsewhere. At the most, the price
methodology can be compared with the net back price from Henry Hub price
after deducting transportation, trading margins etc and the net back
price that is paid to the producers. The price to the producers should
be determined in convertible Indian rupees only to maintain the
stability in the economy,” said J.K. Jain.
Jain felt that the pricing formula for all the products should be
clearly spelt out in the NELP tender itself so that there is no room for
ambiguity and little scope for an entity to try and negotiate or
influence a decision on the pricing formula.
P. Balakrishna, however, has a slightly different point of view. He
claims that the main argument advanced by Reliance and BP for seeking
a revised and higher price was the fact that there should be an
incentive for oil and gas companies to find and produce gas from the
difficult-to-operate deep sea fields. “Hence, it is my considered view
that the Rangarajan formula for pricing of gas should be applied only to
gas produced from newly-discovered fields,” he added.
The Planning Commission official, who preferred anonymity, believes that
the entire Rangarajan formula is meant to create a high price for
domestic gas to make the Indian market attractive for LNG suppliers.
In Part-I of our report, we stated that Dr Rangarajan’s intellectual
honesty came in for questioning. In Part-II, not only his intellectual
integrity but also his conceptual honesty is under attack.
The gravest charge that Dr Surya Sethi levels against Rangarajan is that
the formidable economist, who is in his eighties, played a virtual
fraud on the nation by switching the second half of his formula from a
volume-weighted average to a simple average in order to determine the
Indian wellhead price for Indian producers. That is a serious charge and
borders on the defamatory. But it does raise a very serious question:
Did Rangarajan start the entire exercise with a number in mind?
At the broad conceptual level, the Rangarajan Committee wants us to
accept that the prices prevailing at international gas hubs and the
adjusted netback prices of LNG imports, as calculated under the
Committee’s methodology, are a measure of the market-driven prices
obtained by gas producers for dry natural gas at their well heads
worldwide. According to the experts, this approach is plain wrong.
Dr Surya Sethi says the Rangarajan formula makes a number of grave arithmetical and conceptual errors. In
his view, the high price for natural gas in India, as delivered by the
Rangarajan formula, is obtained through “five masterstrokes of
fallacies.”
First, in calculating the weighted average world producer price for dry
natural gas, the Rangarajan Committee ignores over 35% of the global gas
markets that enjoy the benefits of relatively-low priced natural gas
prices. These include countries in the Middle East, South and Central
America, Africa, Australasia and Asia excluding Japan. The exclusion of
these natural gas markets is the first reason why the Rangarajan formula
delivers an erroneous and high world producer price for dry natural
gas. The exclusion of key markets also effectively raises the weightage
of Japanese and European LNG imports beyond their legitimate shares in
the global gas basket in determining the volume-weighted average world
producer price for dry natural gas.
Second, the formula uses the Henry Hub price for all North American gas
despite the fact that there are several hubs within North America. More
importantly, the Henry Hub price is higher than the average price
obtained by gas producers in the US for dry natural gas by at least 10%
or more. Further, the price of natural gas at the Canadian Hub in
Alberta is typically about 20% below the Henry Hub price – thus Canadian
producers could well be getting about 25% less than the Henry Hub price
for their dry natural gas. And while Mexico’s regulated gas prices on
average are higher than Henry Hub prices, given Mexico’s low relative
consumption, the use of Henry Hub price for all of North America, most
definitely overestimates the average price realized by North American
gas producers for their dry natural gas at the well head. It is pointed
out that Mexico’s share in North American gas consumption is only 10%
and Mexico supplements domestic production with piped natural gas
imports from the US and LNG imports from other countries.
Thirdly, for the whole of Europe and former Soviet Union (FSU) and
Eurasia, the NBP price is used as the price of natural gas even though
it is, typically, three times the Henry Hub price. Like the Henry Hub
Price, the NBP price is also not the price of dry natural gas realized
by producers of natural gas feeding Europe, FSU and Eurasia. The NBP
price is much higher because Europe relies on high priced LNG for around
15-20% of its consumption. An additional 37% or more of the European
consumption is met by Russian imports that include high costs of
pipeline transmission and arbitrary geo-political premiums.
The Rangarajan formula makes no attempt to net-back the LNG or Russian
imports into Europe to determine producer prices. There are several hubs
even in Europe and they follow substantially different methodologies to
regulate domestic gas prices with NBP prices being just one of the
comparators. More importantly, the Rangarajan formula prices the
sizeable consumption of Russia, other FSU republics and Eurasian
countries also at the NBP price even though the prices in these
countries are much lower than the NBP price. These conceptual and
methodological errors in the Rangarajan formula result in a very high
estimate for the well head price obtained by producers of dry natural
gas feeding Europe, FSU and Eurasia.
The
fourth fallacy is that LNG imports by Japan (that go into determining
the volume-weighted world average producer price for dry gas) as also
the Indian LNG imports are netted back using standard costs of
liquefaction, ocean transportation, insurance and local transportation
in the exporting country. As stated above, this does not, in any way,
establish the price of dry natural gas obtained by gas producers at the
well head in the LNG exporting countries. The truth is that the average
well head producer prices in the countries exporting LNG to India and
Japan are a small fraction of the notional net-back producer price
determined by the Rangarajan methodology.
The impact of the four fallacies yields a very high volume-weighted
average world producer price for dry natural gas at the well head.
“However, all of these fallacies”, says Sethi, “pale in comparison
to the fifth fallacy whereby the Rangarajan formula, with complete
contempt for conceptual and intellectual integrity switches from a
volume-weighted average to a simple average for determining the Indian
well head price for Indian producers.”
The formula determines the Indian producer price at the well head for
dry natural gas by taking the simple average of the already high and
incorrectly estimated world average producer price for dry natural gas
at the well head and the so called net-back producer price for all LNG
imports into India duly weighted by the respective volumes from various
LNG sources. In effect, this gives an additional weightage of 50% to LNG
in determining
the price of dry natural gas at the Indian well head. (Japanese LNG
imports, corrected for the so-called net-back producer prices and
European LNG imports without any such correction, are already present in
the volume weighted world producer price estimated for dry natural
gas.)
This effectively raises the high LNG-linked price component in the
Indian price determined by the Rangarajan formula to around 60%.
India’s LNG imports account for about 0.6% of the global gas consumption
and LNG’s share in the global gas consumption is only 9.75%.
Had the Rangarajan Committee not made these errors and weighted the high
so called net-back producer price of Indian LNG imports by its relative
share in the world gas basket (0.6%), the formula proposed by it would
have been more defensible. Of course, maintaining such conceptual
integrity would have brought down the producer price estimated for
Indian producers significantly!
“It is highly unlikely that the high-caliber Rangarajan Committee,
including two world renowned economists, did not understand the simple
arithmetical and conceptual errors it was making. One would suspect that
they had a number in mind and somehow achieved it by actually building
in these simple conceptual and mathematical anomalies in the formula and
methodology they proposed,” alleged Sethi.
In Part-I of the Report, we observed that a formula like this cannot be
imposed on Dr Ranagarajan as he is a very intelligent person and would
easily see through the game. In the light of the new arguments, that
comment now stands withdrawn and we want our readers to form their own
judgment uninfluenced by anything we have to say. After all, we are not
the experts.