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India's bold move to increase domestic gas prices

India's government is set to increase domestic gas prices in a move applauded by analysts and the industry

India will more than double its domestic gas price in a bold move that is expected reinvigorate its energy landscape.

The government has approved a new gas pricing formula, which could increase domestic gas prices to $8.40 per million British thermal units (Btu) from April 2014, the minister of petroleum and natural gas, Veerappa Moily, has confirmed.“It’s certainly a boon for existing players, India’s Oil & Natural Gas Corporation (ONGC), Oil India, Reliance Industries and BP, whose projects, particularly in the deeper waters, become economically viable,” Alay Patel, an India specialist at Wood Mackenzie, told Petroleum Economist.

Data from the energy research firm shows that the reform will unlock some 12 trillion cubic feet (cf) of discovered reserves that would have been uneconomic to produce under the previous pricing terms.

Artificially low domestic prices have deterred investments in exploration and production. But higher prices should revitalise India’s upstream sector and ultimately help cut the nation’s hefty import bill. Gas production has been falling for the past three years, while demand has been on the rise.

Increased domestic production would help displace India’s increasing dependence on costly imports of liquefied natural gas and rein in a yawning trade deficit.

There is no doubt the price increase will make licensing rounds more attractive to new entrants. But with the government seeking to scrap cost recovery in favour of a revenue sharing contract, investors will still be cautious about bidding on deep-water blocks, said Patel.

Analysts say that if cost recovery is removed from future production sharing contracts, companies would likely pursue deals to farm into state-owned ONGC’s existing acreage over bidding for new acreage under the revised contract terms.

Both ConocoPhillips and Shell are exploring the possibility of an alliance with the national oil company.

Consultancy IHS-CERA predicts that India could increase recoverable gas reserves by 30 trillion cf – nearly double current levels – and attract $95 billion in new investment with a gas price of $8/m Btu. Reserves could rise by 55 trillion cf to 91 trillion cf with a price of $10-12/m Btu.

New Delhi has yet to give specific details of the pricing reform. But based on the formula proposed to the government by the Rangarajan Committee, analysts estimate prices could rise more than 150% to more than $10/m Btu within two years.

Under the formula, which uses long-term and spot import contracts, as well as international trading benchmarks to calculate a competitive price for India, prices will be revised every quarter until March 2017. Thereafter, all controls on pricing will be lifted.

The move has been applauded by analysts. Significantly, the formula brings automatic as well as transparent increments, rather than the earlier ad hoc and unpredictable increases from the government, said Jal Irani, an Indian-focused analyst at Macquarie, an investment bank.

The news was also welcomed by India’s national oil companies, which have been increasingly hunting for new gas sources overseas to help bridge the supply gap at home. Most recently, ONGC and Oil India paid $2.48bn for a 10% stake in a major offshore gas project in Mozambique.

For BP, which paid $7.2 bn in return for a 30% stake in Reliance Industries’ Indian assets in 2011, the price increase will be a welcome relief.

Clarity on pricing will allow the pair to push forward investment decisions for their Krishna Godavari D6 Block, home to India’s largest gas field.

The UK supermajor has previously signaled that a gas price of less than $7/m Btu would make the investment marginal.

Confirmation of the gas price above $8/m Btu will generate revenue benefits for BP from April 2014 and incremental volume from late 2014, RBC Capital Markets analyst, Peter Hutton, said.

Based on BP’s 2012 net production in India of 313m cf per day, a $4/m Btu price increase would add $450m of new revenue to the company’s bottom line.

There is a risk that the next government, to be elected in 2014, may not honor the new formula. But it would be difficult to roll back such a significant policy decision, said Irani. 

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