Plummeting crude oil prices over the past year have been a big positive for the import-reliant Indian economy. The scenario not only softened oil and gas import bills for the country, but also provided a window to the government to fix the domestic policy framework. A number of long-pending policy announcements were made and were well received by the industry. However, there are doubts about how these policy changes will translate to action on the ground. Industry experts share their views on developments in the sector and the way forward…
How has the oil and gas sector progressed in the past one year?
In the past one year, we have seen mixed progress in the oil and gas sector with some elements of the value chain doing better than others. In the upstream segment, we have seen good policy progress enabled by new policies launched by the government (Hydrocarbon Exploration Licensing Policy [HELP], automatic extension of contracts, the revenue sharing mechanism, discovered small field bidding, marketing and pricing freedom for gas under HELP and the high pressure/high temperature policy). The upstream segment has also witnessed the resolution of some legacy issues (such as the drill stem test) showcasing better governance.
The pipeline segment, on the other hand, has lagged and has seen little or no change with hardly any progress on new pipelines. Existing pipeline utilisation has remained low and new pipeline development has lagged mostly due to viability and right-of-use (RoU) issues for some projects (Kochi-Mangaluru). New pipelines planned under the viability gap funding model too have been delayed and the final structure for the first such pipeline has not been operationalised yet.
Liquefied natural gas (LNG) terminal infrastructure continued to expand and showed positive signs. Mundra port on the west coast and Ennore port on the east coast have firm development plans and will take off as per schedule, adding substantial regasification capacity. Plans for additional terminals on the east coast are also being discussed and given the low spot price of LNG, more plans may be announced over the next one-two years.
Globally, oil and gas prices have given reason for cheer as spot LNG prices have been at historic lows and are expected to remain below long-term prices for some time to come as excess LNG capacity will prevail over slowing global demand growth. The LNG market has turned into a buyers’ market thereby enabling new demand centres to become viable. It is also facilitating fresh terminal development plans.
The city gas distribution (CGD) sector is now a priority area for the government (especially residential connections) as it is tied to the release of the liquefied petroleum gas (LPG) subsidy. However, CGD bidding continues to draw aggressive bids. Also, the criteria for selecting cities for bid rounds are less than perfect as some geographical areas (GAs) have not received any bids while other GAs have attracted very aggressive bids in the same round.
On the implementation side, the Petroleum and Natural Gas Regulatory Board (PNGRB) recently ordered the cancellation of contracts in two GAs where no progress was witnessed for a year. This action will send strong signals to other bidders and the upcoming smart city bid round is likely to see less aggressive bidding.
Overall, it has been a good year for upstream policy in India. Low LNG prices have spurred demand, driving new LNG supply business models and plans for terminals. However, infrastructure development (pipelines and CGD) has lagged and has not seen any progress in the past one year.
The Indian oil and gas industry has been a big beneficiary of the sharp fall in oil prices over the past year, with refining and marketing (R&M) companies as well as midstream companies (LNG regasification, transmission pipelines and CGD) benefiting significantly. On the other hand, upstream companies felt the pinch of this price drop with a sharp fall in their cash accruals, with some companies even slipping into losses. R&M companies benefited by way of high gross refining margins, a significant decline in working capital borrowings following a fall in inventory-holding costs, lower gross under-recoveries, robust demand for petroleum products and improvement in marketing margins on auto fuels.
R&M companies with vertical integration (such as petrochemicals) and gas marketing companies also benefited from the margin recovery. Midstream companies benefited because of the renegotiation of long-term LNG contracts with RasGas of Qatar, a pick-up in spot LNG demand following a sharp fall in its prices, improved marketing margins on regasified LNG sales, higher quantity of gas transmitted and healthy compressed natural gas margins. Contrary to this, upstream companies bore the brunt of the fall in oil and domestic gas prices, with many of them slashing capex in order to preserve cash.
On the regulatory front, the central government infused some life back into the exploration and production (E&P) segment through HELP. The PNGRB continued with its bidding rounds for CGD networks in new cities that saw enthusiastic response in a few cities with bidders quoting near-zero tariffs and high performance bank guarantees.
How do you perceive the new Hydrocarbon Exploration and Licensing Policy?
HELP is most certainly a step in the right direction. The most notable feature of this policy is the marketing and pricing freedom allowed for gas found under the new policy framework, albeit with a price capping formula. The freedom for gas allocation and the ability to negotiate prices with buyers should give a much-needed boost to the domestic upstream industry.
In completely free markets, one would not expect any caps to be present. However considering that in India the buyers of gas are primarily the power and fertiliser sectors, such a cap will ensure that the prices remain below full import parity with LNG. The policy also allows for a unified licence for exploring all forms of hydrocarbons (whether conventional or unconventional) under a single licence and under the same terms. This is a good provision and will enable synergistic exploration efforts.
A move to the revenue-sharing principle will increase overall transparency and reduce the need for regulatory oversight by the government. While this increases the risk perception of upstream companies in frontier areas (as there is no cost recovery), with reduced government involvement and approvals required, it will make the process much smoother for E&P companies and is a welcome step.
According to ICRA, HELP is a long-term positive for the E&P segment as it ushers in a new regime in the form of a uniform licensing policy for exploring all types of hydrocarbons, the open acreage policy, marketing and pricing freedom for gas discoveries in challenging fields which are yet to commence production, besides the policy for grant of extension to production sharing contracts for small- and medium-sized discovered fields.
However, the introduction of a revenue-sharing contract regime has its own merits and demerits, and its success remains to be assessed in the Indian context, given the high geological risk characteristic of Indian basins and high probability of time and cost overruns in developing the fields.
What are the challenges in the sector that remain unaddressed?
A number of challenges still need to be addressed, particularly in the midstream and downstream segments. Among the more important ones are the funding mechanism for pipeline development needed to unleash new demand centres for gas, newer models for supply (virtual pipelines), realignment of pipelines and CGD bidding parameters that enable viable bidding, taxation issues on gas vis-à-vis alternative fuels, affordability issues for key demand sectors, models to expand existing markets for gas, etc.
There is a need to take a holistic view of the gas sector and plan a two-three year intervention programme to enable its development so that gas can fulfil the role of a clean fuel, as India moves towards meeting its intended nationally determined commitments made at the Conference of Parties 21.
The E&P sector could face a high cess burden and hence lower cash generation if oil prices were to increase beyond $45 per barrel, given the 20 per cent ad valorem rate imposed in the last Union budget, from a specific levy earlier. Hence it is imperative that the government reduces the cess rate for the industry to ach-
ieve meaningful returns. Moreover, there is a need to revisit the domestic gas pricing guidelines, since prices are on a free fall because of a softening in global gas prices. There is an urgent need to introduce a floor price or a change in formula, so that the industry is incentivised to pursue new discoveries.
In the midstream segment, the industry could do with greater regulatory clarity, especially on tariff fixation for gas transmission pipelines with several contentious issues between pipeline owners and the PNGRB on tariff methodology. Due to the low tariffs fixed, pipeline companies have not been able to achieve normative returns. This is made more complicated by the retrospective implementation of tariffs leading to a lack of predictability on earnings from the investor perspective.
Pipeline companies will also require better regulatory and state government support for receiving RoUs in time, an issue which is being increasingly politicised. In the downstream segment, the introduction of the direct benefit transfer to LPG consumers for superior kerosene oil and identification of consumers with greater purchasing power through a better criterion than the Rs 1 million income threshold for LPG subsidy will be needed to reduce the subsidy burden on the central government.
What is the sector outlook for the next one to two years?
Globally, prices for energy commodities are expected to remain low over at least the next two-three years. This is due to lower-than-expected global economic growth during the past few years. This has led to an oversupply situation for LNG, which is likely to remain so for the next three-five years. This is a very fortunate development for consuming countries such as India that have heavy import dependence with regard to energy resources.
Policymakers can take this opportunity to implement more reforms in the oil and gas value chain and completely deregulate the sector to make it more market based. This will enable market fundamentals to drive demand, supply and pricing, which in turn will attract private, national and international capital.
The outlook is negative for E&P and oilfield service companies, stable to moderately negative for midstream companies and positive for downstream oil companies. Due to the bearish outlook on oil prices and a further drop anticipated in domestic gas prices from October 2016 onwards, cash flows of upstream companies will be under strain, with the impact being partially mitigated for public sector undertakings because of the low subsidy burden. Oilfield service companies could see their earnings plummet with more contracts coming up for renewal.
As for midstream companies, while regasification and pipeline companies could benefit from the higher demand for spot LNG, the CGD segment could see challenges in piped natural gas (PNG) industrial and commercial sales as they will be competing with cheaper liquid hydrocarbons (such as fuel oil/low sulphur heavy stock) and coal/coke.
Thus, CGD companies with a higher share of sales of PNG (industrial and commercial) will be affected more than companies with CNG and PNG (domestic), which will benefit from the fall in gas prices and favourable economics of conversion. R&M companies should be in a sweet spot with modest crack spreads, healthy demand growth for products, low interest costs because of low working capital blockage, besides buoyancy in petrochemical margins. If oil prices were to recover, they are also likely to benefit from inventory gains.
“Overall, it has been a good year for upstream policy in India. Low LNG
prices have spurred demand, driving new LNG supply business models
and plans for terminals.”
Gurpreet Chugh, Consulting Director, Energy, ICF International
“The outlook is negative for E&P and oilfield service companies, stable
to moderately negative for midstream companies and positive for downstream
K. Ravichandran, Senior Vice-President, ICRA Limited