A Significant Year

Marked by the arrival of LNG, major oil and gas finds and NELP-IV

There was action in every segment of the sector. LNG imports, downstream and upstream integration, public issues, a draft pipeline policy and talk of mega mergers kept up the momentum in the sector.

What, according to you, have been the significant developments in the oil and gas sector in the last year or so?

Anindya Chowdhury
Internationally, the last one year has been significant in terms of oil and gas prices. Speaking of gas prices, the US markets have hit all-time highs in terms of Henry Hub price levels, clearing at around $6.5 per mmbtu. As a result, US markets are attracting a lot of attention from LNG suppliers. On the domestic front, the outlook on gas supply has improved significantly. India has now joined the elite club of LNG importing nations and would soon boast of two operational LNG terminals. The conclusion of the NTPC tender is also noteworthy as it has generated a lot of interest among potential users. Overall, a pretty significant year.

Mohit Saraf
The last year has witnessed several major developments in the sector. It is likely that some of these will have an immediate effect while others will leave an enduring legacy. The commercial operation of Petronet LNG’s Dahej terminal in record time and the arrival of the first shipments of gas at the said terminal from Qatar was a significant development. This arrival is significant for several reasons. One, it provides the country with gas at a significantly cheaper price than other competing fuels. Two, India has access to a dependable, rich source of gas. This would facilitate financial closure of a number of projects which could not otherwise have closed financially on account of “fuel risk”. This is crucial since there does not appear to have been significant headway in the development of pipeline infrastructure from other gas-rich countries like Iran. Last but not least, sale of the entire gas consignments over the last few months will hopefully put an end to scepticism about the price competitiveness of regasified imported LNG.

The fourth phase of the New Exploration Licensing Policy (NELP-IV) presents an exciting opportunity for investors to tap into one of the world’s fastest growing hydrocarbon reserves. NELP-IV was launched against the backdrop of major deepwater gas discoveries in the Krishna-Godavari basin. These are widely believed to be among the largest natural gas reserves in the world. The discoveries made subsequent to NELP-IV can go a long way in reducing India’s dependence on imported fuel.

A noteworthy development was the Government of India’s partial divestment of its stake in ONGC, IBP and GAIL through public offering. The presence of large retail and institutional investors can be expected to have a positive impact on the management and the creation of shareholder value.

Issuance of the draft pipeline policy and the judgment of the Supreme Court of India on the constitutional validity of the Gujarat Gas (Regulation of Transmission, Supply and Distribution) Act, 2001 were major milestones. The gas sector was opened up for private investment sometime ago. However, the lack of a unitary regulatory framework was hampering existing and potential investments. Though the draft pipeline policy is yet to be finalised, it is a salutary step. It embodies much-needed principles like non-discriminatory open access, regulation of transmission tariffs, common carrier, etc.

On account of the Supreme Court judgment, we can now expect a unified regulatory framework for interstate pipelines like HBJ. The previous scenario of regulation by different states through their own gas acts and regulators had the potential for creating a nightmarish situation for pipeline operators. The draft pipeline policy should help ensure that many investments still in the pipeline (pun intended) reach the proverbial end of the tunnel!

Nigel Shaw
The most significant developments in the oil and gas sector in the last year or so have been the arrival of LNG; the discoveries of oil and gas by private producers and joint ventures; the introduction of NELP-IV; and development of new local distribution zones. There has been progress on the reform process in the natural gas sector, with the imminent Petroleum and Natural Gas Regulatory Board Bill, 2004, and the draft pipeline policy.

What were the broad trends visible in the sector during the year?

Anindya Chowdhury
The Indian oil and gas sector continues to be dominated by PSUs. What has changed is that many of these companies have stepped out to participate in international projects. We were pleased to be involved in some of these initiatives. The oil PSUs have also been enlarging their roles within India and entered into roles that were earlier reserved for others. This is a good trend. Competition and even-handed regulation will result in a choice for the customer and improved customer value propositions. This cause will be furthered with the entry of private companies.

Mohit Saraf
The need for regulation in the petroleum sector is urgent in view of the shift from an administered pricing mechanism (APM) and the involvement of private players in the downstream marketing of products. It is ironical that though the APM is officially dismantled, the majority shareholder of the oil PSUs, that is, the government, continues to have complete de facto control over pricing of products. This de facto status quo of continuing government control is an unhealthy trend that deserves to be reversed.

Backward and forward integration of oil companies is another clearly observable trend. This trend started with IOC’s acquisition of IBP and continued with ONGC’s acquisition of MRPL. Recent news report indicate that the government is now considering the merger of an upstream company like ONGC with downstream players like HPCL and BPCL to create a unified monolith.

The number of retail outlets in India seems poised for exponential growth. This is courtesy the grant of retail licences to private sector players and ONGC. Companies like Reliance, Essar and Shell propose to set up around 11,000 new retail outlets. This has put pressure on the PSUs to expand their retail networks and improve their quality of service. To cope with increased competition, the existing PSU players have proposed an addition of around 2,900 retail outlets. The average consumer hopes that this will translated into cheaper, cleaner fuel.

Another conspicuous trend in the sector is the feverish pitch of investments in pipelines. This seems largely fuelled by the pipeline policy. The Gas Transportation and Infrastructure Company, a wholly owned subsidiary of Reliance, has proposed several investments. Similarly, GAIL is also laying a grid of pipelines spanning 6,000-7,000 km across India. An elaborate pipeline network provides gas with a tremendous cost advantage over coal on account of savings in transportation. This trend is likely to spill over into the next year.

Nigel Shaw
Natural gas is set to form an increasing part of India’s overall energy mix. The country is moving from a supply-constrained environment to a scenario where supplies are enhanced with LNG imports and new domestic discoveries.

Clearly, investment in interconnectivity will be important to enable supplies to new demand centers such as new city gas distribution projects. The expansion of the interstate pipeline network is set to drive the development of the national gas grid. On the policymaking front, gas pricing and regulatory issues will be key to the development of a market-determined environment in the industry.

Do you think that the slowdown in the pace of divestment of oil and gas PSUs will hamper the progress of the sector?

Anindya Chowdhury
Disinvestment in oil and gas PSU should not necessarily be seen as the only measure of progress in the sector. Political compulsions clearly polarise views on this decision. However, action, or the lack of it, is watched keenly across the world as, perhaps rightly, this is seen as a measure of India’s commitment to reforms. There are several other aspects on which progress can be made. For a start, introduction of an independent regulatory regime and the unbundling of monopolies can help promote investments, introduce competition and unlock value to the customer.

Mohit Saraf
There can be no doubt that the slowdown in the pace of disinvestment will have a profound negative impact on growth. Continuing government monopoly in the oil sector will discourage competition. Lack of competition will translate, inter alia, into poor quality of service. In the final analysis, the consumer will be the loser. It’s difficult to ignore the consumer in this case. Spanning the entire range from cooking gas users to aviation turbine fuel buyers is a nation of a billion people.

Previous experience with regard to divested PSUs has shown that the growth rate of most PSUs has shown that the growth rate of most PSUs has increased considerably after divestment. CMC, IPCL and Balco are a few obvious examples. A slow pace of divestment, therefore, also translates into slow growth.

Nigel Shaw
BG India believes that divestment is a decision of the government. We believe that policy reform and positive fiscal measures are drivers towards a more investment-encouraging environment in which both the public and private sectors can grow the energy sector.

Despite deregulation announced in April 2002, the government still has substantial control on the sector. What are the reasons for this?

Anindya Chowdhury
The oil and gas sector in India lags behind other sectors such as telecom, insurance and power in implementing reforms. The sectors that have reformed under the watchful eye of competent and independent regulatory authorities can be showcased as successes. It is therefore not understandable why there is so much diffidence in introducing reforms in oil and gas. This industry has a major role to play in driving economic growth and excessive public interest concerns leading to continued retention of government control will be counterproductive.

Mohit Saraf
The compulsions of electoral politics in a democracy encourage the continuance of governmental control. Pricing of cooking gas, which is the household fuel of choice for middle-class urban India, and automotive fuel can have substantial electoral ramifications.
Deregulation of the petroleum sector might translate into a restriction of the government’s currently unbridled power to determine the pricing of petroleum products. The stage may then be set for a stark showdown between the need for fiscal prudence and political survival. In this choice between economics and election politics, it is anybody’s guess what will win.

Nigel Shaw
Uncertainty in the regulatory environment and fiscal measures such as high sales tax rates, which negatively impact natural gas.

Do you think LNG prices will further rationalize as more gas becomes available? Has NTPC been able to set a benchmark of sorts?

Anindya Chowdhury
India is currently undergoing an interesting experience. While LNG prices the world over are at all-time highs, India has remained relatively insulated. However, current and foreseeable gas supply arrangements remain woefully short of demand. India has to supplement the current supply arrangements, and hence there will be a need for stronger linkages with global supplies at market prices. While this may be counter-intuitive in the current situation, it makes sense considering the cyclicity of world energy prices and the need for Indian industry to remain competitive in the long run. If India is to enjoy a world-class energy service, pricing of the service needs to recognise cost of service at the minimum and to shed the mindset that shortages are acceptable.

NTPC has benefited from the recent gas discoveries in India and it was able to leverage its position as an anchor customer to obtain a good price. In the backdrop of current world LNG prices and reports on the likely increase in domestic gas prices demanded by private gas suppliers, the prices obtained by NTPC would be seen, at least in the short term, as a floor rather than a benchmark.

Mohit Saraf
Given the long gestation period of gas exploration projects, it is premature to expect that new gas discoveries will help rationalise prices in the foreseeable future. The NTPC-Reliance contract price cannot be regarded as a benchmark of sorts. It is well known that Reliance was under tremendous pressure to get a committed buyer before it could embark on the expensive project of developing its gas reserves in the Krishna-Godavari basin. NTPC is by far the largest domestic consumer of gas with an impeccable credit record. It appears plausible that Reliance felt the need to agree on a low price in order to secure a committed buyer. There is a considerable time gap between gas discovery and its commercial exploitation. Therefore, it is unrealistic to benchmark the NTPC contract price with current gas prices when the NTPC gas supply is envisaged many years later. The manifold conditions precedent to effectiveness of supply obligations, mainly commercial clauses, present an easy escape route should cost considerations militate against Reliance’s ability to supply gas. Commercial contracts often contain carefully embedded “performance escape vents”. Ask any good lawyer.

Nigel Shaw
LNG pricing in the past was typically driven by the Japanese Crude Cocktail. As more gas becomes available in India, LNG prices are expected to rationalise. This, coupled with an increasing share of gas in the county’s overall energy mix, is expected to drive prices towards levels that are sustainable and suited to the Indian economy. In this context, the NTPC price will be a test case in benchmarking long-term pricing of gas to the power sector.