Saturday, February 22, 2014

Gas Pricing - Reply to Kejriwal

Yesterday Mr. Kejriwal asked Mr. Modi "Would you bring down the gas price from 8 dollar per unit to 4 dollar?" 

As I belong to Natural Gas sector, I have drafted a reply on behalf of Mr. Modi. This should clarify all the myths relating to Gas Pricing issue being created by Nautanki Party. Mr. Kejriwal, I hope you have the guts to reply to this one. (please note this is my reply and not the official reply from BJP/Modi)

Mr. Kejriwal, our party believes, as you mentioned in the CII meet that “government has no business to be in business”. We do not want to be into the business of determining gas price. The Gas price should be determined by transparent bidding system and precious natural resource like gas should be sold at the highest price possible. Your ‘Nautanki party’ might interpret the answer simply to say that the gas price might be higher than even $8.4. Yes, it might be as high as $14, the price Indian customers are paying for imported and regassified natural gas in the country.

But you have to go beyond headline sound bites and understand basic economic principles. I know you have mentioned that you people do not know and want to learn by making mistakes in the next 5 years. Indian economy is not a toy car where you can learn from playing. One bad move can be fatal for the whole country. We have more than 15 years of experience of running government in Gujarat and we know what we are saying. Ask any expert they will tell you that when it comes to using Gas as source of energy, Gujarat state performs better than all Indian states put together. So we do not only have good intentions but our good intentions are backed by sound knowledge and extensive experience of execution.

Point 1: Scarce natural resources should be sold to the highest bidder at the maximum possible price through a transparent bidding mechanism like Telecom spectrum.

When the spectrum was allocated by government and not auctioned you complained (and rightly so) that there is corruption. Why the same logic does not apply to gas. Gas is also scarce natural resource like spectrum. Due to high spectrum prices, telecom service prices also increases for end customers. As the latest round of spectrum auction has proved, transparent action is the best method of allocation natural resources and this leads to higher revenue for the government to meet its social objectives.

Point 2: Government allocation leads to corruption

If scarce resources like natural gas are sold at below the market price, there would be more demand than supply and then government would have to step into the role of allocation of resources which would lead to corruption. Government nominees would bend rules to favour people they want. Why should we sell these scarce resources at below market prices to private parties who would make super profits at the cost of government revenues?

Point 3: Increasing prices does not means that all goes into Mukesh Ambani’s pocket. In fact government earns more.

 One needs to understand how a Production Sharing Contract (PSC) works. (These are complicated things and I suggest you get some expert to help you understand this. For your maturity, it might be difficult. But still I would give it a try).

When Gas blocks are bid out, the bidder bids for the percentage share of the produce. The bidder who agrees to give highest share to government wins the bid. RIL has won the bid on this basis. In RIL contract the structure is as follows:

a.     Till the time RIL finds any oil or gas in the fields all expenses incurred is risk capital and if they do not find any Oil or gas the whole investment is lost. RIL gets no recovery of the same. Generally exploration cost billions of dollars and chances of success is as low as 10%. You need to appreciate that companies who have technical know-how to handle such projects would take such risks only if there is sufficient incentive built in on success. Otherwise our natural resources would never reach the hands of people

b.    Once the company finds Oil & Gas, they have to submit a budget for development and production from the field. Once the budget is approved, that budget acts as a basis of cost recovery. So suppose, RIL spends $10 billion on total exploration, development and production then cost recovery is allowed upto 2.5 times. The ratio of produce sharing would be as follows:

Till cost recovery reaches 2.5 times of $ 10 billion i.e. $25 billion, RIL’s share is 85% and Government share is 15% of the production.
Once the cost recovery crosses 2.5 times of investment, RIL share becomes 15% and government share becomes 85%.

So suppose earlier price was $4.2 and total sales was $50 billion. RIL was getting $28 billion and government was getting $22 billion. When the price is doubled to $8.4 total sales would double to $100 billion. In that case RIL would get $35.5 billion and government will get $64.5 billion. Hence RIL revenue would increase by only 26%, while government royalty income would increase by 193%. And this 26% is before income tax. After income tax, income increase would be only around 18%.

Now you should be able to appreciate that when price of gas is increased it’s the government who gains more in form of royalty. This is apart from the increased revenue in terms of income tax, sales tax etc. Please note that this 2.5 times ratio is does not takes into account time value of money. So if somebody invests $10 billion today and gets $25 billion after 10 years, and that also after so much skilled efforts and risk, he is not reaping super natural profits. And that is obvious from limited interest shown by International Oil and gas majors in taking up such projects in India. And you would appreciate that we need to invest to be able to get our unutilized natural gas up on the ground and we need to attract best oil and gas companies to do that. Resource is of value only if reached the ground. Your Nautanki can’t get this gas to the ground.

Point 4: Government should take its share of gas produce in kind and allocate it to industries as per the social priorities. 

Alternatively, Royalty, income tax and other taxes collected from Gas sales can be kept in a separate fund to fund the subsidies to meet the social objectives. This would be more transparent, corrupt free and efficient method of distributing subsidies. We do not want to act like congress government who are black marketing the gas at subsidized price to private companies for their personal gains.

Point 5: Indian should end this system of “retrospective regulatory changes” started by Congress government. 

That does not only effect the foreign investment into the country but also affect adversely Indian Banks, domestic investors and overall investment climate. It leads to uncertainties which are not good for long gestation projects like Infra projects. And I believe you would agree that India needs to invest heavily in infrastructure over the next 10-15 years to provide better life to our citizens.

The PSC was signed long time back through a bidding system. We should always try to improve contracts going forward and make the bidding more transparent and competitive. But let’s not put into question agreed commercial philosophy of such contracts. You are giving a wrong picture of your mental health when you compare an Oil & Gas company entering into Production Sharing Contract (PSC) with a servant. Kindly appreciate; the relationship is that of a partnership and not that of a servant. We need to partners Oil & Gas companies because these are complex projects requiring great technical and management skills. Without these skill the resource will never reach the ground and will go waste.

Point 6: Why should we force Government-RIL partnership to sell the gas at below market price and let countries like Qatar to sell us gas at $14. Why don’t you use your Nautanki to force Qatar to sell gas to us at $4.2?

Point 7: We also believe there is fraud on the nation done by RIL and Congress combine. But the fraud is not in terms of lower pricing, but in terms of gold plating of investments.

Assuming, RIL has shown the cost of development of these fields as $ 10 billion while actually it is only $ 5 billion. In that case, they should be getting revenue share of only $15.5 billion rather than $28 billion. When we form the government, we will get the accounts audited by CAG to make sure that there is no gold plating and would disallow RIL any excess cost they have built in. Automatically their revenue share would fall and government share would increase. The increased government revenues can be deployed to meet social objectives.

Mr. Kejriwal, we request you to kindly detest from making comments without basic knowledge on things. Everybody loves to get things cheap and when you say you will reduce power prices or gas prices everybody claps. But then people clap during Nautanki also. Let’s not mislead the nation. What you are not telling them is actually you will not reduce prices but you would reduce power supply and gas supply itself. You would send India back to license raj days when we used to stand in queue for years for basic things like telephone connection, power connection etc. And then your team intends to black market the limited supply to fill in your pockets. India’s inflation problem is due to supply side problems and not due to pricing problem. For a developing country like India the government needs to focus on increasing supply and let price be determined by competitive forces. Increased prices would take care of pricing issues. But you would not understand that. You want to use Indian Economy as a toy car. Indian voters are intelligent enough and would not handover the wheels of this great nation into hand of novices like you. Spend time in the system, read & learn more rather that doing Nuatanki, once you have matured enough then ask for the wheels of the country.

Link to model Production Sharing Contract (PSC) on petroleum ministry website:


Lalitabh Shrivastawa said...

Extremely well researched and succinctly put across. The Pricing formula and the revenue sharing was most useful. As far as Gold plating of Investments, well, RIL is RIL.
Great post!!!

Neeraj Gutgutia said...

Thanks Lalitabh for your comments. I tried my best to keep it as simple as possible. Do you think Kejriwal has the patience to read the whole thing and then form opinion. Will he be able to understand the revenue sharing mechanism from this blog?

reshvishes said...

Gud one Sir...

kt said...

Excellent, specially point 4, 6 & 7. One point I would like to make , In the absence of a global marker price, how does one price domestic gas? The Rangarajan Committee recommendation now being implemented by the government, is based on a convoluted weighted average price of the three gas markets — the Henry Hub, the European markets and the Asia-Pacific market. The last is dominated by Japan, China, Taiwan and South Korea, all woefully gas-deficient and hugely dependent on imported LNG. Their desperation to ensure fuel security has pushed up LNG prices so steeply that their weight in any pricing formula is bound to PUSH it on the higher side.

Instead of imposing this formula, gas pricing should be determined by the domestic market. RIL’s current price of U.S. $4-20/mmbtu itself was based on competitive bidding by the company from prospective gas-based electricity generators before it commenced commercial production. The bidding did not take place at a time of acute gas shortage and hence got pegged at a level that was considered acceptable in the domestic gas market, although there is no rationale for fixing the price of a domestic commodity in dollar terms. A similar bidding process is not feasible under the current supply shortage situation, especially one caused by RIL itself. Until such time RIL makes good its commitment and restores the demand-supply balance in the market, no gas price increase is justified.
Secondly LNG prices are high due to restrictions on LNG terminal facilities.If LNG market is opened up LNG prices may fall in India.
I agree Arvind Kejriwal has done nautanki like comparing partner to servant etc. but he has some point.