Opportunities and Pricing Strategies of ONGC in Natural Gas Business

Executive Summary

1.Background
India is looking at liberalizing the natural gas sector following deregulation of liquid petroleum
sector in 2002 for promoting competitiveness and efficiency. As a result of deregulation process,
ONGC would have new opportunities in Natural Gas Business and also shall face the task of
formulating different strategies for pricing its natural gas in future as the current pricing
mechanism and marketing arrangements are controlled by GoI to a great extent. This study is
based on the assumption that GoI would allow a level playing field to all players including
ONGC in the emerging scenario.







2.Objective

The objective of this study is to analyze the existing and emerging scenario of gas business in
India, study international experiences, various pricing approaches and techniques and
Evolve a model for natural gas business in India in which ONGC would be operating in
the emerging scenario
Identify opportunities for ONGC in gas value chain integration.
Formulate Gas Pricing strategies for ONGC











3.Macro-environment analysis

To assess the scenario that is likely to emerge in India, a comprehensive analysis of the drivers
affecting the natural gas business in India was carried out which included a detailed PEST
analysis, future energy mix scenario, demand supply analysis, infrastructure assessment etc.
and the main findings emerged are the following:
Natural gas is the fastest growing source of primary energy in the world.
Natural gas accounts for only about 8% of the primary energy use in India against share of
24% for the entire world and its share is estimated to go up primarily because of its
advantages, technology development and environmental concerns.
Future demand projections indicate substantial increase.
Considerable increase in supply is expected from recent domestic discoveries, LNG &
pipeline imports and through alternate sources like CBM etc.
GoIs initiatives in the form of NELP, Hydrocarbon Vision - 2025, Petroleum Regulatory Bill
2002, draft natural gas pipeline policy 2004, Electricity Act 2003 etc. has instilled
considerable optimism in the prospects of the gas business in India.
Significant investments being planned in development of gas transmission infrastructure to
create a homogenous gas market in the country.
Porters five forces model for natural gas sector in India indicate attractiveness of business
and pricing shall play a key role.










4.International experience

For assessing the future scenario, structural changes that occurred and pricing practices that
were followed in developed gas markets of U.S, U.K & Europe and emerging economies like
China were studied and are summarized as below:
Structural changes like price decontrol, third party access (TPA) unbundling lead to
Emergence of new markets, new players and new relationships.
Gas pricing approaches depends on the market models
Discriminatory netback basis* and/or regulated pricing (cost plus or rate of return) in
monopolistic markets
Inter-fuel / gas-to-gas competition based pricing in developed competitive markets.
In developed gas markets, spot, futures and market centre (hubs) were in place where
gas prices are determined by interplay of supply and demand
Shift in gas price indexation techniques from traditional oil / oil products basis towards
spot pricing.
Shift towards flexible contractual practices.

* Netback price = Delivered price of cheapest alternative fuel to the customer (including any taxes) adjusted
for any differences in efficiency or in the cost of meeting environmental standards/limits

Minus cost of transporting gas from the beach or border to the customer;
Minus cost of storing gas to meeting the customers seasonal or daily demand
fluctuations;
Minus any gas taxes.


5.Emerging gas business scenario in India

Based on the environment scanning and international experiences, likely emerging model for
the natural gas business in India in different time frames in future were built as follows.

I. Medium term (< 5 years)














Changes that are likely to happen in Indian Gas Industry in the next 5 years are the following

Setting up of a regulator by the government to oversee the gas sector.
Gas transmission would come under regulation for providing open access on common
carrier principle and charging regulated tariffs to prevent exploitation of their monopoly
position.
Unbundling of transmission / transportation activities from marketing / trading
activities. Though unbundling would take place, in the initial stages, the transmission
and distribution company like GAIL is expected to only setup separate subsidiary for
transmission business with same ownership and may like to retain their existing
marketing rights for some more time.
Development of infrastructure facilities for transmission and distribution in the form of
National gas grid with segments being built and operated by any player nominated on
competitive basis.
Development of Wholesale competition with many new gas fields being put on
production and capacity addition by way of LNG imports leading to nascent gas to gas
competition.

II. Long term

The changes that are likely to happen in Indian Gas Industry in long term are the following:

National Gas Grid in full scale operation with many suppliers both domestic producers
and importers (pipeline and LNG) feeding the gas into the grid and mechanisms come
into existence for balancing the supply and demand.
Full scale whole sale competition and development of retail competition.
Development of spot market for gas trading as observed in U.S and U.K.
Full deregulation of natural gas markets and creates a level playing field for all
participants in the natural gas market.
Facilitate the development of a large number of supply companies (marketers) that
purchase natural gas in the wholesale market, resell it downstream, and use the
transportation services of pipeline and distribution companies.
Seek more flexible trading and contractual arrangements. Natural gas to increasingly be
traded through short term contracts to balance supply and demand in the short-term
and give market participants the flexibility they need.
The development of a spot market promotes efficiency in the entire gas market.

6.Implications for ONGC

In this changing scenario ONGC as a producer would have the following mixed bag of
opportunities in Gas marketing
Marketing model and contractual arrangement
Direct sale of gas to bulk consumers like power plants, fertilizer plants etc.

Direct sale to small, medium and large industrial consumers.
Sell gas to Local Distribution Companies for further supply to small / residential
consumers.
Competitive pricing or the market value principle shall prevail as a fair pricing system
for producers including ONGC.
Inter-fuel competition and gas-to-gas competition will become tougher and gas pricing
will become more complex.
Deregulation shall bring in competition but will not be a guarantee for high prices,
however will lead to higher volatility.
Synchrony of oil and gas prices may still continue to exist with lesser correlation as seen
in markets like U.K, U.S where spot prices have moved away from crude oil prices.
Use of gas pipelines and infrastructural facilities
ONGC will be free to lay transmission pipeline but such pipeline shall be designated as
open access by Government and at the same time will also be allowed access to others
pipeline.
ONGC shall have emerging business opportunities in
Alternate sourcing options - LNG imports, Imports through pipelines etc.
Pipeline markets Construction, Transmission, Operation services etc.
Financial gas markets - Spot, Futures, and Options etc.

7. Recommendations

Based on company internal assessment, SWOT analysis and emerging opportunities following
recommendations are made.

I. Integration in Gas value chain
Direct sales to be effected wherever possible to bulk users of gas namely Power
companies, fertilizer companies, large industries and LDCs.

ONGC to enter into new emerging markets of setting up and operating transmission
infrastructure by creating a separate subsidiary pipeline company.
To set up joint venture enterprises (LDCs) with established and experienced players for
retail marketing of gas to residential sector and transportation sector in areas where
ONGC has operations in line with its strategy of setting up retail fuel outlets.
Enter into LNG import and regasification business by setting up regasification terminals,
whereby augmentation of domestic production of gas is possible through imported LNG
to already locked in customers.
II. Gas pricing strategies for ONGC in emerging scenario

Various gas pricing options and indexation techniques were analyzed for their merits /
demerits and appropriate pricing strategies for ONGC in the emerging scenario, which can be
the basis for starting point of negotiations with the customers were drawn under assumption
that prices will be decontrolled by GoI:
A. Monopolistic / Transition phase towards competition

During the transition phase towards competition, netback approach is the best pricing concept
to begin with as gas from existing producing fields of ONGC is marketed through a single
agency which does both the transmission and distribution.

Base price to be negotiated based on weighted average value of the gas in competition with
other fuels (Naphtha, fuel oil etc) on the end-user market, adjusted to allow for the regulated
transportation tariff from custody transfer point to end user premises and any taxes on gas.
After fixation of base price based on this method, further indexation is recommended based on
the competing fuels.

(In the current situation in controlled price regime, ONGC need to impress upon GoI for a state
administered net-back concept to start with as Net-back approach guarantees the
competitiveness of gas against competitive fuels and encourages fuel switching to gas and at the
same time protects upstream investment as well).

B. Medium term - Introduction of open access / Unbundling

ONGC would have the option of selling natural gas produced from its fields either to a gas
marketing / trading company or directly to end consumers at market determined prices
availing the facilities of a T&D company. However, marketing directly to the final consumer
exposes ONGC to many risks like market risk (demand and price), credit risk etc. Selling to a
creditworthy natural gas marketing company may partially reduce market risk but shall result
in lesser realizations. ONGC has to weigh both the options in conjunction with the risks and
return involved and strategies that can be adopted for both the options is as under:

i. Pricing strategy in case of gas sold to Trader / Marketer

The price paid by the buyer of gas to the producer shall be negotiated on the basis of the
weighted average value of the gas in competition with other fuels (Naphtha, low sulphur / high
sulphur / heavy fuel oil) on the estimated end-user market to be serviced by the marketer,
adjusted to allow for the regulated transportation tariff from custody transfer point to end user
premises and any taxes on gas. After fixation of base price based on this method and further
indexation is recommended based on the competing fuels.

ii. Pricing strategy in case of gas sold to bulk consumer on direct basis


Long term contracts with price review clauses recommended for Power, Fertilizer
segments and LDCs.
Medium Term contracts recommended for other cases.
C. Long Term Full scale competition

Development of a full scale spot market shall ensure that short term and medium term contracts
be based on spot prices, where price is determined through the interplay of supply and demand
in a liquid market as prevailing in U.S and UK. Long term contracts to be indexed to gas spot
prices.

D. Gas sales to processors extracting VAPs

Keep whole type of contracts is recommended whereby ONGC gets compensated for the
portion and composition of gas it supplies to the processors. The compensation should be based
on the market price of the components in the shrinkage gas reflecting the true market value.

8. Problems in implementation
Uncertainties in this sector - Strategies 7A, 7B or 7C has to be worked out dynamically
in line with market conditions, wherever appropriate and deemed fit.
Decontrol of prices not overnight and government intervention is required in many
areas particularly where subsidies are to be removed, which may have political
repercussions.
o Fertilizer sector
o North-east subsidy
Affordability of the customers is a major concern particularly where products prices
are controlled or limited like in case of user segment like power.


9. Conclusion

Natural gas industry in India is on the threshold of change and is likely to witness significant
structural shifts in the coming years. Currently, the industry is emerging out of the constraints
of regulatory control, with GoI allowing players including ONGC the freedom to devise own
pricing strategies in certain cases. With the number of players in the gas sector set to increase,
gas pricing would increasingly be influenced by competitive forces; however, GoIs future road
map for this sector on the regulatory issues would play a major role in implementation of the
strategies discussed in this study.