Book Excerpt: The Next Stop | How is natural gas pricing done in India?

The pricing of domestic gas in India has been a contentious issue for several years, with domestic pricing reform undergoing several reconfigurations. At first glance, gas pricing in India appears notoriously complicated. There are a variety of different prices at the well head.

To put it in simple terms, for many years the price of domestic gas to producers was set according to the terms of the fiscal regime that governed a specific producing field. India has had multiple fiscal regimes in place at different points in time—including the ‘nomination regime’, the pre-New Exploration Licensing Policy (pre-NELP) regime, the NELP and the Hydrocarbon Exploration Licensing Policy (HELP; the ruling regime which now includes an ‘open acreage’ licensing system)—therefore a multitude of prices have existed simultaneously. Transportation costs, marketing margins and Central and state taxes were then added to this well-head price to obtain the delivered price for gas. As states have considerable fiscal autonomy over indirect taxation, these tax rates have tended to vary across states.

There have been numerous attempts at reforming domestic gas prices. The latest configuration of domestic gas pricing reform, implemented in October 2014, has broken with the previous system (which was based on oil price linkages), with a linkage to a twelve-month trailing (with a lag of one quarter), physical volume-weighted average of four international ‘benchmark’ gas prices—the US Henry Hub price, the UK National Balancing Point (NBP) price, the Russian domestic gas price and the (Canadian) Alberta reference price for gas. Transportation tariffs and indirect taxes are then applied as before. The formula is adjusted bi-annually and although this simply adds to the multitude of pricing regimes for domestic gas, previous regimes are expected to eventually converge to this new pricing regime.

It can be argued that these numerous attempts at reforming domestic gas pricing have been mainly predicated around managing the price level, rather than establishing a logical basis for price formation, which reflects the dynamics of the Indian economy—in other words, they have focused
on price levels as opposed to pricing mechanisms.

This chapter summarizes the policy discussion on the need to move to a pricing mechanism for Indian gas, and in doing so addresses the following research questions:

• How should domestic gas be priced for the Indian market?
• What are some of the key trade-offs that policymakers face in gas pricing and what are the underlying distortions?
• Is there a general framework of guiding principles for natural gas pricing that can be applied to the Indian market?

At the time of writing, India is grappling with the global coronavirus pandemic, facing a severe economic contraction due to lockdowns imposed to control the spread of the virus. Policymakers around the world are facing a choice on where to direct fiscal stimulus packages to catalyse economic recovery—at ‘traditional’ carbon-intensive industries, or at industries that could facilitate a transition to environmentally sustainable economic growth. Gas features prominently as an option in these debates, particularly in European economies, given its potential for decarbonization via several technological pathways, without the requirement for new investments in network and storage infrastructure.

The next section sets out some general guidelines around the design of a gas pricing mechanism. The following section reviews the trade-offs faced in designing a pricing mechanism, after which the discussion moves to highlighting some key distortions that have resulted from the existing system. The penultimate section sets out policy options to consider going forward and is followed by the concluding section. Other chapters in this publication deal with issues relating to the end-user sectors in detail. However, this chapter is meant to frame the problem and suggest broad policy options to resolve it.

GENERAL GUIDING PRINCIPLES ON GAS PRICING

The literature on pricing suggests that there are a set of distinct economic principles which can serve as a general guide to determining price mechanisms. Summarizing from the works of Peng and Poudineh, and Reneses, Rodriguez and Perez-Arriaga, these are described as follows:

• Sustainability: The price should enable a regulated company to finance its businesses and new investment required for future operations.
• Efficiency: The price should act as a signal that incentivizes consumers to use the amount of resources that are efficient for the system.
• Equity: An equitable price does not unduly discriminate against one group of consumers in service provision and cost allocation.
• Transparency: The price should be communicated (e.g., published) in clear and understandable terms.
• Simplicity: The price should be easy to understand and accept.
• Stability: The price should be based on a calculation methodology that is consistent over time.
• Consistency: The price should be coherent with the industry structure and regulatory framework in place in the country at any given time.

Having set out these principles, it is important to note that there are trade-offs between them and it is extremely difficult to meet them all simultaneously. Peng and Poudineh, for instance, contend that equity (also referred to as the fairness principle) has the most ambiguous definition and has been interpreted differently in different countries. In some instances, policymakers use it to subsidize energy access for low-income consumers. However, this is because equity is often confused with affordability (or the ability of low-income consumers to pay) of gas. Instead, equity implies that all consumers should face the same calculation methodology for price regardless of whether they pay the same charges. Further, the principle of economic efficiency may conflict with the principles of equity, sufficiency or simplicity. For instance, company operations need to be planned around efficiency (ensuring the company’s medium- and long-term viability) and sustainability/ sufficiency (ensuring that resources have been allocated optimally in the company’s operations) but the price for consumers needs to balance equity, efficiency (in terms of signals to end-consumers) and sufficiency (ensuring that prices allow sufficient revenues) say Peng and Poudineh. Thus, policymakers may need to find a balanced compromise between the various principles.

Excerpted with permission, from "Pricing: A Complex Evolution", by Anupama Sen (Oxford Institute for Energy Studies), in The Next Stop: Natural Gas and India's Journey to a Clean Energy Future (April 2021), edited by Vikram Singh Mehta and published by HarperCollins Publishers India.