Avoid a high-cost gas economy

In the RIL vs RNRL case the apex court has held that the production sharing contract does call for prior government approval. In calling for rigorous governmental purview of pricing, the ruling seems to be going against the spirit of the PSC. Given the rigidities in supply and evacuation, the rule of thumb in gas is that prices are regional and market-specific.

In the judgement in favour of Reliance Industries Ltd in the gas dispute with Reliance Natural Resources Ltd, the Supreme Court, it seems, has based its interpretation as per the letter of the law.

The court has cited key clauses in the production sharing contract and in the Companies Act to negate the ‘three themes that RNRL presses' (para 55).

The court has duly clarified that government approvals (in terms of gas price, supply, etc) are very much required, that the MoU between the Ambani brothers is not legally binding for operationalising the contract by RIL, and that the ‘maintainability' of the earlier company court order, which went in favour of RNRL, is erroneous.
    
But it is also notable that the ruling goes on to add (para 164) of the express need — the phrase used is ‘high time' — for a comprehensive policy, including specific legislation, for the supply of natural gas under production sharing contracts (PSC).
What's suggested is that there is at present a general absence of policy clarity, implying a lack of transparency, and which in turn has led to other unintended consequences. That being the position, it cannot be gainsaid that both the letter and spirit of the relevant clauses in the law are germane.
    
On the key issue of pricing, since the price of $2.34 per mmBtu — as pressed by RNRL — was not quite approved by the Centre, and further that $4.2 per unit was arrived at, lately, by an empowered group of ministers, the latter quote is to be taken as the more appropriate price albeit subject to renegotiation.

It cites Article 21.6.3 of the contract which says that the formula or basis on which prices would be determined ‘shall be approved' by the government prior to the sale of gas.

But to the extent that the contested price of $2.34/unit was discovered as per international competitive bidding by NTPC, the public sector power major, it could be argued that the price is as per the spirit of the law.

Note that the clause does call for governmental nod for the price ‘formula or basis,' but not necessarily whole-scale vetting and reformulation of the very methodology of valuation.
    
The point is that in calling for rigorous governmental purview in terms of pricing, the ruling seems to be going against the spirit of Article 21.6.1 in the PSC which does call for arm's length prices read market determined prices.

Additionally, since the gas supply to various consuming sectors is to be as per ‘prevailing policy', and as roughly 80% of current gas output is earmarked for either fertiliser or power, denying broad sectoral marketing freedom may well mean back to the future and a panoply of perverse governmental controls in terms of pricing and supply.

In the days of autarky and pre-reform, there were indeed such mindless controls right across the board in hydrocarbons, but the whole idea of reforms is to better determine scarcity value and rev up supply with competitive, market-determined prices.
    
However, the judgement does mention (para 126) that the supply parameters between NTPC and RNRL are of a ‘significantly different order.' The onerous ‘take or pay' clause is a part of the NTPC contract, but not in the gas supply agreement with RNRL, it is stressed.

As the ruling elaborates, there are other differences as well, including the fact that the NTPC gas contract — which has since been contested by RIL and is being heard in the Bombay High Court— is for a smaller quantum, and is not open-ended as that with RNRL.

The ruling states that as per the MoU, which is the starting point or basis for the gas deal, 40% of all future gas output likely to be produced by RIL is to go to RNRL, and which again is materially different from that for NTPC. Hence the invalidity of the wellhead price of $2.34/unit, it is opined.
    
The ruling goes on to add that following the price discovery by NTPC, when the MoU was executed a few years later, the prices of natural gas ‘all over the world had risen considerably.'

But given the rigidities in supply and evacuation, the rule of thumb in gas is that prices are regional and market-specific.
More important, the economics of gas is that higher volumes, and for a longer period of delivery, implies a relatively lower price given the logistics. So the RNRL price, linked to the NTPC price, may well be efficient, as per the ground realities.
    
The point remains that gas supply for a long, secular period cannot really be seen as comparable with spot prices and the going rates abroad and much less so vis-a-vis those in mature gas markets like the US.

Besides, the relevant clause in the PSC says that gas is to be valued on the ‘basis of competitive arm's length sales in the region for similar sales under similar conditions.'

And both the NTPC and RNRL contracts are for similar lengths of time and involve large volumes. Unfortunately, there is much opacity in the gas policy, for instance when it comes to determining production costs.

If competitive bid prices can be dismissed out of hand in favour of more administratively determined gas prices it would doubtless mean much scope for routine arbitrariness. We do need to go out of our way to avoid a high-cost gas economy.