PRICING of fuel has been one of the most contentious issues in India. Pricing not just at the retail level for consumers, but even at the sourcing level, where oil and gas producers have been demanding a higher price.

Last week, the petroleum ministry sent a draft note to the union cabinet, seeking nearly doubling the price of natural gas in the country. The ministry accepted all the recommendations of the C. Rangarajan committee, a high-level panel headed by the chairman of the Prime Minister’s Economic Advisory Council, which had last month suggested a new formula for calculating the price of gas to be paid to producers.

Natural gas pricing is a very complicated affair in India. There are at least three different prices at which gas is sold. While natural gas importers sell liquefied natural gas (LNG) at internationally-determined prices – which had peaked at $16 for mmBtu (million metric British thermal units) last year – there are two distinct prices for domestically produced gas.

The price of gas is as low as $2.5 mmBtu under the administered pricing mechanism and applicable to state-owned producers who began production before the New Exploration and Licensing Policy (NELP) came into force. The government conceived of the NELP in the late 1990s to encourage both domestic and international oil and gas companies to explore for energy. It went in for ‘arms-length’ pricing for gas reserves discovered after the NELP.

Till 2010, eight rounds of NELP were held and 400 production sharing contracts (PSCs) were signed between the government the bidders. Last year, the ninth round of bidding was completed and earlier this month, the cabinet committee on economic affairs (CCEA), finalised the allocation of blocks.

The biggest gas discovery, the Krishna-Godavari (KG) basin in the southern state of Andhra Pradesh, was won by Reliance Industries Ltd (RIL). The government fixed a price of $4.2 per mmBtu for the KG basin gas, though Reliance has been demanding a higher price.

Last week’s note by the petroleum ministry to the cabinet suggested doubling of the price of natural gas produced by ONGC and OIL, two state-owned energy majors, to $8 to $8.5 per mmbtu from this year and for Reliance from April 2014, when the existing contract expires.

RIL, and its two international partners, BP and Niko Resources, has been demanding a price of nearly $13 per mmBtu for gas from KG’s D6 block – which was India’s biggest natural gas discovery in 2002 – where reserves add up to about 14 trillion cubic feet (tcf), once the existing contract comes to an end in April 2014. The government has been reluctant to pay such a high price for the KG-D6 gas.

Last week, RIL appeared to have softened its stand on the price, admitting that the Rangarajan committee’s report, suggesting a doubling of price of domestically sourced natural gas, would create “an investment enabling environment.” The report would result in “positive traction in domestic exploration and production business environment,” it added. The panel’s recommendation was also a positive sign for monetising of marginal fields, said the company.

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THE high-powered panel suggested that domestically produced natural gas be priced at an average of international hub prices and the cost of imported LNG. It suggested the averaging of volume-weighted price of gas for the trailing 12 months at Henry Hub in the US – the spot and future prices of natural gas at Henry Hub reflect the pricing of North American natural gas – the National Balancing Point (NBP), which reflects the price of gas in the UK; and Japan’s Customs-cleared Crude (JCC) index, with the net price of imported LNG.

The committee suggested uniformity in pricing for natural gas, including conventional, coal bed methane (CBM) and even shale gas and for both state-owned and private producers. Similarly, the price should be uniformly applicable to all consumers, unlike at present where some – such as fertiliser plants and power generators – get gas at rates of as low as $2.52 per mmBtu.

And after five years, the panel wants pricing on the basis of gas-on-gas competition, which today determines more than half the gas prices in Europe. In the US, where the discovery of vast reserves of shale gas has transformed the energy industry dramatically, gas prices are set by the fundamentals of supply and demand and are not linked to crude oil prices.

The panel also wants major changes in future exploration contracts. The present complicated system allows a producer to deduct the cost of investment in a block before giving the government’s share of revenue. This has resulted in controversies, especially relating to RIL’s KG discoveries, with the Comptroller and Auditor General (CAG) suggesting that the government was being deprived of revenue because of additional expenditure being shown.

There have also been allegations of ‘gold-plating’ – artificially inflating the cost of development of gas fields – by the company. The government, however, recently denied the charges. According to official figures, the capital expenditure on D6 was revised from $2.4 billion in 2004 to $8.8 billion two years later after recoverable reserve was projected at 10.3 tcf from 3.81 tcf earlier. In September 2012, the company revised the reserves to 3.4 tcf and capex to $6.2 billion, and the DGH, the industry regulator, was ‘critically examining’ the revision, claims the government.

The Rangarajan committee identified cost recovery as the biggest issue at present, which led to unnecessary disputes between the producers and the government.

RIL has also been facing problems at KG basin, where it has had to shut down eight of its 22 wells. This has led to a sharp decline in output. According to the director-general of hydrocarbons (DGH), RIL’s production has dipped to an all-time low of just over 20 mcmd (million cubic metres per day). At its peak in August 2010, the main fields of Dhirubhai 1 and 3 (D1 and D3) were producing 55 mcmd.

The company has had to shut down the wells because of flooding of water. However, its plans to spend about $100 million to renovate the blocks have not been cleared by the government, as it will add on to the overall cost, thus further reducing its share of the revenue.

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INDIA’S domestic natural gas production has been declining sharply in recent years. This fiscal (ending March 31, 2013), total production is estimated to be around 104 mmscmd (million metric standard cubic metres per day), down from 114.9 mmscmd last year. Earlier, at the peak of production from KG, the country was producing more than 150 mmscmd.

But demand for natural gas is soaring: according to estimates, demand for gas will jump from 179 mmscmd (in 2010-11) to 473 mmscmd in 2016-17. The huge hunger for electricity has seen in soaring demand for gas from power plants, which are anyway facing an acute shortage of coal. According to the government, total power generation capacity – currently at around 210,000 MW – could expand by 8,200 MW if adequate gas is supplied to power plants.

The government is also giving the final touches to its policy on shale gas. India has recoverable reserves of shale gas of between six trillion cubic feet and 63 trillion cubic feet. The government has identified six basins for tapping blocks for shale gas. These include KG onshore, Cauvery onshore, the Indo-Gangetic basin, Cambay, Assam-Arakan and Gondawana.

Unlike in the case of natural gas, the government was market-determined pricing for shale gas; it will also not allow cost recovery and profit sharing, the two issues that have resulted in controversies in the production of natural gas.