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Complex gas pricing issue in trans-border projects

International benchmark essential because of the globalising trend in trade

— Photo: PTI

CONTENTIOUS ISSUE: A tripartite meeting was held to discuss the Iran-Pakistan-India gas pipeline project in New Delhi last month.

THE RECENTLY concluded tri-partite talks among India, Pakistan and Iran on the IPI (Iran-Pakistan-India) gas pipeline give a glimmer of hope. A positive outcome has been the hiring of an international consultant to resolve the natural gas pricing issue. The consultant is to give its formula shortly.

Given a price-gap of over 60 per cent between the offers of Iran and India, the consultant will have a tough job formulating a pricing mechanism agreeable to both parties. Against Iran's demand of about $7.2 per million British thermal units (mBtu), India is willing to pay $4.25. Incidentally, the latter is 10 per cent lower than the price charged by the ONGC-RIL venture for supplies from its Panna, Mukta and Tapti fields.

What are the options for India? Are there any any lessons to draw from other countries? Why, in the first place, is there such a huge price difference between the two parties? These are among the more important issues that will come up while attempting an efficient pricing mechanism.

Pricing disputes

Pricing of gas is more complex than for oil and the complexity increases with transnational transportation through pipelines. Historically also, gas pricing has been contentious. The 1980s had witnessed pricing disputes between Algeria and France. Early this year Gazprom of Russia cut supplies to Ukraine over a pricing dispute, which in turn affected supplies to most European countries. Bolivia has had gas pricing disputes with Brazil and Argentina.

At present most of the gas traded internationally is indexed to oil prices. Perhaps this was a reason for Iran asking a high price for its gas, which is indexed to the Brent oil price. Such indexation should normally have a smoothening effect and help stabilise cash flows. However, given the volatile conditions in West Asia and the uncertainty on different fronts - depleting stocks, increasing demand, hurricanes and regional conflicts among others — the present indexing seems inappropriate.

As the gas market gets increasingly globalised, an international price reference for gas has become imperative. The two existing benchmarks — Henry Hub (HH) in the U. S. and National Balancing Point (NBP) in the U. K. — are potential candidates to serve as a price marker for international trade in gas. The first is better qualified for the purpose because of the huge volumes of gas traded on the U.S. spot market and the large experience accumulated by the New York Mercantile Exchange (NYMEX) in gas trading. Moreover, the U.K. market is expected to import more gas indexed to oil in coming years.

There is a general consensus that natural gas is the fuel of the 21st century for the following reasons: (a) doubling of global gas reserves in the last 20 years in contrast to meagre additions to oil reserves; (b) the ratio of proven gas reserves to current annual production is between 60 and 70; (c) environmental concerns, particularly enhanced greenhouse effect and global warming, have led to a shift from oil to gas; and (d) gas prices have been relatively much less volatile and more cost competitive.

The share of gas in the global energy mix has been projected to grow from 22 per cent to about 28 per cent by 2025. In India, its share of 7 per cent is likely to grow for two reasons — large new gas finds in Krishna-Godavari basin; and serious bid to diversify supply sources through deals with countries such as Iran, Qatar, Turkmenistan and Myanmar.

Choice of benchmark

For oil, there are two price references: West Texas Intermediate (WTI), which plays the role of a marker for sour crudes traded in the Atlantic basin, and Brent for sweet crudes traded in Europe. One major factor for a global marker price for oil is the existence of an organised market. International trade in gas is highly regionalised and hence does not permit any international price reference.

There are three reasons for the gas trade to remain regional. First, the share of gas in total energy demand is still not significant — only 22 per cent against over 50 per cent for oil. Gas reserves are highly localised vis-à-vis oil; three countries - Russia, Iran and Qatar — account for 56 per cent of total reserves. Last, most gas markets are still regulated.

In the absence of an international benchmark, the consultant may opt for a weighted average of the HH and NBP prices as a marker price for gas trading between Iran and India.

For the present, the U.S. gas market of over 660 billion cubic metres (bcm) a year and the U.K. market, close to 100 bcm, are considered mature enough for a reference price. The HH price is determined at a physical location in Louisiana and the NBP price is determined (virtually) somewhere inside the national transmission system (NTS) in Britain, without any precise location.

With production and transportation of gas increasingly becoming economical thanks to technology, there has been a surge in gas deals. It has been found that for distances of up to 4,500 km, pipeline transport of gas is one-third cheaper than sending it as liquefied natural gas. An international gas price marker will facilitate speedy conclusion of 130 gas pipeline projects valued at $100 billion.

Apart from the pricing issue, there are security concerns and political considerations, given the current state of Iran - U.S. and Indo-Pak relations. Since gas is crucial for the development of its troubled North-West region, Pakistan has decided to go ahead even if the deadlock over pricing persists. Its stake in the project is at three levels. Gas constitutes 50 per cent of Pakistan's energy mix and its fields are fast depleting. It is expected to import gas from 2010. It hopes to earn annually $500 million in wheeling charges. A deal will help reduce the political and economic cost of disturbed relations with India.

For India, a high price for natural gas will impact government finances through larger subsidy burden. Gas is primarily used in fertilizer production and power generation, both dependent on state subsidy. Market-based pricing may help gradual withdrawal of subsidy for these sectors, but this will require political will.

Once the pricing issue is out of the way, project structure and route finalisation can be taken up to ensure a secure pipeline. A recent twist to the IPI project is a proposal from Russia's Gazprom, suggesting an alternative route for the pipeline and offering to be the lead manager of the project. It is in the interests of India and Pakistan to have the deal finalised at the earliest, to prevent such suggestions from delaying work on this vital project that will provide the much-needed boost to Pakistan's economy and strengthen India's energy security.

VINISH KATHURIA

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