Natural Gas Prices May Double In October, Capping It May Not Be A Solution

Capping gas price will not solve the issues of dependent sectors unless natural gas prices cool and reference prices are changed.

<div class="paragraphs"><p>The gas receiving compressor station of the Nord Stream 1 natural gas pipeline in Lubmin, Germany.</p></div>
The gas receiving compressor station of the Nord Stream 1 natural gas pipeline in Lubmin, Germany.

As natural gas in India are set to cost almost double from next month, the government has kicked off a review of the pricing formula for the locally produced fuel to ensure fair price to end-consumers. But that may not be enough.

The domestic gas prices have increased by over three times from $1.8 a million metric British thermal unit in the first half of FY22 to $6.1 an mmBtu at present. This is expected to increase to $10.5-11/mmBtu from Oct. 1, 2022, Kotak Institutional Equities Research said in a report.

Industry experts told BQ Prime that the government-appointed panel, led by Kirit Parikh, to review domestic gas pricing formula is unlikely to solve concerns of the energy-dependent sectors unless the benchmark reference prices reflect the correct picture in the pricing formula and global LNG prices cool.

“Sectors that depend on natural gas must recalibrate their business models to the high natural gas prices as geopolitical situation in Europe may keep gas prices on the boil for some time,” said Debashish Mishra, partner at Deloitte India. “Capping domestic prices may not be a solution as long as global prices remain high.”

The availability of long-term LNG contracts will be a major concern for India, he said, as European buyers would crowd the market to reduce dependence on Russian gas.

This would mean India may have to reconsider the current pricing formula and change the reference prices, Mishra said, as the world is seeing a tectonic realignment of demand and supply.

Present Gas Price Situation

In the aftermath of Russian invasion of Ukraine, the price of spot natural gas rose to a high of $60 an mmBtu by August 2022. Though the spot price has fallen to $40/mmBtu by September, it is expected to rise as Russia tightens supply by closing the Nord Stream pipeline that transports around 50% of Europe’s natural gas requirements. Europe’s need would escalate as winter steps in by the next quarter.

This will put India in a tough spot, the Kotak report said, as long-term contracts would be difficult to come by given the extreme LNG spot prices. This situation would exacerbate given that several planned LNG projects like the Mozambique project, where India’s Bharat Petroleum Corp. holds a stake, has seen considerable delays, the report said.

Kotak also said the LNG markets have tightened since second half of 2020 given the strong global gas demand post-pandemic. Also, India, according to the Ministry of Petroleum and Natural Gas, aspires to increase the share of the cleaner gas in its energy base from 6-7% to 15% by 2030.

India, the Kotak report said, has been a price-sensitive market for spot LNG. Hence, LNG at more than $20 an mmBtu will lead to few takers.

Indian Consumption And Price

India’s domestic gas consumption, according to the Petroleum Planning and Analysis Cell, has dropped in a decade since 2011. LNG imports, however, have more than doubled during the same period.

The drop in domestic consumption was on account of a decline in domestic production between 2012 and 2017. The consumption, the PPAC data showed, dropped from 127 mmscmd in 2011 to 80 mmscmd in FY22, as production from the KG D6 field of Reliance Industries Ltd. and Oil and Natural Gas Corp. dropped.

Among all the gas-consuming sectors, only city gas distributors saw growth during this period. While consumption declined 6% for fertiliser and 10% for the power sector, that of CGD sector rose 8% during the decade, the PPAC data showed.

LNG imports, on the other hand, have more than doubled to 85 mmscmd in FY22 from 35 mmscmd in FY11. This has mostly offset the decline in domestic production.

The CGD sector, according to analysts, will continue to be the key driver of gas consumption in India.

City gas distributors such as Indraprastha Gas Ltd. and Mahanagar Gas Ltd. have been forced to mix LNG to meet the shortfall in allocation of domestic gas, which has raised their costs, according to the company disclosures.

The unified blended cost of CGDs, analysts said, have increased to $10.5 an mmBtu. With expected increase in gas price from Oct. 1, the costs are expected to rise even higher.

Expectations From Expert Panel

Another concern that the industry expects to get resolved through the expert panel is the resolution of differential pricing for different sectors that competes for same licence.

When operators buy gas at different prices and sell in the same market, some tend to bleed due to high prices, whereas others make windfall gains. Those who procure at high prices will tend to pass on to market at the detriment of clients, especially in markets where there is a monopoly like city gas distribution.

India would do a great service to investor community and socially sensitive sectors if the inputs costs of gas are made uniform for all players in respective sectors, according to Deepak Mahurkar, partner at PwC India.

“Sectors such as CGD, power, fertiliser and others compete in the same market and bid for licences in competition to each other,” he said. “But differential inputs make difference to operators, and sometimes to the detriment of consumers.”

“The price of gas must reflect its economic value in the market,” Mahurkar said. “Any step towards that, is welcome since it will attract investors, while subsidy can be targeted directly to consumers of gas derived products.”

The prices of gas have moved from getting linked to global gas indices in long-term contracts to replacement fuels like crude derivatives, he said. Hence, the domestic gas pricing would also merit review for those linked to global gas indices.

CGD Performance

Despite rising prices of LNG, city gas distributors, HDFC Securities said, are likely to perform well on account of overall gas demand from the compressed natural gas and domestic piped natural gas.

“The correction is overdone, especially as CGDs have passed on the input gas cost increase underscoring their pricing power,” the report said. CGD companies such as Indraprastha Gas, Gujarat Gas, and Mahanagar Gas have corrected 26-29% over the last 12 months, underperforming the Sensex by 28-31%, as investors expected sustained margin pressure with rising input gas costs.

The government has tweaked domestic gas supply to favour the CGDs and CNG/PNG volume has seen minimal adverse impact of the retail price increases.

“Notwithstanding the challenges, we expect overall gas demand from the CNG and DPNG sectors to grow at 15.7% CAGR over FY22-27 supported by aggressive expansion in infrastructure,” the report said.

According to the Kotak report, CGDs’ gas costs have increased more than four times over the past one year, when the administered pricing mechanism price increased three times. The shortfall has been met by expensive LNG, the report said. “While delayed, the recent announcement of a new committee on domestic gas prices is a positive,” it said.

“India must come across as one market for any region’s producer or importer. The tax treatment ought also to be one,” said Mahurkar of PwC. “It’s an uphill task, best done without missing the opportunity of crisis.”

Ability to swap seamlessly and get infrastructure access easily will make it an effective gas economy, Mahurkar said.