2 Natural gas pricing in India Current policy and potential impact Current scenario in Indias natural gas market Intricacies of natural gas pricing in India Potential impact of new pricing on energy industry C o n t e n t s 3 Natural gas pricing in India Current policy and potential impact Current scenario in Indias natural gas market Chapter 1 Indias natural gas consumption far behind the global average 1 Indias expanding economy and growing population have led to increased consumption of primary energy resources such as coal, oil and natural gas in the country. In line with this, its primary energy consumption grew at a compounded annual growth rate (CAGR) of 6% to 563.5 million tonnes of oil equivalent (MTOE) in 2012 from 420.1 MTOE in 2007. The share of natural gas in its primary energy mix increased marginally from 8% in 2008 to 8.7% in 2012.
This is fairly low, compared to the global average of 24%, primarily due to supply-side constraints. Furthermore, in terms of individual consumption, Indias annual gas consumption of 44 cubic meters (cm) per capita is far behind the global average of 470 cm per person. Figure 1: Low consumption of natural gas in India, 2012 -500 0 500 1,000 1,500 2,000 2,500 3,000 0.0% 10.0% 20.0% 30.0% 40.0% 50.0% 60.0% P e r
c a p i t a
g a s
c o n s u m p t i o n ,
c u b i c
m e t e r Gas share in energy mix, % Source: BP Statistical Review of World Energy 2013, The World Bank and EY analysis China India Brazil France Singapore South Korea Australia Germany Japan Canada US UK Turkey Malaysia Russia Sinihcant as dehcit ~ demand fcr suppIy traiIs; increasin reliance on imported LNG lndia's naLural qas markeL is seeinq a supply delciL, primarily due Lo low domesLic production and an inadequate transmission and distribution infrastructure. Domestic qas producLion received a siqnilcanL impeLus wiLh commencemenL ol producLion aL Lhe KCD6 leld, locaLed in Lhe counLry's Lhe easL coasL, in 2009. However, Lhe leld's output has been steadily declining after reaching 60 million standard cubic metres per day (mmscmd) in 2010, and has hit a trough of 12 mmscmd in 3QFY14 2 . According to Reliance Industries Limited (RIL), the fall in KG-D6s production is mainly due to qeoloqical complexiLy and a naLural decline in Lhe lelds. 1he decline in mosL ol Lhe counLry's aqeinq lelds has lurLher compounded Lhe supply delciL. On Lhe oLher hand, Lhe demand lor naLural qas in lndia has increased siqnilcanLly due to the demand from the power and fertilizer sectors, and cumulatively accounted for more than 61% of gas consumption in FY13. The demand is also driven by its growing usaqe in Lhe ciLy qas disLribuLion (CCD) secLor and indusLrial secLors, such as relninq 4 Natural gas pricing in India Current policy and potential impact and petrochemicals. Rising concerns on carbon emission have also contributed to the demand for natural gas in the country. 3
1his has led Lo lndia's increased dependence on imporLed liqueled naLural qas (LNC). 1he counLry's LNC imporLs have increased lrom approximaLely 8 million meLric Lons (mmL) in FY09 Lo 11 mmL in FY13, accounLed lor 287 ol Lhe LoLal supply. 4 According to the BP Statistical Review of World Energy 2013, India is the worlds fourth-largest imporLer ol LNC in Lhe world. LikeIihccd cf !ndian as market remainin in suppIy dehcit despite rising production and import of gas Over the next few years, the shortfall in natural gas production in the country is expected to continue with its supply trailing demand. Shortage of gas is likely to reach its peak in FY15, with around 37% of the demand being unmet. 5 However, lrom FY16 onwards, Lhe delciL may decrease, primarily due Lo Lhe planned producLion ol privaLe/ |oinL venLure companies and increased LNC imporL capaciLy. Power and lerLilizers are expected to remain the anchor segments that consume natural gas and are likely to account for around 68% of the total demand for it in FY17. Furthermore, deregulated pricing of petroleum products and an increasing focus on addressing environmental concerns are expected to drive the demand for natural gas from industrial users, residenLial users Lhrouqh piped naLural qas (PNC), and in Lhe LransporLaLion seqmenL Lhrouqh Lhe demand lor compressed naLural qas (CNC). However, Lhis demand is hiqhly price-sensitive and will depend on the price affordability of end users, especially in the power and fertilizer sectors. 6 Figure 2: Future natural gas demand-supply scenario (mmscmd) Source: Ministry of Petroleum and Natural Gas 87 87 129 150 149 170 177 209 371 405 446 473 135 148 140 114 FY14 FY15 FY16 FY17 LNG imports Domestic production Natural gas demand Delcit 1he LoLal supply ol naLural qas is expecLed Lo reach Lo 359 mmscmdin FY17, a CACR of 15% from FY14 in India. Most of this incremental supply is expected to be met by LNC imporLs, since Lhe qrowLh in domesLic supply will lail Lo keep pace wiLh Lhe anLicipaLed rise in demand. 1he counLry's poLenLial Lo imporL LNC is expecLed Lo increase to 150 mmscmd in FY17, contributing around 42% of the total supply. Domestic production is expected to increase at a CAGR of around 12%. 7 This is likely to come from new discoveries which are currently under development, expectation of partial recovery in the output from KG-D6 and increased production from unconventional sources, particularly coal bed methane. 5 Natural gas pricing in India Current policy and potential impact Intricacies of natural gas pricing in India Chapter 2 PrevaiIin naturaI as pricin reime in the ccuntry complex and heterogeneous There are multiple natural gas pricing regimes in India. These can be divided into the following: Administered Pricing Mechanism (APM) NonAPM APM gas pricing: NaLural qas produced lrom Lhe exisLinq lelds ol Lhe nominaLed blocks ol lndian sLaLeowned companies, OlL lndia LLd. (OlL) and ONCC, caLers Lo fertilizer and power plants, court-mandated customers and those requiring less than 50 thousand standard cubic metres per day (mscmpd) at APM rates. The price of APM gas has been set by the Government on a cost-plus basis and is US$4.2 per mmbtu in lndia (USS2.52 per mmbLu in Lhe NorLheasL). 1he price in Lhe NorLheasL is 607 ol Lhe APM price elsewhere in the country (the balance 40% is paid by the Government to naLional oil companies or NOCs as subsidies). 8 Indias move toward a market-based pricing regime: In June 2013, the Cabinet Committee on Economic Affairs (CCEA) approved a market-based pricing formula for produced natural gas produced in India. The revised prices are based on recommendations made by the Rangarajan Committee. The pricing formula, valid for Lhe nexL lve years, peqs Lhe base price ol naLural qas aL around USS8.^ per mmbLu, up from US$4.2 per mmbtu currently. The upward revision in prices is based on the weiqhLed averaqe ol Lhe neLback price aL Lhe wellhead ol counLries exporLinq LNC Lo lndia and qas prices in Lhe Lradinq hubs ol NorLh America, Lurope and Japan. 1hese are calculated on a trailing 12-month basis. Prices will be revised every quarter. Non-APM gas pricing: NonAPM qas is divided inLo Lwo caLeqories (i) imporLed LNC, for which prices are determined by the market, and (ii) domestically produced gas from Lhe New LxploraLion Licensinq Policy (NLLP) and preNLLP lelds. Pre-NELP PSC pricing: This is applicable for gas produced from in Panna-Mukta, 1apLi and Ravva lelds. Cas prices are deLermined on Lhe basis ol Lhe lormula speciled in Lhe producLionsharinq conLracL (PSC). All Lhe qas produced is sold Lo CAlL. CurrenLly, Lhe preNLLP pricinq is beLween USS3.5 and USS5.7 per mmbLu. NELP gas pricing: 1his applies Lo qas lelds awarded under NLLP rounds. 1he price of gas is determined on the basis of arms length prices (market prices), subject to the Governments approval, and is controlled by PSC terms. This pricing regime was valid until March 2014. After this, a new pricing mechanism has come into force, based on the Ranagrajan Committees recommendations. Currently, NLLP qas is priced aL beLween USS^.2 and USS^.7 per mmbLu. Price of imported gas (LNG): 1he price ol lonqLerm LNC imporLed lrom OaLar has been linked to Japanese Custom Cleared (JCC) prices and varies on a monthly basis for PeLroneL LNC. However, lndia's dependence on expensive spoL LNC Lo meeL Lhe bulk ol its demand sees limited growth from this source. According to industry estimates, the imporLed qas lrom lonqLerm LNC conLracLs cosLs around USS13 per mmbLu, while Lhe spot price was at around US$18 per mmbtu in January 2014 9 . 6 Natural gas pricing in India Current policy and potential impact Potential impact of new pricing on energy industry Chapter 3 Overall, the new gas pricing policy augurs well for Indias natural gas market. It is expected to increase domestic production by encouraging upstream investment. This will improve Indias energy security and increase availability of gas for its key gas-consuming industries. So far, the gas market has been adversely affected by the Governments current gas-pricing policy and investment in the upstream sector declined to US$1.8 billion in FY12 lrom USS6.3 billion in FY09. 1he new policy, which has been puL on hold due to the on-going General Elections in the country, is expected to increase certainty and transparency in pricing of natural gas in India. Upstream sector The increase in natural gas prices is expected to encourage investment in the upstream segment and boost production. It will also improve the commercial viability of marqinal, deepwaLer and lronLier lelds, which require cuLLinqedqe Lechnoloqy and increased capiLal spendinq. Accordinq Lo lHS CLRA's esLimaLes, lndia's recoverable qas reserves could increase by 55 Lrillion cubic leeL (Lcl) Lo 91 Lcl aL qas prices ol USS10 US$12 per mmbtu due to the factors mentioned above. 10 lncreased domesLic producLion due Lo Lhe enhanced commercial viabiliLy ol qas lelds is expecLed Lo decrease Lhe prevalenL qas supply delciL in lndia. lL could reduce Lhe counLry's LNC imporL bill. 11 According to Morgan Stanley, gas prices of more than USS8 per mmbLu could resulL in incremenLal producLion ol nearly 95 mmscmd over 20 years. 1his would help Lo reduce lndia's LNC imporL cosLs by around USS16 billion. 12
The proposed hike in gas prices will help to boost the revenues of indigenous gas producers. CurrenLly, ONCC, OlL and RlL accounL lor 857 ol Lhe LoLal ouLpuL ol domestic gas. According to Moodys estimates, the proposed increase in gas prices will auqmenL ONCC's revenue by USS1.5USS2 billion and RlL's revenue by USS300 US$500 million in FY15. 13 Furthermore, the rise in gas prices will augment the CovernmenL's revenue in Lhe lorm ol increased Laxes, royalLy, prolLs and dividends. Increased production of gas will help to alleviate the existing supply crunch, and reduce the countrys reliance on high-priced LNG. However, price-sensitive sectors such as power and Iertilizers may hnd it diIhcult to absorb this hike. ThereIore, there is a need for the Governments policy to effectively address the concerns of the consuming sector. 7 Natural gas pricing in India Current policy and potential impact Power sector The power sector is the largest consumer of natural gas in India. Gas-powered power plants are plagued by high generation costs and a low average plant load factor (PLF). Currently, around 6,000 MW of commissioned and 1,000 MW of un-commissioned (aL an advanced sLaqe ol consLrucLion/commissioninq) qasbased power planLs are non-functional due to unavailability of gas. While the new pricing regime is expected to increase domestic gas supply, which can be used to bring these power plants on stream, the demand for natural gas for gas-based power generation remains highly price-sensitive. Power plants are currently being supplied APM gas at US$4.2 per mmbLu aL a variable cosL ol lNR2.1 per uniL. AL a PLF ol 507, Lhis LranslaLes inLo a qeneraLion cosL ol lNR^.8 per uniL lor new commissioned planLs owned by privaLe players. The increase in gas prices to US$8.4 per mmbtu is expected to result in a rise in iLs variable cosL ol lNR2 per uniL and increase Lhe LoLal cosL Lo lNR6.7 per uniL. 1his will only make iL allordable lor peak load purposes. FurLhermore, iL will be dillculL lor the companies to switch from natural gas to coal due to high conversion costs, a longer gestation period, their reliance on imported coal and environmental constraints 14 . Fertilizer sector In the case of the fertilizer sector, another major consumer of gas, increased gas prices would result in a rise in feedstock costs and working capital requirements. 8 Natural gas pricing in India Current policy and potential impact NeverLheless, any rise in domesLic qas producLion will be a posiLive developmenL in the fertilizer industry, since it enjoys a top priority position for allocation of gas. 15 In addiLion, Lhis would reduce Lhe indusLry's dependence on hiqhpriced LNC
. According to a report submitted by the Governments Parliamentary Standing CommiLLee on Finance, producLion cosLs would increase by lNR1,38^ per Lonne wiLh every rise of US$1 per mmbtu in gas prices. Consequently, this would lead to an increase in the Governments subsidy burden. An increase in gas prices to around 8.4 per mmbLu will increase Lhe CovernmenL's subsidy burden by lNR120 billion (USS2 billion). This subsidy burden can be offset by additional revenues received by the CovernmenL lrom increased royalLy, prolLsharinq and Lax collecLions lrom upsLream operations expected in development of new gas resources. City as distributicn sectcr The CGD sector is another key consumer and has witnessed rapid growth in recent years. The sector will continue to create a demand due to the addition of gas networks in new ciLies, Lhe price advanLaqe ol CNC over auLo luels and increased use ol PNC in Lhe domesLic, indusLrial and commercial secLors. However, Lhe new qas pricinq policy will increase sourcing costs for CGD companies with a high APM gas allocation. CGD companies are expected to witness a decline in their earnings due to an increase in their input costs. These companies are unlikely to pass on the increase in gas prices to industrial and domestic consumers due to their limited headroom with alternative fuels (domesLic LPC and lurnace oil). 1he new qas pricinq will noL have a siqnilcanL impacL on operaLions in reqions wiLh a predominanL mix ol LNC in Lheir sourcinq ol qas, e.q., in lndia's wesLern reqion. 1his is because CNC prices are already hiqh in such qeoqraphies. However, Lhe LhreaL ol depreciaLion ol currency will conLinue Lo be a cause ol concern, since the cost of sourcing is dollar-dominated 16 . Overall, increased availability of domesLic qas lrom new pro|ecLs is likely Lo increase invesLors' conldence in Lhe secLor. Petrochemicals and other consuming sectors The petrochemicals sector uses natural gas to extract ethane and produce polyethylene, propane and butane for production of LPG. Input costs account for around 80% of manufacturing costs. Increased gas prices would mean reduced prolLabiliLy lor peLrochemical companies. 1his would also hold Lrue lor oLher indusLries such as ceramics and glass, since their input costs are also likely to go up with the price revision. On the other hand, companies that have replaced expensive fuels such as naphLha and diesel wiLh naLural qas will sLand Lo benelL lrom Lhis revision, since iL will remain compeLiLive aL revised prices. Relninq would remain unallecLed lrom Lhe hike in gas prices, since the sector meets most of its demand from imported gas or naphtha. 9 Natural gas pricing in India Current policy and potential impact 1. 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"1wellLh Five Year PlanVolume ll (201217)," Planninq Commission ol lndia, hLLp://planninqcommission.qov. in/plans/planrel/12Lhplan/pdl/12lyp_vol2.pdl, accessed 16 April 201^. 7. "lndian PeLroleum & NaLural Cas SLaLisLics 201213," MinisLry ol PeLroleum & NaLural Cas, hLLp://peLroleum. nic.in/pnqsLaL.pdl, accessed 16 April 201^. 8. "Price APM qas," MinisLry ol PeLroleum and NaLural Cas, hLLp://peLroleum.nic.in/PriceAPMCas1.pdl, accessed 16 April 2014. 9. "LNC opporLuniLies in lndia enqulled wiLh serious problems," Moneylile, 21 January 2013, via FacLiva 2013 Moneywise Media Pvt. Ltd. 10. "New qas price Lo boosL ONCC, OlL boLLom lines il qovL doesn'L play spoilsporL," Financial express, 17 July 2013, via FacLiva 2013 lndian Lxpress Online Media PvL. LLd. 11. "China, lndia qas price relorms open door Lo more LNC imporLs," ReuLers News, ^ July 2013, via FacLiva 2013 Reuters Limited. 12. 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"ALLOCA1lON AND PRlClNC OF CAS," MinisLry ol PeLroleum and NaLural qas, hLLp://16^.100.^7.13^/ lsscommiLLee/PeLroleum720&720NaLural720Cas/15_PeLroleum_And_NaLural_Cas_19.pdl, 18 OcLober 2013. 16. "ALLOCA1lON AND PRlClNC OF CAS," MinisLry ol PeLroleum and NaLural qas, hLLp://16^.100.^7.13^/ lsscommiLLee/PeLroleum720&720NaLural720Cas/15_PeLroleum_And_NaLural_Cas_19.pdl, 18 OcLober 2013; "Vision 2030 NaLural qas inlrasLrucLure in lndia," PeLroleum & NaLural Cas RequlaLory Board, hLLp://www. pnqrb.qov.in/newsiLe/pdl/vision/visionNCPV203006092013.pdl, accessed 17 April 201^. References 10 Natural gas pricing in India Current policy and potential impact For more information, visit www.ey.com/in Connect with us Assurance, Tax, Transactions, Advisory A comprehensive range of high-quality services to help you navigate your next phase of growth Read more on www.ey.com/India/Services Our services Centers of excellence for key sectors Our sector practices ensure our work with you is tuned in to the realities of your industry Read about our sector knowledge at ey.com/India/industries Sector focus Easy access to our knowledge publications. Any time. http://webcast.ey.com/thoughtcenter/ Webcasts and podcasts www.ey.com/subscription-form Follow us @EY_India Join the Business network from Ernst & Young Stay connected 11 Natural gas pricing in India Current policy and potential impact Ahmedabad 2nd loor, Shivalik lshaan Near. 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