Gas pricing: Can we learn from the US shale revolution?

Recently India’s premier gas company GAIL has offered to sell LNG at $21 per million British thermal unit (mmbtu). In contrast the regulated gas price is $4.20. In the unregulated gas market of the US it is around $4.00. In Europe and Japan it is around $10 and $15 respectively. When Gujarat State Petroleum Corporation offered to sell its gas bids were received for $8.80. It is this various gas prices around the world which has created the dilemma for India.

Unlike oil for which there is an international market to assess oil prices, there is no such market for gas.  For this reason the government has been setting a series of high level committees of experts to recommend gas price formula. The most recent committee headed by C Rangarajan has suggested to increase gas price from $4.20 to $8.50 using a complicated formula which has no relevance to India’s market conditions.

When one makes an objective analysis of the development of India’s gas sector during the last 20 years, it will be an understatement to conclude that irrational pricing in India has been an unmitigated disaster so far. About 30 per cent of 18,000 mw gas based generation capacity which has come on line has remained idle while another 10,000 mw of additional capacity may join them.

From time to time suggestions have been made to arrive at gas prices based on cost of gas production. On paper it sounds like a sound concept. However in an industry where discovering resources like oil and gas are almost like gambling though backed by complex scientific studies, estimating cost of producing oil and gas has been found to be problematic. It is because of this reason production sharing contract concept was developed to avoid wind fall profits to producers.

India’s irrational gas pricing has resulted in huge supply and demand gap in gas sector and prevented the proper exploration of gas reserves. Proposed gas import pipelines have become pipe dreams. Even a bigger disaster is that our political system is not allowing us to learn from the experience of other countries who have also faced similar problems.

Historically as late as 1978, natural gas sector was regulated in the US which resulted in gas shortages. However once gas was deregulated, not only there was surplus gas supply, the gas prices instead of increasing as predicted by the opponents of deregulation decreased. In recent years, the totally deregulated US gas market had seen as high a price as $15 in 2005. Because of shale gas revolution it fell below $2.
Dominant exporter

Unlike the US whose gas import dependence has not been all that significant, UK and western European markets have been dependent upon imports and that too on Russia. Still because of the gas market liberalisation, they have been able to force the dominant exporter Russia to delink gas prices from crude oil prices to some extent. This has resulted in lower gas prices in those markets than the oil linked gas market in Japan, Korea and Taiwan.

The argument of Rangarajan committee against the deregulation of Indian gas market is that India has no well developed gas infrastructure like in the US and western Europe. The committee also felt that since gas supplies are limited, producers may be in far more powerful position to exploit their market power. In fact similar arguments were advanced in the US when the government was getting ready to deregulate its gas market.

Thanks to the shale revolution in the US, it may soon achieve energy independence. It is also contemplating exporting gas in significant amount. As in India, there are two major groups taking two diametrically opposing views. While producers and liberal economists are supporting the market to decide the quantum of gas exports, major gas consuming industries like Chemicals and power are opposing it. The government appointed consultants have concluded that under all possible scenarios, gas export will have net positive impact though there will be some losers. It looks like the President Obama may allow free gas export.

In India, the government is in a dilemma about gas pricing. Fertlizer and power sectors which get gas allocation on a priority basis consume about 70 per cent of gas supplies. Both these sectors are subsidised by the government and any gas price increase will increase subsidy burden. On the other hand there are many sectors of industry which are ready to pay higher gas prices as demonstrated by GAIL and GSPC. In gas sector not only gas prices are controlled but also who has access to gas. As a result gas is not used optimally to generate maximum benefit to India’s economy.

Just like in the US, if gas market is liberalised, it will help India’s economy in more ways than what we can predict. In fact this may actually produce higher revenues to the government. Producers will be attracted to invest in gas exploration including shale gas. There will be no need to give the so called incentive price for shale gas exploration. It is even possible that India may succeed in importing LNG at lower price. In conclusion how India will resolve gas pricing dilemma will have huge impact on India’s development.