Pricing of natural resources
1. How are natural resources priced in major countries of the world? Have any countries adopted differential pricing for natural resources?
2. How are they priced in India?
3. Can natural resources found in a particular state be priced cheaper than for the rest of the country because there are less transport costs?
Requested By- A LS BJP MP from Gujarat
DUE DATE: March 10, 2008
Response
BACKGROUND
It is estimated that by 2025, today's global demand of 84 billion barrels of oil per day will have grown to as much as 130 billion barrels a day. The United States is the world's largest energy consumer, but no amount of Alaskan oil exploration or production will rise to meet U.S. requirements. China and India, too, will have to import considerable quantities of crude oil to make up for gasoline guzzling automobiles. Already, India imports 70 percent of its crude oil. It is in this context that natural gas has emerged as a more environmentally sound, cheaper and more easily available oil substitute. Compared to the current oil cost of about $70 per barrel, an equivalent amount of gas cost only $20 to $30 in recent months. Energy experts predict that gas, once considered a wasteful by-product of oil exploration, will become the number one fossil fuel in the future. But the problem is that the United States, India and China—and especially the first two, plus Japan and European Union countries—are all about equally distant from major gas reserves in Iran, Qatar, Yemen, Russia, Central Asia, Nigeria, Angola and Venezuela. Added to the problem is that these gas-rich countries face unstable political situations. The gas from their fields will have to be carried through politically unstable and often dangerous areas.
Both China and India want to quickly establish close ties with these gas rich countries to address their future requirements, counterbalancing U.S. and separate Asian demands to meet their own rising requirements. After protracted negotiations, India has signed a $22 billion deal to buy liquefied natural gas from Iran over a period of 25 years starting in 2009, and a separate LNG deal with Qatar to address its more immediate energy shortages. The real story as well as conflict of interest, however, lies elsewhere. At present, the Bush administration is balking at the idea of giving its approval to the 1,600 mile gas pipeline from Iran through Pakistan to India, even though all three countries had agreed to go ahead with the massive project. While the United States is objecting because of Iran’s supposed nuclear program, it has also put strong pressure on Pakistan, threatening Islamabad with sanctions if it gives the project a go-ahead.
INDIA'S PROJECTED ENERGY NEEDS
The country faces “formidable challenges” in meeting its energy needs, according to India’s Planning Commission. The government hopes to maintain an annual GDP growth rate of about 8 percent over the next quarter century to meet its goals for poverty eradication. That level of growth will require India to at least triple its primary energy supply and quintuple its electrical capacity. This will force India, which already imports a majority of its oil, to look beyond its borders for energy resources. “There’s a tremendous amount of concern” that the gap between the energy demand and supply will slow down the economy, says researcher Tanvi Madan, author of a recent Brookings Institution report on Indian energy issues. Furthermore, India’s energy sector is plagued by sporadic nationalization efforts. During the 1990s, India began liberalizing its economy, allowing for privatization of some sectors historically under state control. But, of India’s various industries, the energy sector remains most firmly in the hands of the state, says Pramit Pal Chauduri, an Asia Society fellow and foreign editor of the Hindustan Times. Chauduri says the real need for reform “lies not within what we do overseas, but the need to liberalize our markets internally.”
ROLE OF THE STATE IN THE ENERGY SECTOR
India’s tradition of state-dominated, centralized planning slows progress in the energy sector. The Public sector contributes over 90 per cent of the total mineral production in India. In 1996-96, India produces minerals (excluding atomic minerals) worth US$ 9 million. India's mining industry employs 800,000 people, and accounts for about 3.5 per cent of the Gross Domestic Product (GDP), and 11 per cent of the country's total industrial production with over 2,767 private and 316 public operating mines in the country, minerals form 17 per cent of India's exports. This included cut-and-polished diamonds, mica, iron ore, chromate, granite (dimension stone), manganese ore, barites and soapstone, valued at US$ 7.2 billion in 1996-97.
Privatization efforts have been entirely piecemeal and investors are jittery. Private firms waver over investments when they see preferential treatment for state-owned companies. For example, the production of coal, India’s most highly-consumed energy source, remains largely in state control, with 90 percent of production accounted for by the mines of state-run Coal India. The national government also subsidizes energy prices, at times limiting profitability for both private and state investors. Experts say the government would probably prefer to set energy prices at market rates, but doing so results in risking a vote loss in elections. Critics say that governments introduce the idea, “but then an election comes and they say ‘no, no, no, subsidize.’”
THE LEGISLATIONS: INCOHERENT ENERGY POLICY
India had a central energy ministry until 1992, which was then broken down into the ministries of Coal, Petroleum and Natural Gas, Nonconventional Energy Sources, and of Power. Several other government agencies, including the Planning Commission and Department of Atomic Energy, play a role in energy policy. While there are common policy goals, the lack of integration causes problems with implementation. Experts say lack of coordination among competing government ministries has slowed the effort to institute effective energy policies. India has yet to develop a coherent policy with the four main energy ministries acting like “different countries at work.”
The Union Petroleum and Natural Gas Ministry constituted the Petroleum and Natural Gas Regulatory Board (PNGRB) in July 2007 with former bureaucrat L. Mansingh heading the board as its first Chairman. The board has been created under Sec. 3(1) of the Petroleum and Natural Gas Regulatory Board Act, 2006. As per the statute, the PNGRB will regulate the downstream activities in the petroleum and natural gas sector, namely, refining, processing, storage, transportation, distribution, marketing and sale of petroleum, petroleum products and natural gas so as to protect the interests of consumers and entities engaged in specified activities. It would ensure uninterrupted and adequate supply of petroleum, petroleum products and natural gas in all parts of the country and to promote competitive markets. The functions of the board include registration of entities to market notified petroleum, petroleum products and natural gas, establish and operate LNG terminals and establish storage facilities beyond a certain capacity as may be specified by regulations and to lay build, operate or expand a common carrier or contract carrier or city gas distribution network. In respect of notified petroleum, petroleum products and natural gas, the board should ensure adequate availability and display of retail selling prices at the retail outlets, monitor prices and transportation rates for common carrier or contract carrier. It would take corrective measures to prevent restrictive trade practices and enforce retail service obligations for retail outlets and marketing service obligations for entities. The board should also maintain a data bank of information on downstream activities in the petroleum and natural gas sector and lay down the technical standards and specifications including safety standards.
INTERNATIONAL PRACTICE: PRICING OF NATURAL GAS
Worldwide, the price of natural gas is not determined through demand and supply. Also unlike oil products, there is no cost in manufacturing gas. Beyond the capital costs of drilling, the cost of extracting gas is minimal. There are no refining costs. The only cost involves pumping and piping. Pipeline costs are amortised over years of operation.
Given this situation, countries choose from three strategies to fix prices.
a. They can decide on long-term price agreements. For instance, Europe, which is dependent on Russian gas, fixes rates periodically.
b. The other option is to link the price of gas to the basket of imported crude. If the average of different oil products goes up, the price of natural gas also increases—a floating price index. But this is an artificial construct because there is no market price.
c. The third option is to fix the price of natural gas at the rate of liquefied natural gas (lng), which is often more widely available, since it can be transported without pipelines. In the case of LNG, the extra costs involve the costs of cooling and re-gasification. But as there is no ‘market’ price of natural gas, this is equally a construct, created on the basis of agreements. For LNG to be the basis of the price of natural gas there needs to be substantial agreements on gas imports. Currently, India has one or, at most, two. There is no market to work with.
Natural gas prices in India are currently controlled under the Administered Pricing Mechanism (APM). Natural gas prices are held artificially low, and supplies are rationed to states, industries and end-users. In 1997, the Ministry of Petroleum and Natural Gas initiated a process to move away from the APM toward a pricing scheme that better reflected market realities. The plan was to price wholesale natural gas relative to the world market price of a basket of low-sulfur and high-sulfur fuel oils, which are in many cases the substitutes for natural gas. Initially the price of gas was to be 55% of the blended fuel oil price, rising each year until full import parity was reached in 2000. The process of raising gas prices stalled however, when world oil prices spiked in 1999. At that time, the landfall price of gas hit a pre-determined price ceiling of Rs 2850 per thousand cubic meters (approximately $2 per MMBtu3). As part of a wealth redistribution scheme, wholesale prices in the Northeast states of Assam and Tripura were already pegged to 45% of the fuel oil blend—but those too hit the pricing ceiling at Rs 1700 per thousand cubic meters. The prices described above are wholesale rates paid to producers. Consumers who receive gas through the HBJ pipeline, for example, pay a fixed transportation charge, regardless of distance, of Rs 1150 per thousand cubic meters. Thus, prior to taxes, consumers along the HBJ currently pay Rs 4000 per thousand cubic meters of gas (about $2.14 per MMBtu4).
While these prices are roughly in line with domestic production costs—the current pricing system is not compatible with the imports of natural gas. The expected cost of imported LNG is expected to range from $2-$3 per MMBtu at the coast and up to $4 per MMBtu if it is transported by pipeline to the Northern parts of the country (Jensen 2002). Furthermore the flat pricing scheme does not facilitate efficient location of gas users, nor does it provide a means to fund pipeline expansion outside of the state sector. The fixed transport cost, regardless of distance, creates no incentive for users to locate closer to the source. Conversely, there is no marginal funding provided to encourage expansion of the pipeline grid.
Gas pricing reforms are inextricably linked to reforms in Indian the fertilizer industry. Similar to the energy industry, fertilizer industry reforms have proceeded slowly over the past decade. Fertilizer producers continue to operate under a system of fixed prices for fertilizer sales, and subsidies are based on cost of production for each individual unit (called the retention price). While the subsidies are purported to be for the benefit of the millions of Indian farmers, the actual effect is that most of the subsidy goes to a relatively small number of inefficient fertilizer producers. It would be economically more efficient to import the ammonia fertilizer directly, rather than importing gas to then produce ammonia in the country.
The immediate constraints to expanding gas use in the power sector are similar to those described in the fertilizer sector. India’s electric power system is in poor financial condition. The roots of this ill health are inefficient state-owned companies and heavily subsidized prices for electricity. Private investors in gas import projects will be hesitant to sign contracts with power companies until they are financially viable. Raising electricity prices to the bulk of the population that are rural consumers is politically difficult. Pricing and regulatory reform are necessary to secure gas imports. However, raising gas prices, without first raising electricity prices, will further weaken the power companies and simply increase subsidy payments.
In Delhi, because the market was mandated by the Supreme Court, through its order that all public transport vehicles should transit to gas, the price was also controlled on a cost-plus basis. In 2002, the then Union minister of petroleum and natural gas was dead against the introduction of cng in Delhi. He wanted diesel to continue. When all ploys to mislead the court failed, he simply raised the price of gas. The court asked Society for Environmental Communication (SEC) to examine if the price rise was justified. When they looked at the balance sheet of the company, it became clear that because the market was not developed (and never could be) the price, if not regulated through a formula, could lead to windfall profits. They asked that the price should be set so that costs were recovered and profits were secured, but that profits should not be excessive. As a result, Delhi’s gas company, Indraprastha Gas Limited (IGL), has been making profits but prices of gas have not increased substantially.
As cng was being introduced in other cities, SEC also wanted a policy directive on its availability and price, which would encourage its use as an environmentally acceptable fuel. This was not done. A pricing policy was made. But by then private players had entered the lucrative market and it was in their interest to keep things unregulated. The policy wasn’t finalised. In city after city—Ahmedabad, Gurgaon, Noida, Lucknow—the programme has faltered because the private company, which by now has arm-twisted state governments to secure rights to distribute gas, has dictated the price.
Everyone knows air pollution is choking our cities. But they also need electricity. The option is to build coal-based power stations to supply this need. But even with the best of technology (which India does not have) for so-called clean coal, air and solid waste emissions are high. Gas would be an ideal option for these cities. But if the price of gas is determined based on non-existent market rates, then there is no way it can compete with coal—domestic or even imported. In other words, we have through this non-existent market policy of imaginary competition compromised, indeed jeopardised, our energy and environment security. But then who said anything about government or the market being free or fair.
CONCLUSION
Ten years have passed since economic reforms aimed at liberalization were initiated in India. These reforms did much to reform the government’s fiscal regime, ended the system of industrial licensing, and created an enabling environment for business and industry to function (Pachuari 2000). Yet, the energy industry, one of the country’s largest, remains largely unchanged from the pre-reform command economy. In particular, natural gas production remains dominated by state-owned firms, prices are set well below competitive levels, and supplies must be rationed. One state-owned company, GAIL, has almost a complete monopoly on the transport and sale of natural gas.
India’s federalist system creates uncertainty about where the authority to regulate the energy sector lies, at the center or with the states. To date, the center has controlled gas supply and allocation through its monopoly, GAIL. In the electricity sector, however, the responsibilities for transmission and distribution lie under the states’ authority.
India, thus far, has proceeded slowly in the process of reforming its gas sector regulations to create competition. The government has not established a clear policy framework for private investment. Reforms also cannot be limited to the gas sector alone. The industries that are the major users of natural gas must also be restructured to create viable customers for gas importers. India’s geopolitical position further complicates the outlook for natural gas expansion. The most economically attractive routes for gas import are fraught with challenges. This situation forces India’s gas supply decisions to be shaped by political and security concerns by as much as economic efficiency.
REFERENCES
- http://www.thehindu.com/2007/07/06/stories/2007070656961800.htm
- http://www.cfr.org/publication/12200/indias_energy_crunch.html
- http://www.taxindiaonline.com/RC2/inside2.php3?filename=bnews_detail.php3&newsid=6548
- http://www.bu.edu/globalbeat/syndicate/srivastava091205.html
- http://www.downtoearth.org.in/editor.asp?foldername=20070715&filename=Editor&sec_id=2&sid=1
- http://uspetro.nic.in/ng.htm
- Mark Hayes, "India’s Natural Gas Sector: Historical Development, Options and Obstacles to Reform, and Supply Alternatives" (Working Draft)
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