In his article in The Hindu (editorial page, “Making a mockery of domestic gas pricing,” January 18, 2013, Surya P. Sethi attacks the gas pricing formula proposed by the Rangarajan Committee, curiously enough, for being based on numbers from foreign markets that do not reflect the supply, demand or cost of production in India.

I say “curiously” because on the exact opposite side, domestic producers are also pillorying the committee’s recommendations using exactly the same logic. The musings of the recent 12th Five Year Plan adopted by the NDC again find solace in the fond hope that “Natural Gas prices charged to producers ... must be determined by market forces.”

Since all parties are invoking the same God of markets, some basic high school economics is in order. Any market perforce consists of buyers and sellers. One constitutes demand, the other, supply. Prices are fixed at their intersection.

So we have a market price. A price “fixed” by a Committee, or the Government is not called a market price; it is called an administered price.

Mr. Sethi is right in his assertion that the formula suggested by the Rangarajan Committee does not reflect the market price in India but rather the price in foreign markets.

But by that very same logic, producers can argue that the market price perforce has to be the marginal price of the highest cost gas that is being absorbed in the Indian market. This happens to be spot LNG bought and sold between willing buyers and sellers at over $15 per mmbtu. Why should domestic producers, they will argue, be barred from tapping into this market and benefiting from prices willingly paid by buyers in the great Indian market? Is this market reserved only for production from overseas?

Contracts and prices

Actually both Mr. Sethi and the producers, standing on opposite sides of the divide, are wrong for exactly the same reason.

Mr. Sethi, while talking of demand and supply, and the operation of market forces, is really arguing for administered prices that are linked to the cost of production. This is advocating a return to the principles of the APM regime which allowed ONGC and OIL to get a fixed rate of return on all domestic production of oil and gas. The problem with all cost of production linked pricing regimes being that they promote rather than eliminate inefficiencies, something which led to their being jettisoned years ago.

The producers are wrong in using the highest priced LNG as the benchmark and then making a leap of faith to presume that all gas available will be absorbed at the highest marginal price. They too are thus arguing not for a market price but for their own version of an administered price coming from the government.

The only pertinent question in this debate, which all sides miss, is the simple one of whether the legally binding Production Sharing Contracts (PSCs) allow for administered or market prices.

Far removed from all the noise about fiscal deficit and subsidies, all PSCs signed by the government under NELP mandate arm’s-length market prices, not prices linked to the cost of production. The provisions apply to all PSC producers including ONGC, OIL and private firms.

All PSCs are constructed on the principle of revenue maximisation — the same principle which gave occasion to the CAG to rub a lot of noses into the ground. Based on this principle, PSCs incorporate clauses of approval to any pricing formula to ensure that contractors do not underprice gas to related parties and siphon away revenues that are part of the contract.

These provisions do not give the government the power to control gas prices to contain its subsidy burden. Just as — in spite of subsidies on kerosene, LPG and diesel — the government must allow international prices for all crude oil being produced under these contracts, it cannot control gas prices to contain subsidies. Beyond the four walls of the contract, the government has every right to fix its priorities. It is free also to abandon the God of markets. But, should it decide that low gas prices are the priority, then all bidding for future oil and gas blocks must be on the basis of lowest prices rather than highest profit share. What it cannot do is to invite bids for revenue maximisation under ring-fenced contracts and then seek to implement, through stealth, the exact opposite. The buzzword in contract administration is transparency and not stealth. The latter can only lead to a few subsidy scams being unearthed by the CAG.

On the market

What prevents the operation of the contract as signed under NELP? The culprit is the Gas Utilisation Policy that fragments the market for gas into a hierarchy of the more favoured, the less favoured, and the discards. Rationing of gas makes the development of a unified gas market impossible. This means the prevalence of a dozen price levels confounding all — buyers and sellers, and investors on both sides. The spin-off leaves India struggling with the most poorly developed gas infrastructure — LNG terminals, transnational and domestic pipelines. Ironically, this perpetuates underdeveloped markets limiting our access to the one fuel that has caught the fancy of the world.

Hence the strange paradox of a Government committee being asked to “administer” a “market price”!

So why blame the hapless committee?

Confronted by the irresolvable dilemma of discovering the market price for a market rendered dysfunctional by policy, the good economist, Dr. Rangarajan, takes the weighted average of prices across functioning gas markets in the world and recommends that the result be applied to India. Does he, in the process, arrive at the “true” market price in India? No, he certainly does not — and to be fair, the committee admits as much by suggesting that we move to gas-on-gas competition within the next five years. Where it fails is in not even attempting to give/suggest a path that can make this possible.

If Mr. Sethi is right, the market price could be far lower than what the committee recommends. Or the producers may yet have the last laugh. But no committee or professional (no matter how competent) can ever second-guess the market. Let it alone decide which of the several parties advocating its version of administered prices is the one wanting to eat its cake and have it too.

(Sunjoy Joshi is Director, Observer Research Foundation.)

Surya P. Sethi responds

My criticism of the gas pricing formula recommended by the Rangarajan Committee is based on the absence of a natural gas market in India and the fragmented/non-fungible global gas market. A market, and hence a market price, can only exist when full fungibility is assured and multiple buyers and sellers compete freely under rules established by enlightened, independent and watchful regulators. This is not the case in India for gas or any competing energy source. Globally, only the North American gas market exhibits these essential characteristics. I believe the Rangarajan Committee and indeed Sunjoy Joshi accept this truth and support the need for an administered price for Indian Natural Gas producers.

My criticism is not that the Rangarajan Committee chose numbers from foreign markets but that it chose numbers that do not reflect prices obtained by natural gas producers in the three markets covered. The absurdity of its formulation is best demonstrated by the inclusion of Japan that has no natural gas producer/supplier. “Curiously,” perhaps inadvertently, Mr. Joshi supports my arguments by trashing the Indian Natural Gas producers’ demand for import parity based on the economic principle of marginal cost of the highest price gas (LNG at “$15/mmbtu”) absorbed by willing Indian buyers. European Natural Gas producers do not get such parity even though LNG accounts for about 30 per cent of all European gas imports. Neither do American Natural Gas producers, even though America still imports some LNG.

Having failed to disagree while ostensibly arguing against my stand, Mr. Joshi shifts focus to issues of PSCs and subsidies that were not a part of my criticism. The landmark judgments of the Bombay High Court and the Supreme Court of India conclusively establish that Mr. Joshi’s interpretation of PSCs is incorrect. The government not only has the right but indeed the obligation to regulate both the price and distribution of natural gas produced in India.

Coming to the bogey of subsidies, one cannot talk of subsidies in isolation of the annual Central and State Taxes/Levies on the energy sector. As an example, about 22 per cent of diesel produced in India is exported at a price that is well below the “subsidized” price paid by the Indian consumers at the pump. The Central and State governments simply take a massive cut from the top of what Indian consumers pay before passing the balance to domestic producers, resulting in the so-called “under-recoveries.” The Central government does not stop here; it then passes 40 per cent of the burden of “under-recoveries” to publicly traded state owned upstream oil companies that Mr. Joshi believes receive an international price for crude.

To answer Mr. Joshi’s question “Why blame the hapless Committee”; I blame it for not addressing the anomalies/distortions plaguing prices paid to Indian Natural Gas producers. The committee has, instead, inflated the distortions at the cost of my fellow suffering Indians.

(Surya P. Sethi, formerly Principal Adviser, Power & Energy, Government of India, is Adjunct Professor, Lee Kuan Yew School of Public Policy, National University of Singapore.)

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