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Monday, September 27, 2021

Over the Barrel: Pipelines over politics

An energy source that is cheap and relatively clean has not found its place due to political shortsightedness and pricing issues

Written by Vikram S Mehta |
Updated: September 5, 2016 12:05:26 am
Representational image. Representational image.

Many years ago, when Shell was contemplating investment in a LNG Regasification terminal in Gujarat, the management debated whether the company should first secure the customers and then spend the $ 700 million or so required. Or whether it should invest ahead of the market and then leverage its supply capability to lock in the customers.

The industry practice, at the time, was to do the former. This was because companies (and bankers) were loath to take the billion dollar plus exposure in the gas value-chain from exploration and production, liquefaction, cryogenic shipping, regasification and then pipeline sales without the assurance of long-term “take or pay” supply contracts . But this practice was not going to work in India. Anchor customers were not going to foreclose their supply options especially because they had the possibility of accessing relatively cheaper coal.

So the real issue for Shell was whether it wished to take a “punt” on the Indian economy. Whether it was prepared to bet that the potential demand for gas would outstrip indigenous supply and as a result the market for imported LNG would be strong and growing. Shell took the “punt” and, in time, it paid off. The price was competitive against alternative fuels and, most important, Gujarat created an intra-state gas pipeline grid. This expanded the market and enabled Shell gas to reach industrial and residential customers .

Gas, however, does not seem to be increasing its share in our domestic energy basket. This, despite the fact that our PM has called for a transition to a gas-based economy and the landed price of LNG today, at less than $ 5 per MMbtu, is less than half what it was when Shell’s Hazira terminal commenced operations more than a decade back. The price has, in fact, never been lower.

The reason is fundamentally because we have not built the gas pipeline infrastructure. This is on account of three reasons. One, the Centre and states have different — and often clashing — views on the modus operandi and financials of a gas pipeline. This has been a long standing problem. The Kochi LNG Regasification terminal was commissioned years back but is currently running at only five to seven per cent capacity because Tamil Nadu wants the pipeline to be laid along the highways while GAIL argues that such a routing would be unnecessarily costly and it is the state government’s task to secure consent from landowners.

Two, the bidding process for construction of pipelines has been compounded by inconsistent gas flows. That is, in part, the result of the current formula of gas pricing; in part because of the dire financial situation of the power distribution companies who cannot afford to pay and in part the monopoly GAIL has over the industry. The latter has introduced an element of uncertainty into the current “open access” regime wherein suppliers have right of access to all pipelines. This is because GAIL is also a marketer of gas and therefore has a business interest in denying access to its competitors.

Three, there has been a lack of innovative and creative thought in matters pertaining to financing of gas pipelines . The economics of investment in this business is not fundamentally attractive. It is capital-intensive; its utilisation rests on factors beyond the operators’ control and it generates utility rates of return. So to get investment into this sector requires out-of-the-box thinking.

To redeem this situation, I would suggest that the government contemplate three measures . One, it should announce that the creation of a national gas pipeline grid is of national importance and strategic significance. It should then get all the state governments to read from the same script on issues like land acquisition, right of ways, environmental approvals, tariff structures and taxation rates. The PM should use the weight of his experience and understanding of energy business to bring this about. Two, it should create a national gas pipeline company in the public sector. The mandate of this company should be to link all the regions through a national gas pipeline grid. The company should be financed from the government’s balance sheet (a good case for viability gap funding); it should receive a fixed post tax return on equity with maybe upside incentive for efficient and safe operations and it should have no direct or indirect links to existing public sector companies. GAIL should be asked to transfer all of its pipeline portfolio to this company. They will of course resist this decision just as the ONGC fought to prevent the government from transferring its pipelines to GAIL almost four decades back. The government should override these objections. And finally, the government should reexamine the gas pricing model.

Gas prices are currently linked to the prices in Russia, the US and Canada. This makes no sense as the gas markets in those countries are totally dissimilar to those in India. Gas pricing should be linked to the Asia Pacific market. Gas is a relatively clean fuel. It is abundantly available in our region. Its current price is competitive even against imported coal. The government must, therefore, create the appropriate institutional, structural, and financial incentives for the rapid development of a national gas pipeline grid. The Shell experience shows that it will not be a punt.

(The writer is the chairman of Brookings India and senior fellow, Brookings Institution)

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