The entitlement to natural resources vests in people through the State that legally owns such resources on their behalf. It follows that natural resources are considered as national assets which the State exploits for the benefit of the public.

One such natural resource is natural gas, and the role of the State in the exploitation of natural gas has come into question of late, in light of the issues relating to gas pricing need further examination.

The Government of India (GoI) opened up hydrocarbon exploration and production in the country to private and foreign entities under the economic reforms of 1991. Small and medium sized blocks were opened up in the first round as per the New Exploration and Licensing Policy (NELP). Thereafter, through successive NELPs, more and more blocks were made available for exploration. Although the NELP Although the NELPs provided, inter alia, details of the blocks and the manner therefor, no clear indication relating to pricing found a place in the NELPs.

Traditionally, there were two methods for pricing of gas – administered price mechanism (APM) and free market gas. APM, which is the subsidy component of the gas market, refers to gas produced from fields handed to ONGC and OIL by the Indian government. The price of gas from these fields is administered by the GoI and this APM gas is allocated only to a select category of consumers belonging primarily to the power, fertilizers and city gas distribution business. As a result, in pricing to final consumers, gas prices were lowest for the power and fertilizer sectors and higher for other (non-APM) consumers.

The free market gas pricing regime can be further subdivided based on the source of the gas into (a) domestically produced gas from joint venture (JV) fields and (b) imported liquefied natural gas (LNG). In the case of imported LNG, the terms were governed by the agreement between the seller and the buyer while the domestically produced gas was on agreed commercial terms. The National Oil Companies (NOCs) were paid for their gas on a cost-plus basis.

HOW THE GAS PRICING ISSUE CAME ABOUT

Under the earlier regime, the price was arrived at by negotiations between private players and the GoI, set out in product sharing contracts (PSCs). This came under the scanner as the basis of the formula for price fixation appeared to be completely commercially driven. In some cases it was even contended that the gas prices arrived at through private negotiation between the GoI and the private player far exceeded the cost of production.

Thereafter, in 2007, the GoI developed the new Gas Utilization Policy (Policy), applicable for a period of 5 years. Under the Policy, an Empowered Group of Ministers (EoM) was constituted to examine issues relating to pricing and commercial utilization of gas under the NELP. The EoM approved guidelines for the sale of natural gas by private players under the NELP.  The gas procured from private players was then sold to consumers in accordance with the pricing policy determined by the GoI under which.  The valuation of natural gas was determined as below:

Selling price (in USD/MMBTU) = 2.5 + (CP-25)0.15 (in USD/MMBTU)

Under the approved formula, if crude oil prices were to rise to USD 60 or more, the gas price could rise to a maximum of USD 4.2, and fall to a minimum of USD 2.5, if crude oil prices fall to USD 25 or less. It was decided that the price discovery process on arms length basis was to be adopted in future NELP contracts, only after the approval of the price basis/formula by the GoI. The rationale for this formula is unclear. Further, it does not provide for the price of gas increasing if the price of crude oil increases beyond USD 60.

THE NEW CALCULATION METHOD

In 2012, a committee chaired by C. Rangarajan, the Chairman of the Prime Minister's Economic Advisory Council (Committee) recommended changes to the PCSs between the GoI and oil and gas exploration and production companies. In order to facilitate greater transparency in the cost and revenue accounts of companies, the Committee proposed moving away from cost-recovery

to revenue sharing agreements. An attempt was made to contextualize internationally prevalent gas pricing mechanisms to the Indian market. The new pricing policy was based on the price of imported LNG; after which, the weighted average price at major trading hubs in the UK, the US and Japan were also calculated. Finally, a simple average of the prices of imported LNG and the average international price was calculated. 

In June 2013, based on the Committee recommendation, the GoI raised the price further to USD8.4 per mmBTU. These new prices were to be effective for a period of 5 years, scheduled to end in 2017. However the implementation of this price has been deferred. How the figure of USD8.4 per mmBTU was arrived at is unclear. There is no transparency in the calculation method, leaving it open to speculation. Even the Ministry of Petroleum and Natural Gas (Ministry) appears to be unclear on how this price was arrived at. News reports suggest that Ministry officials are seeking clarification on whether the calculation will be on the basis of gross calorific value (GCV) or net calorific value (NCV)[1]. It is believed that the high-level panel had wanted it based on NCV, but the global practice is to use GCV. The Ministry was to approach the Cabinet for clarifications on some of the contentious issues affecting the implementation of the new price for domestically produced natural gas.  It has been alleged that corporate influence has played a role in the policy formulation. Because of the criticism, this recommendation of the Committee was deferred.

In view thereof, a new gas price forming mechanism was suggested in the Domestic Natural Gas Pricing Guidelines, 2014 (Guidelines). These Guidelines were to be applicable to all natural gas produced domestically, irrespective of the source, whether conventional, shale or coal-bed methane (CBM) effective from April 1, 2014 whether produced in the public sector or by the private sector firms. The formula was based not on cost, but also largely on import prices. The chief criticism is that the base price is to be calculated by the average prices of imported gas by multiple users over a 1 year period, and prices prevailing in major international hubs for gas. The pricing policy get further complicated if part supply is derived from international markets and the other part, domestically. This notification has also been deferred. The present Government is currently considering a comprehensive high-level review of the suggested formulae.

PRICING FOR END CONSUMERS

In this context, it would also be useful to have regard to the Petroleum and Natural Gas Regulatory Board (Board) was established under the Petroleum and Natural Gas Regulatory Board Act, 2006 (Act). The Board was set up to inter alia protect the interest of consumers and entities engaged in specified activities relating to petroleum, petroleum products and natural gas and to ensure uninterrupted and adequate supply of petroleum, petroleum products and natural gas in all parts of the country and to promote competitive markets. The Board is also mandated to monitor prices and take corrective measures to prevent restrictive trade practices. Therefore, the Board, can to some extent, influence the gas prices for sale to end-use consumers. The extent of the exercise of these powers may also need to be considered in the entire equation for determining gas prices, although currently this may not be significant.

CONCLUSION

In Jamshed Hormusji Wadia v. Board of Trustee, Port of Mumbai[2], the Supreme Court held that the State’s actions and the actions of its agencies/instrumentalities must be for the public good, achieving the objects for which they exist and should not be arbitrary or capricious. In the field of contracts, the State and its instrumentalities should design their activities in a manner which would ensure competition and not discrimination. They can augment their resources but the object should be to serve the public cause and to do public good by resorting to fair and reasonable methods. This mandate should inform the decisions the GoI makes in this regard.

The PSCs tend towards letting the market determine the pricing. In contrast, the recent GoI pricing policies seek to tightly regulate pricing through methods that appear opaque. Taking into consideration the observations of the Supreme Court in the Jamshed Hormusji Wadia case and pricing policies of the GoI, at this juncture what is required is a clear and consistent pricing policy when it comes to gas. There are several factions that seek complete decontrol of gas pricing for incentivizing investments in this sector. However, given the sensitive nature of gas as a natural resource, this seems unlikely. The GoI could consider setting price policies on the basis of demand and supply conditions as well as Indian economic conditions.

A gas pricing policy that provides a long term solution and an appropriate value for this significant natural resource would be effective in providing a clear path for all agencies involved, incentivize investments and at the same time bring in the balance of public interest.

Disclaimer: This article was first published in the July 2014 issue of the Infrastructure Today magazine. It has been authored by Aakanksha Joshi, who is an Associate Partner and Tarini Menezes, who is an Associate at Economic Laws Practice (ELP), Advocates & Solicitors. They can be reached at aakankshajoshi@elp-in.com or tarinimenezes@elp-in.com for any comment or query. The information provided in the article is intended for informational purposes only and does not constitute legal opinion or advice. The contents of this article/update are intended for informational purposes only and do not constitute legal opinion or advice. Readers are requested to seek formal legal advice prior to acting upon any of the information provided herein.