CCEA Approves Revised Natural Gas Price Of USD 8.4

In a major development that would have a long-term bearing on the Indian energy space in particular and economic growth in general, the Cabinet Committee for Economic Affairs (CCEA) has approved the Rangarajan Committee’s recommendation to raise the price of natural gas to USD 8.4/mmbtu. This development spells cheer for the upstream oil and gas companies from both the public and private sectors.

In line with the Rangarajan Committee’s recommendation, gas prices will be decided by taking an average of two prices. One price would be derived from the volume-weighted net-back price to producers in the exporting country and well-head for Indian imports. The second price would be the volume-weighted price of the US Henry Hub, UK's NBP and Japan’s Custom Cleared (on net-back basis, since it is an importer) prices for the trailing 12 months. As per this formula, the price comes to USD 8.4/mmbtu considering the import contracts price for Indian companies.

The existing price of USD 4.2/mmbtu for KGD6 gas will be valid till March 31, 2014, and the new price will kick in from April 1, 2014. It will be valid for all producers, private as well as PSUs, unlike the existing practice, where an Administered Price Mechanism (APM) is used for gas pricing for PSU companies.

In our latest cover story 'Energy For The Growth Engine' we, at Dalal Street Investment Journal, have clearly pointed out that the energy sector has the potential of solving many of India’s economic problems. The new pricing will surely be a game changer for the sector and its companies.

As a matter of fact, RIL, ONGC and Oil India had been demanding this price hike for quite some time now. Companies had been demanding this price hike as there has been none in the last 3 years. On the other hand, though, it is estimated that this hike will send power costs shooting up by more than 15 paisa per KWh and double the fuel costs for gas-based power plants.

As far as positive impact of this price revision goes, it will strongly boost the toplines as well as bottomlines of RIL, ONGC and Oil India, which will in turn help their valuations. T K Ananth Kumar, Director – Finance, Oil India had stated that, “As far as Oil India is concerned, every USD 1 rise in the price will push up our topline by Rs 400 crore and the bottomline by Rs 250 crore”. With a USD 4.2 increase, the company’s sales figure will go up by Rs 1680 crore and its profits by Rs 1050 crore annually.

ONGC produced 23.55 BCM of gas in FY13 and RIL’s production stood at 14.99 BCM, while for Oil India this was at a mere 2.64 BCM. Thus, this price hike will increase the profitability of ONGC and RIL more than that of other players. Currently, the average cost of production for Indian companies works out to USD 3.2/mmbtu. As per the estimates, the profitability of ONGC will go up by more than Rs 9000 crore annually and that of private companies by more than Rs 5500 crore following this price hike. It will also be a positive for investment in the sector, as more companies would see reason to invest in India now.

Experts hold the view that every USD 1/mmbtu increase in price will increase the viability of 32 tcf of additional gas exploration and production. Moreover, it will also help the government to garner an additional USD 69 billion as a part of production sharing contracts (PSC).

Today’s decision has come as a big surprise though, as all the ministries including Power and Fertilisers were opposing the Rangarajan’s Committee’s recommendation on the grounds that it will jack up the price of power and fertilisers for consumers. To appease these ministries, the Ministry of Petroleum and Natural Gas had recommended a price of USD 6.7 in the Cabinet note. However, the CCEA has taken a different path altogether to approve the Rangarajan Committee’s formula.

Overall, the CCEA's move vindicates our view that energy remains one of the pivotal sectors that can significantly alleviate the current economic condition. The revised pricing will help attract foreign money as higher prices makes exploration and production (E&P) of gas more viable and profitable. British energy giant BP had earlier stated that it will invest USD 5 billion over the next three years if such a price hike is ushered in.