New pricing mechanism may bring immediate cost benefits to CGD firms

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The new gas price mechanism will bring immediate gas cost benefits to city gas distribution (CGD) companies.

What is lost, however, is the lower price advantage of a cheaper Henry Hub gas in the medium term, said analysts.

New gas pricing mechanism

Starting April 7, the government approved a new gas pricing mechanism for output from ONGC and Oil India’s legacy fields. The new mechanism links prices to 10 percent of the Indian crude oil basket, allows for a monthly revision, and has a floor of $4 per mmBTU and ceiling of $6.5 per mmBTU. MMBTU is metric million British thermal unit.

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The floor and ceiling will remain unchanged for the next two years. The ceiling will expand by 25 cents annually, after the completion of a two-year cap.

Had the old formula been in use, gas prices for CGDs would have been 24 percent higher in the current financial year.

The new-versus-old formula, analysts said, allows for lower gas costs for CGDs in the current and next financial year. “APM prices would be approximately 24 percent lower in FY24 (expected) and 13 percent lower in FY25 (E) as per the new formula, vs. old,” analysts with Ambit Capital wrote in a note dated April 10.

However, CGD companies and end-consumers stand to lose in the medium term.

They said prices (under the new formula) are expected to be in the higher range, but affordable. “Prices under the new mechanism are expected at $6.4 per MMBTU, which would have been lower at $5.4 per MMBTU under the old computation, “the analysts noted.

Analysts at Motilal Oswal saw the new price mechanism as a negative development for CGDs on account of both the floor and the ceiling.

“The pricing mechanism will be negative for CGDs as it raises the gas cost to $6.5/mmBtu as long as the Indian crude basket is above $65/mmBtu,” the brokerage said in an April 7 note. “In the older APM pricing regime, we would have expected a sharp correction as US Henry Hub has already come down to ~$2/mmBtu,” the report said.

The monthly average of the Indian crude oil basket last traded below the $65 per barrel mark in January 2022, at $63.4 per barrel.

US Henry Hub gas prices in March were at $2.31 per mmBTU, lower from $3.27 per mmBTU in January and a high of $8.81 per mmBTU in August 2022, according to US Energy Information Administration (EIA) data.

Gas prices under the old formula were calculated on the basis of a 12-month average of four international gas hubs, and with a lag of a quarter.

Analysts with Motilal Oswal also noted, APM gas prices were higher than $4/mmBtu (floor) in only three out 16 periods due to high weightage of cheap Henry Hub gas,” the report said.

Between October 2015 and March 2023, APM gas prices (under the old formula) was higher than the new price ceiling of $6.5 just once and was above the floor of $4 on four out of 17  occasions of price fixation, CRISIL data shows.

Ashu Shinghal, managing director of Mahangar Gas, a  CGD company  based in western region , however, sees the price movement (under the old formula) as an aberration. “ It is too uncertain to predict the prices after three years. The abnormal prices a few years back was an aberration. The current proposal sounds good, and, by and large, beneficial for CGD companies.”