Lydia Powell, Distinguished Fellow and Head, Centre for Resources Management, Observer Research Foundation
With the launch of the India Gas Exchange (IGX) on June 15, 2020, will industry players check one box in their long wish list for the country’s natural gas industry? Perhaps, but not without some hesitation, as there are far too many uncertainties in the evolution of the exchange into a full-blown gas trading platform.
The IGX is an automated trading platform for imported liquefied natural gas (LNG) that will allow buyers and sellers to trade on spot and forward markets across three physical hubs – Dahej and Hazira in Gujarat and Kakinada in Andhra Pradesh.
Price discovery is through double-sided closed auctions in which members place buy or sell bids based on their customised requirements. The hope is that the IGX will generate clear signals for making rational economic decisions related to consumption and investments in the currently fragmented and relatively opaque gas sector.
There are strong tailwinds that the IGX can count on for growth. There is an intense policy push from the government with the stated goal of increasing the share of natural gas in India’s commercial energy basket from the current 6 per cent to 15 per cent by 2030. There is optimism over the government’s plans to gradually introduce pricing and marketing freedom for natural gas and rationalise pipeline tariffs to help garner a greater share of gas. There are also plans to increase the pipeline network from about 16,000 km to about 27,000 km in the next decade. By 2023, at least 20 million tonnes (mt) of additional LNG regasification capacity is expected to come on-stream.
There is a strong demand pull from low spot prices that are below $3 per million metric British thermal units (mmBtu) for Asian markets. Spot prices are now comparable to the regulated gas price of $2.39 per mmBtu set for domestic gas, making spot LNG attractive even for the most price sensitive buyer. Indian importers bought roughly half the LNG through spot trade in 2019 (Chart 1). LNG imports increased by 25 per cent in January 2020 as compared to the previous year and by a record 68 per cent in February 2020. The International Energy Agency projects that India will become the most attractive market for LNG after China with a 28 billion cubic metre (bcm) increase per year in the next five years as long as the government continues to implement progressive policies. Since 2014, the demand for natural has picked up primarily because of targeted policies to increase the use of piped natural gas as fuel for cooking and compressed natural gas as fuel for urban transport through city gas distribution (CGD) networks. In the period from 2014-15 to 2018-19, consumption of natural gas by the CGD sector increased by 13.6 per cent. Most of this growth was met by imported LNG, which has grown by over 11 per cent since 2014 (International Energy Forum [IEF] 2019). In the next ten years, the CGD segment can add about 250 mmscmd to consumption and make the biggest contribution (about 60 per cent) towards increasing the share of natural gas in India’s commercial energy basket (IEF 2019). There is optimism in the industry after the bidding rounds have been completed for 228 geographic areas (GAs) comprising 402 districts and covering 27 states in which 70 per cent of the country’s population lives. The new trading hub adds to the optimism as it will contribute to supply security.
The IGX is definitely a bold initiative by the Indian Energy Exchange even though it is short on many of the prerequisites of a typical gas-trading hub in terms of supply, demand, infrastructure and price. Unlike other mature gas hubs through which multiple sources of gas supply (domestic production, cross border pipeline gas and LNG) flow, the IGX will focus only on spot LNG shipments for now. Government policy will continue to direct the flow and pricing of most of the domestic gas output, which accounts for about 47 per cent of the total consumption.
A strong consumer base with competing buying interests (like power generators, industrial consumers and households) that is necessary for developing a diverse market place is evolving in the country, but is price sensitive. The power and fertiliser industries along with CGD networks that cater to household and transport demand accounted for 66 per cent of the country’s gas demand in 2019 but roughly half this demand was met by low-priced domestic gas. However, the share of gas consumed by other sectors (besides power and fertilisers) that are the most price sensitive exceeded the share consumed by the power and fertiliser segments in 2019 (Chart 2). If this positive trend continues, the influence of the market over gas supplies can increase in the future.
In the short term, the government could mandate that a share of domestic gas (including all other domestic production such as coal bed methane, high temperature high pressure gas, deepwater gas, ultra deepwater gas and pre-New Exploration and Licencing Policy gas with marketing freedom) and LNG be transacted on the hub. Nevertheless, in the longer term, a substantial increase in the supply of tradable gas, gas storage facilities, a competitive wholesale natural gas market, non-discriminatory third-party pipeline access, standardised contracts for both transportation as well as the sale and purchase of gas, liquid physical markets that encourage the development of a futures market, and price reporting will be critical for the IGX to mature into a liquid gas trading hub.
The experience of China, Japan and Singapore in developing LNG hubs offers some key insights in this regard. Though these hubs have been in the making for about a decade, they are yet to develop into trading platforms comparable to the Henry Hub in the US or the National Balancing Point in the UK. One of the primary reasons is that there is no competitive wholesale market for gas in these countries. China’s gas market, which is roughly five times the size of the Indian gas market, is yet to separate transport and commercial activities and is yet to introduce third-party access to infrastructure. The same is true for Japan. Though Singapore is a liberalised market, its domestic gas market, which is only a fourth of India’s market size, is too small and does not have enough market players to create a truly competitive wholesale market that is a prerequisite for a hub.
Unlike pipeline supply-based hubs in the US and Europe where receipts and deliveries are continuous and almost instantaneous, the size of a single cargo of LNG and the uneven nature of deliveries limits liquidity in LNG hubs. With LNG, there is no clear geographic location where a traded cargo would automatically default for delivery if the parties to the trade wished to do so. This fundamental feature of pipeline hubs cannot be easily replicated in LNG hubs.
Notwithstanding the challenges, the IGX is a step in the right direction. The first few days of trading has revealed a price $4.07 per mmBtu for imported gas, which means that domestic gas is grossly under-priced. Under-pricing of domestic gas is undermining domestic production while stimulating demand. The IGX’s pricing signals will address the problem of multiple and suboptimal and non-representative pricing mechanisms that have led to price distortion and unfair competition amongst consumers. Price distortion is a serious impediment to the goal of transitioning to a gas-based economy as it discourages investment. From a strategic perspective, the perceived supply risk generally associated with imported LNG will be reduced by the IGX. The eventual development of a transparent and liquid gas market mediated by the IGX may lead to a “gas price index” that will capture the market price of gas in India. This will reduce the premium on imported LNG that arises from indexation to foreign gas or crude markers. The right price will send the right signals to the market on investment requirements in the gas value chain and will facilitate more efficient usage of gas