GAS Price Formula – A Significant Reform for Upstream Oil & Gas - India Ratings

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New Delhi, June 28, 2013: India Ratings & Research (Ind-Ra) says that the government of India’s (GoI) recent decision to base natural gas pricing on the Rangarajan Panel’s formula is a significant reform for the upstream oil & gas sector. Coming on the heels of reforms in downstream oil product pricing and approvals for stalled upstream projects, the decision exhibits GoI’s intent of resolving long pending issues plaguing the sector.

“The formula-based pricing approach will provide far greater clarity to gas producers than the current discretionary government approval based pricing, says Abhinav Goel, Senior Director at Ind-Ra. “Also, quarterly revisions will help keep prices aligned with markets’ rather than being stagnant for years”, added Goel.

On the basis of the current international prices, the formula will result in a near doubling of natural gas prices from the current USD4.2/mmbtu, which would substantially increase cash flows from gas production for domestic producers. The new pricing regime is applicable from April 2014 for five years. While the cash flow change for private producers would be direct, net impact on public sector companies would depend on ‘if and to what extent’ GoI increases their share in oil product subsidy. Also, gas prices could move in either direction depending on the various variables of the formula.

Increased pricing will make significant known gas reserves commercially viable which should help increase production in the medium-long term. This will also encourage investments in exploration which will help increase reserves and production in the long term. This reform would also allay a major concern of international O&G companies and could improve their participation in the future New Exploration Licensing Policy rounds.

“Moreover, higher domestic prices will gradually increase the acceptance of expensive imported LNG and help increase overall gas supplies in the Indian market”, says Goel.

However, concerns would be raised by user industries like power, fertlisers, transport as well as domestic, industrial and commercial piped natural gas users. Ind-Ra expects gas-based power plants to see a fuel cost hike of 91% to INR4.91/kwh, leading to an additional burden of INR128bn on the consumers which would manifest itself as a 14paisa/kwh hike in all India generation of 912bn kwh. This would also push down such plants lower in the merit order dispatch schedule, thus increasing off-take risks.

Increased gas prices would lower the profitability of urea manufacturers due to lower operating profits from sales above the cut-off quantity. Ind-Ra expects the impact to be more for manufacturers with higher energy consumption. Moreover, the increase in retention prices, if not passed on to the consumers, would result in an additional subsidy burden to the tune of INR83bn annually which will have to borne by GoI.

(Source: Manager – Corporate Communications and Investor Relations, India Ratings & Research  A Fitch Group Company.)

Date: 
Friday, June 28, 2013