Without investor incentives, our shale gas industry will be stillborn

An in-depth analysis of the petroleum ministry’s efforts to promote shale gas exploration in India will give a compelling impression that there is no energy crisis in India.

It is more than three years that the government has been struggling to craft a shale gas exploration policy. In recent months, it has been announcing regularly that a new policy will be unveiled soon. But when that day dawns to give birth to shale gas industry, the baby is likely to be stillborn. Moily’s wish for India to be energy independent by 2030 will remain a pipe dream.

Actually there is no difference between shale gas and natural gas excepting that shale gas requires far more complex technologies (horizontal drilling and fracking) while natural gas is relatively easy to exploit. The US has no separate legal framework to exploit shale gas and natural gas. The same is true in other countries. For reasons which are difficult to comprehend, the current exploration agreements signed are prohibiting the oil companies from developing shale gas even if they have succeeded in finding those reserves.

Joshi Technologies and ONGC have succeeded in finding shale gas in acreages awarded to them to explore for natural gas in 2010 and 2011 respectively. But they are prohibited from developing those reserves. About six months back Rangarajan Committee had recommended new terms for production sharing agreement.

Recommendations concerning profit sharing have been incorporated in the proposed bidding terms for shale gas to make them more transparent, equitable, and ‘attractive’ for investors. It is claimed that the new terms will minimise government intervention, incentive for gold plating, and complication in accounting. On paper the new methodology based on production linked payments seems to achieve all these very reasonable objectives.

Unfortunately the proposed methodology is extremely complex and cumbersome for investors to assess the profitability. It still has ample opportunities for overstatement of expenses to reduce income taxes, under selling of gas etc. Even after all these ‘improvements,’ the new methodology designed for shale gas exploration is not radically different. In short India lost precious time in starting exploring for shale gas looking for a perfect legal framework. Besides we ended up with a model which is likely to be unworkable.

The underlying thinking of production linked payments is that the higher the production the greater is the profitability which may not be true. As production goes higher investors should pay more. While this sounds logical at first glance, investors are driven not by production but by profit. It is this misalignment between the government and investor interests will lead to genuinely interested oil companies shying away from India. This has been the reason for monumental failure of India’s earlier efforts to attract major oil companies with plenty of capital and superior technology.

Against national interest

What is not properly appreciated is that the earlier production sharing agreement was sound provided the officials in charge had negotiated the terms properly. They should have put a limit to cost recovery as happens in most such agreements. Then the government can get its profit share much earlier unlike in the case of Reliance today. Even in countries like Ghana, Turkmenistan, Kazakhstan, which have production sharing agreements they are fully aware of the need to put an upper limit on cost recovery. Why did our officials fail to protect the national interest?

In addition to unattractive and cumbersome bidding terms of the new model, the current controversy of gas pricing will be even a bigger hurdle in promoting shale gas exploration in India. None of the companies in India - private or public sector- have the required technical ability to undertake shale gas exploration. Some of them like Reliance, and GAIL by having invested in the US companies have access to required technology. But that is not enough.

Reliance which has invested about $5.7 billion in the US shale exploration companies have already announced that they are not keen to invest in India to explore for shale gas. The prevailing gas prices in the US are around $ 4 per million btu. In India the recommended gas prices are $8.60 based on Rangarajan committee report and around $6.50 according to the petroleum ministry. Still Reliance is not keen. Why?

There are several reasons. In the US gas market is completely liberalized and prices are determined by supply and demand. The infrastructure needed to develop shale gas is in place and also at competitive prices. Success in finding and developing shale gas is extremely high. One of the reasons gas prices have dropped to low level is because of the high profitability of liquids that are produced along with shale gas. In fact in the absence of liquid production, shale economics will be poorer and gas prices have to go up to as much as $ 5 to $6 per mmbtu. It is also possible that should there be a shortage in the US, it can go up to more than $ 10 per mmbtu as happened in 2005 and 2008.

Even the lower recommended gas prices by petroleum ministry are opposed by some of the opposition parties. Their protest is driven not by the market realties but by an opportunity to find fault with UPA. They argue that such high prices will give windfall revenues to Reliance while power and fertilizer industries will be hurt. Unfortunately our public are often swayed by such emotional argument. It is not easy to convince the public that investors will not be interested in risky shale gas ventures if they cannot get attractive returns.

In India where gas prices are determined more by competitive politics and not by market forces, investors will have less incentive to look for shale gas. India has technically recoverable reserves of about 100 trillion cubic feet to meet 50 years of gas needs based on the current consumption. Still India’s efforts of developing shale gas will be stillborn.