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India Needs To Dig Deeper For the Black Gold to Rise & Shine

Posted in Finance Articles, Total Reads: 2570 , Published on November 11, 2014

The oil and gas sector is seeking all the attention these days by making the oil ministry work on a weekend (23rd and 24th of August 2014) to finalise the cabinet note which relates to fuel pricing and subsidy sharing. The dark clouds of rise in crude oil prices due to breakout of civilian war in Syria were cleared when recently, crude was trading at US$ 100 which is US$ 12-13 lower than the crude prices on the day budget was declared. Oil Ministry says that every dollar fall in crude prices saves India Rs.6000 Cr. of its import bill.

The government, Oil and Finance ministry and Panel of Secretaries need to deliver a lot over the fuel pricing mechanism. Diesel prices were deregulated and made more market driven in order to extinguish the under recoveries of Oil Marketing Companies (OMCs). But will the OMCs be allowed to hike diesel prices and have the same freedom they have with petrol after the under recoveries are extinguished completely? Government has also announced introduction of a new gas pricing formula by September 30th which they claim will benefit the investors as well as consumers.

Image Courtesy: freedigitalphotos.net, num_skyman

The existing gas pricing was approved in 2007 under New Exploration Licensing Policy (NELP) and was to remain in force till March 2014, after which it was subject to revision and the government appointed a committee under C Rangarajan in May 2012 for revision of the same. The previous UPA government notified a new gas pricing mechanism on 10th January 2014 formulated by the Rangarajan Committee according to which all domestic gas prices would be revised from 1st April 2014. But before the rate could be announced general elections were declared and the decision was left to the new government assuming to take power at the Centre. On 13th August 2014, Oil minister Dharmendra Pradhan announced that the government will come out with a new natural gas pricing formula by 30th September.

The complicated formula proposed by the aforesaid committee would lead to doubling of domestic gas price to US$ 8.4 per million British thermal units (mmBtu) from present US$ 4.2 mmBtu. According to the committee, all domestic gas prices should be the average of two prices. One price would be derived from the volume-weighted net-back price to producers at the exporting country well-head for Indian imports for the trailing 12 months. The other would be the volume-weighted price of US’s Henry Hub, UK's NBP and Japan's Custom Cleared (on net-back basis, since it is an importer) prices for the trailing 12 months. The present ministry feels that the committee has factored in Japan’s import prices even though it is not a producer and hence the elements of Rangarajan committee formula hold no relevance to gas pricing in India. It also feels that assumption of US and UK hub rates are equal to wellhead prices is incorrect.

Implementing Rangarajan’s formula would lead to hike in power cost by more than Rs.2 per unit, urea production cost by Rs.6.228 per tonne, piped gas by Rs.8.5 per Kg, and CNG by Rs.12 per Kg. Oil ministry being averse to the cascading effect of doubling of gas prices on power rates, urea cost, piped cooking gas and retail CNG cost, wants to tweak the formula to bring the proposed increase in natural gas prices to 75% i.e. approximately US$ 6-6.5 mmBtu.

In the current Production Sharing Contract (PSC) system, the risk of failure is borne by the contractor for which the investor doesn’t get any compensation. Only upon discovery the contractor can recover its cost from sale of oil or gas. In Cost Plus system, all costs up to failed exploration, development and appraisal costs and also the cost of invested capital will be factored in while calculating sale price of oil or gas. Also, oil and gas projects differ from typical heavy infrastructure projects wherein tariff is fixed at the start of the project based on the life cycle costs of the project. Economics of Exploration and Production (E&P) business is based on combination of both successful as well as failed exploration projects. So, fixing of lifetime tariffs will only lead to all economical reserves not being extracted. This would result into sub-optimal recovery of discovered hydrocarbon resources. According to HIS CERA study, onshore gas development projects can be economically viable at price of US$ 6-8 per mmBtu price, whereas offshore projects would need US$ 6-12 per mmBtu price.

India produces around 1000 barrels/day and consumes around 4000 barrels/day. Looking at India’s oil consumption, we need to look out to pump up our domestic production. Mumbai High, India’s first deep sea well came into being in 1976 with the establishment of an offshore rig but it still contributes 80% of offshore oil production and nearly 45% of the India’s total oil production. According to estimates, 3.14 million sq. km. of sedimentary area comprises of 26 basins and a total of 28 billion tonnes of resources have been identified, 2/3rd of which are off-shore.

To promote exploration Indian Government had introduced NELP under which 249 blocks were awarded but it could create huge impact leaving India’s deep water reserves unexplored. As Mumbai High on the west is already pumping out black gold, the east seems to have huge potential. ONGC made discovery at ultra-deep depth of 2841 meters in KG offshore. Yadana and Yetagun offshore areas of Myanmar coast and Andaman & Nicobar deep water sector seems to hold substantial discovery potential.

Considering the rising domestic consumption, sensitivity to geo-political events and probabilistic and volatile nature of oil prices India needs to crack a forward looking policy which can sustain the shocks which oil and gas price absorb on happening of any event. A brave rather than defensive outlook to output and price can solve nation’s oil and gas problem in medium to long term time range. In late 1880s William Lake, an Englishman exhorted the labourers “Dig Boy Dig” and by 1889 first oil well in the entire Asia was established in the town named Digboi in Assam. What can push the hopes high is, someone like William Lake exhorting it out again “Dig India Dig”.

This article has been authored by Ronak Shah from Transparent Value







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