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Press Release [FREE Access]
Petro Intelligence » Rangarajan Formula: Masterstroke Of Five Fallacies

Dr. C. RangarajanThe 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.

K.K. KapoorThe 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:

  1. Where the resource (gas) is owned by a country and the producer sells it within that country, and
  2. 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 KumarRavinder 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 P. SethiDr 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.

J.K. JainThe 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 determP. Balakrishnaining 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.

 


To download the latest issue 'Volume 30 Issue 24 - March 25, 2024', click here
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