Domestic Natural Gas Proves to be a Boon for Imported Coal

BRISBANE, Australia - July 22, 2013 - PRLog -- The Indian government recently endorsed a proposal to double the price of domestically produced natural gas from $4.2/million British Thermal Units (mmbtu) to $8.4/mmbtu. This is the price gas producers will receive for what they sell. With taxes, pipeline transportation and marketing costs, delivered prices to consumers under the new pricing guidelines will exceed $10/mmbtu in all of the states.  

The change will come into effect from 1 April 2014 and will remain in effect for five years.

These guidelines will apply to almost all of the domestically produced gas, except for about 13% of the production where the contract already provides a specific formula for price indexation.

India produced about 40 billion cubic meters (bcm) of natural gas in the last fiscal year. About 40% of this production comes from private operators under a production sharing contract (PSC) with the government as part of the New Exploration License Policy (NELP). Under NELP, private companies were given the right to explore, produce and sell natural gas from fields they were allocated from the NELP auction process.

Future natural gas production is likely to primarily come from fields allocated under NELP. The non-NELP production comes from fields granted to state owned oil-and-gas companies and from a few joint venture associations between government and private companies. Production from non-NELP fields has been shrinking and is likely to be largely insignificant as a share of total production by the end of the decade.

Although NELP intended to allow market determined prices, an appropriate gas market that supports transparent price discovery failed to emerge. In the absence of a market, prices were effectively negotiated with government using proxy market markers.

Government established the currently prevailing gas price of $4.2/mmbtu in 2009 for a period of five years. It was only applicable to gas produced from NELP. Natural gas produced by state owned companies and sold under an artificially low Administered Pricing Mechanism was left undisturbed.

The prices negotiated in 2009 were significantly lower than what Reliance, India’s largest private sector gas producer, had proposed under a formula linked to crude and the exchange rate. In scaling back proposed prices, the government also established a priority scheme for supply recognizing that it would have to be rationed. Power and fertilizer were given the top priority. Despite the promise of free markets under NEPL, the sector complained that it was hamstrung by over-bearing regulations.

The gas industry complained that private producers would not be encouraged to produce at those low prices. Interest in subsequent NELP rounds declined. Most importantly, production from Reliance’s Krishna Godavari offshore blocks in the east (off the coast of Andhra Pradesh) declined sharply.

Reliance claimed that the production decline was the result of unanticipated technical challenges with deep-sea production. It subsequently bought in BP as a shareholder, reportedly to source expertise for deep-sea production. Not everybody believed Reliance. Speculation was rife that Reliance was intentionally withholding production to benefit from an anticipated change in prices.    

The new Gas Pricing Guidelines don’t just double prices. It also gets rid of the sector priority for supply and makes the revised prices applicable to almost all of the gas produced. With the Natural Gas Pricing Guideline 2013, India has suddenly emerged as the hottest destination for natural gas. Where else in the world could a producer be assured of a netback price of $8.4/mmbtu without any volatility?

But the gas price hike isn’t just good news for gas producers. Coal exporters to India should also be uncorking their champagne.

Power plants and fertilizers are the largest consumers of natural gas in India. Fertilizer is subsidized, its prices regulated. For natural gas power plants, however, the increase in power prices should immediately flow through to power prices.

To date, electricity produced from imported coal plants have always been at the margin. At $4.2/mmbtu electricity produced from natural gas was always cheaper than electricity from imported coal. Higher price imported LNG and oil (naptha) never really made it into the electricity supply mix.

Distribution utilities often declined to purchase electricity generated from imported coal, preferring to leave demand unmet than incur the high electricity purchase costs. With the doubling of domestic gas prices, electricity produced from natural gas will now be more expensive than electricity from imported coal. Natural gas will be at the margin in most of the states.    

There’s potentially more to the story than just a change of which fuel power plant is on the margin. The change in gas prices has been sanctioned by government as a matter of policy. As a result, it will be difficult for distribution utilities to avoid purchasing electricity from natural gas power plants on account of their higher cost.

Once distribution utilities accept electricity produced from high priced domestic natural gas, it will be difficult to avoid purchase of electricity produced from imported coal. This consequently opens the door to a much larger volume of electricity produced using imported coal.  

If the change in natural gas price is not reversed, coal imports into India could double within the next two years.

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