OCTOBER 21, 2014

By Naresh Minocha, Our Consulting Editor

"FOR the overall economy to grow, India needs to do unpopular things ­­-- do things that are good for the country. What good is a mandate if you can't do unpopular things."

Microsoft founder and celebrated philanthropist Bill Gates reportedly said this last month while on a visit to India. This sage advice has obviously not struck the right chord in the BJP-led NDA Government.

The new Government has dropped enough hints that it cannot break free from the web of populism spawned by the UPA with both the support & pressure from the NGOs and the judiciary. The NDA Government would thus only take decisions that are perceived politically correct. It has demonstrated this through its stance on the gas pricing.

The new gas pricing mechanism has been prepared under the dreaded shadow of public interest litigants and the Supreme Court. The mechanism is a political comprise between conflicting interests of different stakeholders. It is certainly not a long-term initiative for promoting national energy security and facilitating development of integrated energy market.

Modi Government approved on 18th October certain modifications in the UPA's convoluted gas price formula, which was contrived by a committee headed by veteran economic administrator Dr. C. Rangarajan.

The Government flaunted its commitment to populism by highlighting right in the beginning of its release the fact that "upward revision in gas prices will be approximately 75% less as compared to the price arrived at using Rangarajan formula."

It avoided disclosing the actual hike or the new gas price. A news story suggests that the new formula would result in 33.57% increase in gas price to USD 5.61 per Million Metric British Thermal Unit (mmbtu) from USD 4.2/mmbtu. This is the price that would be charged by the gas producers and is different from the pipeline delivered, retail price of gas that varies from location to location.

Contrary to a viewpoint that Modi Government acted swiftly in announcing its decision on gas pricing, the fact is that it was the Supreme Court that goaded it into taking a stand on the issue.

On 19th September, Supreme Court had asked Modi Government to clarify whether it would continue with the UPA's policy on gas pricing mechanism or frame its own policy. The Apex Court specifically enquired whether the government is going to change Rangarajan pricing formula (RPF) notified in January that doubled the gas price to USD 8.4 per mmbtu or come with its own pricing formula.

Scams-tainted UPA had developed cold feet in implementing its decision to double the gas price. NGO-turned politician Arvind Kejriwal created ruckus over the issue in March 2014, apart from ordering an anti-corruption case against gas pricing doubling move in his capacity as Delhi Chief Minister.

All this ultimately led the Election Commission to order postponement of the gas price hike from 1st April 2014 to any date after the completion of Lok Sabha polls.

Ideally, the Government should have trashed RPF to respect the sanctity of its contractual commitments to oil and gas producers and to promote national energy security. This would have helped the Government in attracting foreign companies that have the technological and financial muscle to explore and produce oil in difficult terrain and deep offshore blocks.

The production sharing contract (PSC) signed by the Government with the most competitive bidder selected under new exploration licensing policy (NELP) stipulates: "the Contractor shall endeavour to sell all natural gas produced and saved from the Contract Area at arms-length prices to the benefit of Parties to the Contract."

The model PSC defines 'Arms Length Sales' as "sales made freely in the open market, in freely convertible currencies, between willing and unrelated sellers and buyers and in which such buyers and sellers have no contractual or other relationship, directly or indirectly, or…."

A model PSC also says that "the contractor shall have the freedom to market the gas and sell its entitlement."

UPA bypassed these obligations without repealing/amending the contracts. And NDA has followed the path paved by its predecessor. The Modi Government thus prefers political discretion to good governance of natural resources including hydrocarbons.

NDA has opted for politically wise route of climb-down from RPF to ward off fresh protests from Kejriwal-type critics as well as strictures from the Supreme Court, which is hearing two petitions against UPA-deferred gas price doubling.

Like UPA, NDA has ignored the potential market prices which gas-starved consumers are willing to offer.

NDA Government also distanced itself from the consultative paper on gas pricing issued by Kelkar Committee in July this year. The Committee was set up during UPA regime to prepare a roadmap for enhancing domestic production of oil and gas and sustainable reduction in import dependency by 2030.

The Consultative Paper captioned ‘Roadmap for switch to market determined gas prices' was not uploaded on the website of Ministry of Petroleum and Natural Gas but on the website of Directorate General of Hydrocarbons. It carried a disclaimer that stated: "The views expressed in the Consultation Paper are the explicit opinion of the Kelkar Committee."

As put by the Paper, "In 2012, approximately 30% of the gas consumed in India was imported. If no significant actions are taken, the share of imports is expected to reach almost 70% by 2017, given the rising demand and declining domestic supply. There is thus an urgent need to address domestic prices for natural gas such that they incentivise domestic production by aligning producer prices to the price of the imports that they replace."

It is obvious that NDA has relegated to background the need for promoting national energy security and integrated energy markets due to political compulsions.

In chaotic democracy, it is, no doubt, difficult to divorce politics from economic decision-making process. Keeping in view this constraint, the Government could have exercised better pricing alternatives over the medium term. Such a course of action would have enabled it to lay the long-term roadmap for market-driven pricing of gas.

The new Government did not even do introspection over the Apex Court's query in April this year as to why complex RPF had been chosen when simpler methods like cost-plus pricing or revenue-sharing were available.

One simple and transparent political option is to take average of the price quoted by gas consumers in response to bidding competition invited by different gas producers. The Government can allow 25% increase in gas price every year over the existing price of USD 4.2/mmbtu. With this, the notified gas price would touch the average market price in the fourth year. In the subsequent years, the Government can let the market forces to decide the gas price.

In this four-year transition period, the Government can facilitate setting up of several new LNG import terminals as well as expansion of the gas grid. There is no shortage of applicants awaiting clearances and favourable policy signals in this arena.

Both NDA's muted gas price hike and UPA's price doubling move reflect arbitrariness. Any administered uniform price (AUP) benefits some producers more and some lesser. AUP would thus benefit fabulously a company that produces gas as co-product of crude oil especially from a shallow onshore well. AUP would benefit least a firm that produces only dry gas (the one which has only one component, methane) as compared to normal gas. The latter has four major components and is thus more valuable as each component can be put to different use or priced and marketed differently.

Another fundamental flaw of AUP is that it has implicit consumer subsidy as it is not based on the dynamics of demand and supply. Moreover, the consumer subsidy is not targeted for any specified section but is meant to benefit directly all gas consumers and indirectly consumers of gas-derived products.

If political compulsions necessitate subsidies for certain sections of the society or for all, then the right way is to pay subsidy from the exchequer and not arm-twist industry to bear the burden of subsidy.

From gas to condoms, the new Government is pursuing UPA policies to control prices ostensibly to benefit consumers. If Government wants to retain the existing macro policy of forcing the industry to share the political burden of subsidies, then it would at best get lukewarm response from the investors to its clarion call to all entrepreneurs to set up manufacturing units and create job opportunities.

NDA might well like to draw lessons from two enlightening working papers on the impact analysis of subsidized gas policies of Bangladesh.

According to the working paper captioned 'Opportunity Cost of Natural Gas Subsidies in Bangladesh' released by ADB in August 2014, "natural gas is heavily subsidized in Bangladesh, and this leads to waste of valuable resource, lower revenues, and gas and power shortages."

Estimating the opportunity cost of underpricing of gas in Bangladesh with two techniques, the Paper concludes: "there is a high opportunity cost connected to the gas subsidy. Despite the fact that withdrawal of the gas subsidy would have some negative effects on macro and sectoral economies, such negative effects would be well compensated by the large positive effects generated by the investment of gas revenue in the physical and social infrastructure."

Another paper captioned ‘Energy Policy Options for Sustainable Development in Bangladesh' released in November 2013 notes: "Quite contrary to the general expectation, the gas price increase without supplementary policies of energy efficiency or fertilizer subsidy does not increase inflation. This is due to the contractionary effect of gas price increase."

It says: "Subsidized gas for fertilizer production more than compensates the negative economic impact of high gas price through its productivity impact in agriculture. Diversification of power sector fuel mix by introducing coal provides good macroeconomic indicators, but result to higher carbon emissions. Investing the gas revenue in infrastructure provides the best macroeconomic indicators."