A Kelkar Committee model could be the best option for oil and gas pricing

Media analyses of the Kelkar Committee on reducing import dependency in oil and gas have focused on the committee's suggestions on gas pricing. But it has also proposed new models for exploration and production contracts to reduce disputes and corruption, while improving bidders' interest in new exploration blocks.

For decades, India has signed production-sharing contracts (PSCs), which are common globally. If successful bidders find any oil or gas, they first get enough 'cost oil' to recover their costs, then they get 'profit oil' that is a multiple of costs, and then 'residual oil'.

Contracts are won by bidders offering the government the highest shares in these three phases: cost oil, profit oil and residual oil.

Waiting for Windfall 

But controversies over Reliance's Krishna-Godavari (KG) field have led to accusations that PSCs have been manipulated to artificially inflate costs, increasing the operator's share of cost oil and profit oil.

Critics pooh-pooh Reliance's claim that technical problems have caused a catastrophic fall in gas production from the KG basin, alleging that the company is simply slashing production at today's low process in order to jack up production once the government decrees an overdue price increase.

Reliance has also submitted plans to invest billions to raise production again. Critics suspect this is another way of inflating costs and, thus, Reliance's share of gas. The petroleum ministry has been paralysed by the swirl of accusations.

Meanwhile, foreigners have lost interest in bidding for Indian fields — the political risks and uncertainties are unacceptable.

Simple vs Complex Model 

The Narendra Modi government has invited public comments on a new model contract. This is quite complex, based on revenue-sharing linked to production. Companies will have to specify the amounts to be shared with the government at different stages and different prices, with different rules for different drilling conditions.

This is a complex variation of the revenue-sharing model proposed by the Rangarajan Committee. That provided bidding for a flat share of production, without getting into calculations about true costs and true multiples for calculating profit oil. This aimed to eliminate complex calculations and disputes.

However, very few countries go for flat revenue-sharing contracts, because if fields turn out to be smaller than expected, or costs higher than expected, production will become uneconomic. Flat revenue-sharing contracts might attract decent bids in blocks with excellent geological prospects (as in Saudi Arabia), but Indian geological conditions are poor by global standards.

The one field that promised a lot, the KG basin, has proved a disappointment. So, revenue-sharing contracts may discourage all but very low-share bids. These may provoke accusations that fields have been given away too cheaply, so an approach aimed at ending controversies could create fresh ones. The Kelkar Committee proposes two alternatives.

The first model just tweaks the existing PSC. In this model the managing committee and directorate general of hydrocarbons focus only on standards and best practices, without assessing costs. Oversight will be left to the tax authorities, who already oversee other forms of government share such as royalties and taxes.

Kelkar's second model is a supernormal tax model. This gives the government no share of oil or gas at all. Instead, the government gets just royalties and taxes when profits are limited. When profitability crosses a certain threshold, a supernormal tax kicks in, providing a much higher government take.

Supernormally Simple 

This model eliminates the need for detailed calculations and disputes on true costs and profit oil shares. It is by far the simplest and cleanest model. The committee says the threshold for levying a supernormal tax could be two to three times the yield on 10-year gilts.

The threshold rate could also be a biddable item, with the highest bidder winning. I favour simplicity and speed. The government's new proposal looks a bit complex, inviting disputes and litigation. Kelkar's first model will not do either: it is too close to the existing one.


The Rangarajan model of revenue-sharing is better, but could inhibit bids for areas with small fields. Kelkar's supernormal profits model looks best. It promises to be simple, fast and dispute-free. It will encourage bids for blocks with modest prospects, combined with a big government share if an unexpected bonanza turns up.

Some politicians will feel comfortable only if they have a physical share of oil or gas, to be allotted according to political priorities. Very well, let's modify the supernormal tax model to mandate a flat 10 per cent government share of all oil and gas found. That will not inhibit bids for small fields, and still remain simple and dispute free.

The Kelkar Committee strongly opposes retrospective changes after a contract has been signed. It also wants contracts to be extended to the full lifetime of fields where hydrocarbons are found. This will incentivise explorers to follow judicious techniques that maximise total oil recovery.

Limited contract timelines (as proposed by the government) will encourage flogging a field for quick gains, even if this seriously damages total recovery. Contracts should stand automatically cancelled if there is no production for five years.

Source: ET

China's sputtering economy crimps gas demand, cuts spot LNG buys

China's gas demand growth is expected to ease to its slowest in three years in 2014 and dip again next year, as a slowing economy and an ill-timed hike in prices keep gas demand at levels well below bullish forecasts.

The slowdown indicates demand will struggle to meet levels forecast by the International Energy Agency, which said in June that China is entering a golden age of gas, and could make life hard for new gas projects hoping for spot sales to China.

PetroChina, one of the country's two top gas importers, has cut shipments of spot liquefied natural gas (LNG), an industry source said, and sees demand growth under pressure for at least three years.

China accounted for half of the world's additional gas usage last year and the scaling back of spot LNG purchases comes as at least four Australian LNG projects are due to start operations in 2014 and 2015.

"If we don't need to import, we won't. As long as our LNG terminals have enough feedstock, we won't need much spot supply," said a source with direct knowledge of PetroChina's gas operations.

The IEA expects China's gas consumption to rise 90 per cent within the next five years to reach 315 billion cubic metres (bcm) by 2019, offsetting slower growth in Europe and elsewhere. That would imply an annual growth rate of 17.5 per cent.

However, China's top oil and natural gas producer, China National Petroleum Corp, sees apparent natural gas consumption climbing just 9.5 per cent, down 4.7 per centage points from 2013.

PetroChina's spokesman Mao Zefeng declined to comment on the firm's spot LNG business but he said at a conference last week that China's gas consumption growth would ease further in 2015.

"In the short term, the gas price reform and slowing economy will affect demand ... but we believe demand growth will be restored three to five years later," Mao said.

As demand in China slows, PetroChina has ample supplies due to additional cargoes that have started to arrive since late 2013 under a term supply deal with Qatargas, company sources said.

The firm has already shut two loss-making gas liquefaction plants and is also reviewing its multi-billion-dollar push to produce LNG to fuel trucks and ships in China.

Traditional energy sources, crude oil and coal, have already fallen victims to China's slowing economy, with diesel set to post its first fall in more than a decade this year and steam coal prices tumbling to a six-year low. Although gas demand has been bolstered by China's pledge to clean up its smoggy skies, higher local production, long-term LNG purchases and more pipeline imports means supply growth has outpaced consumption at a faster rate than last year.

Total gas supplies to China, including imports and domestic production, rose 9.6 per cent in the first half of this year to reach 91.5 bcm. That compares with an apparent consumption growth of 8.9 per cent, data from top planning agency National Development and Reform Commission ( NDRC) shows.

Based on that annualised growth rate of 8.9 per cent, total demand would reach 184.2 bcm at the end of 2014.

A series of gas price hikes, totalling 33 per cent since mid-2013 as part of Beijing's long-term market reform, have also posed as a double whammy for industrial users.

"Ultimately higher prices are going to impact demand," said Neil Beveridge, an analyst with Sanford C. Bernstein & Co.

"They can't have high demand growth with international energy prices."

Source: ET

Nigeria to Triple Natural-Gas Output for Power Supply

Nigeria aims to almost triple its natural gas production capacity by 2020 to help meet the West African nation’s power and industrial development needs, Oil Minister Diezani Alison-Madueke said.

Africa’s biggest oil producer wants to increase gas capacity to 11 billion cubic feet per day, from about 4 billion cubic feet now, Alison-Madueke said in an interview yesterday in Abuja, the capital.

“We are moving very aggressively into gas for industrialization purposes,” she said. “At the same time we have to work very, very critically on our gas-to-power needs.”

Nigeria generates less electricity than is needed by its population of about 170 million, the continent’s largest, and has regular blackouts that the government says are a bottleneck for economic growth. A shortage of gas for delivery to power plants is one reason why generation is below capacity.

Royal Dutch Shell Plc and Nigeria LNG Ltd. are among companies with interests in gas production in Nigeria.

“Gas infrastructure is incredibly capital intensive,” Alison-Madueke said. She declined to say how much money Nigeria needs to build the pipelines, water-treatment plants and other resources needed to deliver gas to electricity generators.

“All intending investors are fully aware of the scope of funding that will be required,” Alison-Madueke said in an interview to be broadcast on Bloomberg Television Africa. “We are seeing from both the East and the West interest in our gas investments.” She didn’t identify any countries or companies.

Petroleum Bill

Central to plans to develop Nigeria’s hydrocarbons industry is the Petroleum Industry Bill, proposed legislation that aims to increase the country’s share of profit from oil pumped off its shores. The bill, first sent to parliament five years ago, would also pave the way for the privatization of the state-owned Nigerian National Petroleum Corp., inside one of whose twin towers in Abuja the minister’s office is located.

“Whilst it is a most critical bill in terms of transformation, accountability in the sector, at this point in time all we can do is work as closely as possible with our counterparts in the National Assembly, the legislators, to try to ensure we support the bill,” Alison-Madueke said.

Source: Bloomberg

Sell gas at top prices like coal blocks, spectrum

The Kelkar Committee has produced a road map for a market-determined price for natural gas. Inter-generational equity, it says, requires non-renewable resources like gas to be sold to the highest bidder. A lower price deprives future generations of their full entitlement to national resources. This novel argument strengthens the simple logic of auctioning resources to promote efficiency and governance. Selling below auction price is favouritism. The CAG estimated huge losses implicit in the failure to auction spectrum and coal blocks. Similar huge losses flow from failure to auction gas, eroding royalties, taxes and the government’s gas share.

India imports 30% of its gas needs, and this may soon become 70%. Kelkar emphasizes a top price for efficient use and to incentivize all-out exploration. The government must honour exploration contracts saying that any gas found can be sold at the market price. Only then will India get more bids, at higher rates, for new fields. Many critics who want auctions for spectrum and coal oppose auctions for gas. What hypocrisy! This often reflects a desire to hit the Ambanis. Now, the Ambanis and crooked politicians may have committed a thousand sins. But good governance means finding hard evidence and prosecuting Mukesh Ambani. It does not mean violating his contracts. Contract violation makes India’s name mud in the global oil business. That’s why few bids have come in recent exploration rounds under NELP (New Exploration Licensing Policy), whereas over a hundred companies bid at earlier auctions.

All contracts say the government should certify that gas sales were at an “arm’s length” price (a competitive price, not a concessional one for friends). This clause has been twisted into an excuse for price control. The history of this is very smelly.

When the NTPC sought global bids for gas for new plants in Gujarat, Reliance won with a bid of $ 2.38/unit. That was a market-driven price, and should have been the model for the future. But Reliance had blundered. Exploration costs quadrupled by 2008. Anil Ambani claimed Mukesh inflated drilling costs, something being investigated. Rising costs meant Reliance would lose heavily in supplying the NTPC at $2.34/unit. Then, Mukesh and Anil quarrelled and split. Anil said the partition agreement entitled his plants to get gas at the cheap NTPC price. Mukesh was in deep trouble. Then petroleum minister Murali Deora intervened. The NTPC price had not yet been ratified as an arm’s length price by the government, an oversight that became an excuse to upend the whole auction. A cabinet committee was set up to decide the “market price”. Only in India is a “market price” decided by the cabinet or official committees, not the marketplace! The government fixed the price at $4.20/unit for five years. In no true market are prices fixed for five years — they fluctuate every minute.

This price fix benefited Mukesh, at the expense of Anil and the NTPC. But the benefit was temporary. Soon after, the global price of gas skyrocketed, up to $15/unit in Asia. The Rangarajan Committee in 2012 suggested a new price formula based on prices in various international hubs. This came to around $8/unit. But India is currently importing gas at up to $14/unit. Scarce goods are priced on par with imports in a free market. Yet critics have denounced $8/unit as a scam benefiting Mukesh, besmirching honourable experts like Rangarajan and Kelkar.

Mukesh produces just 10% of India’s gas today — most comes from the public sector. The ONGC has long demanded at least $7/unit to make its offshore fields viable. But the critics are obsessed with somehow nailing Mukesh. For this they will happily destroy contracts, ruin India’s reputation globally, reduce the number and price of bids for future exploration contracts, leave India short of gas, jeopardize the trade gap, make fresh exploration and production uneconomic, and deprive the government and its oil companies of massive revenues.

Some analysts say gas prices vary hugely from the US to Japan, so there’s no such thing as a market price in India. Really? The price of cement, sand and other items varies hugely from country to country, but does that mean markets for these don’t exist in India? Willing buyers and sellers set prices in each market, and these vary across regions. Newspaper prices vary as much as gas prices from country to country, but that’s no reason for government committees to set the market price of Indian newspapers. The Kelkar Committee sends a clear message — for morality, efficiency and good governance, sell to the highest bidder. The government will reap enormous profits, and can subsidise any sector it deems deserving.

Source: TOI

RIL gas field investments depend on acceptable pricing: Niko

Reliance Industries' USD 10 billion investment in new fields off the east coast depends on the government approving acceptable gas price, its junior partner Niko Resources said.

RIL has an array of natural gas discoveries in the Krishna Godavari basin KG-D6 block as well as NEC-25 area off the Odisha coast and it along with its partners BP plc of UK and Niko has detailed plans to bring them to production in the next few years.

Canadian Niko Resources in its annual general meeting (AGM) presentation yesterday stated that "planned development projects in India (are) dependent on acceptable gas pricing."

While the previous UPA government had approved a formula that would have doubled natural gas rates to USD 8.4 per million British thermal unit, the present dispensation is reviewing it and is likely to take a decision by month-end.

Niko said final investment decisions to develop R-Series gas fields as well as satellite discoveries in KG-D6 block is "waiting on favourable resolution of gas price."

The partners say new field developments are economically unviable at the current price of USD 4.2.

The Canadian firm said final investment decisions on developing gas finds in NEC-25 block is "waiting on favourable resolution of gas price."

With a decision on gas price hike, which was due on April 1, being delayed, Niko said it along with RIL and BP had in May field an "arbitration seeking market pricing as per terms of D6 Block PSC."

Yesterday, BP India head Sashi Mukundan said the delay in gas price hike implementation was frustrating and was holding back investments.

"We are ready to go ahead with our first project which is probably a USD 4 billion project. We are getting ready to potentially move that forward (but) are waiting for the gas price decision. So is that frustration, yes because it was decided last June 2013," he had stated.

The UPA government had in June 2013 approved a new gas pricing formula, which would have doubled the rate on its implementation from April 1, 2014.

The formula was notified in January 2014 but the Oil Ministry delayed announcement of a new rate, during which time general elections were announced and Election Commission asked the government to postpone implementation of the decision till the completion of polls.

The price hike, which was postponed to June 30, was again put off by another three months by the new government pending a comprehensive review.

The government has formed a four-member panel of secretaries to suggest a new gas pricing mechanism. The report of the committee is expected in next few days.

Source: ET

ONGC plans to yield 20 mn cubic metres gas daily from it KG-D5 fields by 2021

State-run explorer Oil and Natural Gas Corp (ONGC) is poised to finalise the field development plan of its Krishna Godavari basin KG-D5 fields at a time of declining gas output from the KG-D6 block in the eastern offshore operated by a Reliance Industries-led consortium.

ONGC chairman D K Sarraf told reporters here that the organisation was quite bullish that the KG-DWN-98/2 block should start production by mid-2018.

"The whole of the executive committee of ONGC went to Kakinada and reviewed the project. Many actions have been taken. It is a very challenging project. By 2021, we will get gas of 20 mmscmd (million metric standard cubic metres a day)," Sarraf said.

Apart from gas reserves, the field has large reserves of crude oil and is estimated to yield 70,000-90,000 barrels of oil per day.

"Our team says 90,000 barrels per day is some times being conservative," he added.

The project is, however, yet to get the requisite approvals.

"It is yet to get the board approval, yet to get government approval, yet to get the Directorate-General of Hydrocarbons` approval. But, technically, there is a proof concept that it can produce so much, it can produce that fast," Sarraf said.

"Investment will be huge. This is cluster development. There are opportunities of putting other small, small blocks. If there is a shortfall in estimates, we can make up for that," Sarraf said, speaking of the output possibilities of cluster development.

Presenting ONGC`s annual report for 2013-14 late last month, the chairman said that with the buoyancy in international crude prices and the strengthening of the company`s US Dollar-denominated revenues expected to continue, there is substantive near-term growth potential in earnings.

In 2013-14, ONGC registered its highest-ever revenue at Rs 842.01 billion, a growth of 1.1 percent from Rs 832.90 billion in the previous fiscal.

The company also posted a higher profit after tax of Rs 220.95 billion, up 5.6 percent from fiscal 2013, after sharing the highest ever under-recovery, or losses on selling below cost, of Rs.563.84 billion.

"With more remunerative pricing of our natural gas and with subsidy rationalization, significant value remains to be unlocked for your trusted shareholdings," Sarraf said in the annual report

The company has proposed a dividend payment of 190 percent with payout ratio of 43.04 percent.

Source: First Post

The Next Chinese Energy Boom

In an effort to reduce pollution, the country is slowing its crude oil consumption and switching to natural gas instead.

But if the current trend holds, China will be forced to pay a heavy price for its newfound environmental conscience.

Why? Simple supply and demand…

China’s natural gas production has fallen well short of its projections. And consumption is far exceeding its production rate.

Needless to say, that’s a recipe for energy disaster… for China, at least.

It means the country will need to import more natural gas.

But this huge new energy boom from one of the world’s largest energy consumers will create a whole new environment for the natural gas industry.

And suppliers are clamoring for a slice of this very lucrative pie…

China’s Natural Gas Drive Hits a Speed Bump

I may have stretched the truth a bit when I said that China has grown a more-environmentally friendly conscience.

China actually has very little choice but to switch over to natural gas as a major fuel source.

Pollution from fossil fuels (mostly from its primary energy source, coal) is out of control. Each time I visit the country, it seems the air quality has degraded even more.

For example, the recent Shanghai Marathon took place just one day before the air quality level was described as life-threatening!

China has its public image to worry about – and statistics like that are highly damaging.

In addition, quality of life concerns and rising costs from pollution-related illnesses are forcing the government to make the shift to natural gas.

This transition won’t occur overnight, but China’s ability to provide its own natural gas isn’t panning out the way the country expected.

China’s Supply-Demand Gap is Swelling

China’s natural gas reserves aren’t the problem here. The country boasts vast amounts of the stuff underground.

However, it still doesn’t have the ability to fully extract these reserves, due to inadequate technology and the location of the reserves. Plus, China’s pipeline infrastructure is weak.

On top of that, the supply-demand gap continues to grow.

Last year, Chinese natural gas consumption hit five trillion cubic feet (Tcf). But the country only produced 3.3 Tcf to replenish supplies.

What’s more, an Exxon Mobil (XOM) study says China’s natural gas consumption will almost triple this decade, to 14 Tcf.

By 2020, it’s estimated that natural gas will provide 10% of all the energy used in China. But there’s a massive shortfall on the horizon.

Some of that will be made up from more internal and offshore production. But the majority of it will have to come from imports.

And that’s where the opportunity lies…

Russia and Australia in the Box Seat

China’s vast quantities of natural gas imports will come through both pipelines and in the form of liquefied natural gas (LNG).

There’s a beneficiary in each area here…

Pipeline: The major winner will be Russia’s Gazprom (OGZPY). The company recently inked a $400-billion, 30-year deal to supply China with 1.3 Tcf of natural gas per year, beginning in 2019. Initially, the gas will come from Gazprom’s prolific fields in Siberia. Construction of the Power of Siberia pipeline began on September 1, and the pipeline is expected to cover some 2,500 miles, including a distribution point on China’s northern border.

LNG Supplier: On this side of supply, the logical choices are companies close to China that have LNG operations already up and running. That means the Chinese will likely deal with the Australians. The top play will be Woodside Petroleum (WOPEY), which has significant operations on Australia’s West Coast. In addition, after investing over $200 billion in LNG operations over the past few years, Australia is expected to unseat the current LNG leader, Qatar, in the next three years.

Source: wallstreetdaily.com