Latest Indian gas price dispute leads to government intervention
Although the Indian exploration and production industry holds great potential for all stakeholders, the lack of transparent or consistent regulatory guidelines has left investors skeptical. The government has been forced to intervene in the latest conflict caused by these market limitations, which could have far reaching consequences for the activities of domestic and international E&P players. The big news story currently circulating in the Indian energy sector is the natural gas supply dispute between Reliance Industries Limited (RIL) and Reliance Natural Resources Limited (RNRL). The dispute has resulted in natural gas production rates from the Krishna Godavari (KG) basin being greatly below the initial targets, which in turn has held up projects at various stages of execution. This has forced the Indian government to intervene and claim its sovereign rights to the natural gas assets which belong to the country, in the process reminding companies that they are mere operators/contractors involved in bringing gas to the surface and supplying it to end customers. In 2005, RNRL (which is led by Indian billionaire Anil Ambani) signed a memorandum of understanding (MOU) with RIL for the supply of 28 million metric standard cubic meters per day (mmscmd) of gas for a period of 17 years, at a price of $2.34 per million British thermal unit (/mmbtu). This is the same price at which RIL won a bid for supplying gas to National Thermal Power Corporation (NTPC) in 2004. However, other fertilizer and power companies have to pay the government-regulated price of $4.20/mmbtu for the gas extracted from KG D6 block. Karan Ahuja*, energy senior analyst with Datamonitor explains: “The rise of fuel prices in the international market and an increase in operational costs has now forced RIL to dishonor its contracts with RNRL and NTPC, stating that it will not be possible to provide the gas at the pre-established price. RNRL has contested this decision and has laid the grounds for what is set to be an epic legal scuffle.” All this has led RIL to cut down its targeted production rate from its KG D6 block, leading the customers with which it has already signed gas allocation contracts to panic. Delayed and lower production also means reduced or delayed revenues for the government. As a result, the Indian government has intervened, stating that gas and oil are national assets and that operators are responsible only for bringing it to the surface and supplying it to end users. Furthermore, the government declared the MOU between the two parties as null and void. Soumya Sen*, energy analyst with Datamonitor believes says: “ideally, the operator and purchaser should sign a contract and establish a price that is either mutually decided or fixed as per the competitive pricing mechanism.” The contract should also accompany a revision clause to allow a periodical review of the prices based on market rates. The government, meanwhile, should be entitled to earn a revenue/royalty for the gas, based on a predetermined rate as per the product sharing contract. However, the government should not be party to such contracts; it should formulate policies that provide a transparent and clear set of guidelines, but should intervene only in cases where policies or contracts are violated. This would reassure international E&P operators engaged in India that while the government is interested in the timely extraction and delivery of the fuel to its entitled customers, the prices that customers are charged are competitive and based on free market dynamics. Although some multinational corporations operating in India may worry about the fact that the government is trying to involve itself in the pricing issue and in selecting customers of gas, given that the stakes are high (the KG basin is touted as one of the key solutions to India’s energy needs), the government’s intervention seems to make sense. The pricing dispute between RIL and RNRL is jeopardizing production from KG blocks and raising serious doubts about the regulatory policies governing the pricing across fossil fuel blocks in India. This could have far reaching consequences and dampen investors‘ appetite for investing in Indian fuel assets. Thus, while the government is acting in the best interests of national resources, it is also playing the role of regulator, acting in the best interests of end users and the players which are involved in the natural gas business. The final verdict from the Supreme Court of India will be a crucial one: upholding the lower price would definitely have a negative impact on investors, as it would force them to sell gas at a much lower price than the existing market price of gas. On the other hand, fixing a price that is near the current market price (i.e. $4.20/mmbtu) would establish a competitive pricing system for the Indian fuel exploration and marketing industry. It is also important that a flexibility clause, where prices can be reviewed from time to time with the mutual consent of the parties involved based on prevalent market conditions, should be introduced or strongly recommended. If a flexible pricing clause is written into the contract, the possibility that gas prices will reach between $2.34 and $4.20/mmbtu cannot be ruled out. Datamonitor believes that the outcome of the epic battle over national assets will set a benchmark for the Petroleum Ministry, as well as the Directorate General of Hydrocarbons. It will steer them in designing across-the-board policy guidelines for fuel pricing and other similar conflicts. This will go a long way toward securing investors‘ confidence and consolidating India’s position as an energy-secure nation. |