Further Reform Needed To Help Gas Generation Grow

BMI View: While a mo ve to hike natural gas prices to boost gas production may payoff, it is not clear that a corresponding move to raise gas utilisation in electricity generation will help put an end to electricity shortages in India. While raising gas prices will support gas producers such as Reliance Industries , they will likely serve to push up the cost of production for electricity generators. Wi th many of these generators, as well as distributors, alr eady operating under the strain of huge debt loads because of regulated electricity prices , it is difficult to see how greater volumes of more expensive gas can be utilised with out the government raising price s for consumers or offering utilities subsidies - both unpalatable options with elections due in 2014 and the economy stalling.

News that the India n government is considering prioritising the utilisation of natural gas drawn from Reliance Industries ' (RIL) KG-D6 gas field for electricity generation comes at a time when India has been beleaguered by power shortages. Plagued by blackouts due to supply bottlenecks, low quality coal , alleged corruption and production problems at KG - D6 , the Central Electricity Authority reported that the power deficit is equivalent to 12,000MW of capacity at peak times. As such , while coal will continue to dominate the electricity generation mix, the government appears to be prepared to support greater gas use, as it consid ers diverting gas supplies to revive US21bn of power projects that have been stalled by a lack of natural gas feedstock. However, weo question whether further reform will be needed to support higher fuel costs for electricity generators and distributors.

A panel of government ministers is set to meet to discuss diverting gas from the KG-D6 field - away from fertilizer makers (normally priority recipients) - towards idle gas-fired generatio n capacity. A ccording to the Association of Power Producers, a group that includes Tata Power , Reliance Power and Adani Power as members , around 8,000MW of gas-fired capacity is currently lying idle . With India 's economy stalling and prolonged blackout and load-shedding hampering growth (a third of population has no access to electricity), moves to ensure electricity supply is adequate to support India's industrial sectors appears to be taking on greater significance.

Gas To Grow?
India - Power Generation By Type, 2013(f)

With the power sector clearly in a parlous state, we have recently revised down our power generation and consumption forecasts for India - aligning with our Country Risk team's decision to downgrade our GDP forecasts for FY2014/15 to 6.0% from 6.7% previously ( see 'Coal Shortages And Economic Weakness Pose Considerable Challenges, June 21). Furthermore, despite repeated promises of reform, coal supply remains extremely tight in India, largely due to delays when attempting to find suitable land and gain environmental approvals for mines. Moreover, a lack of competition and red tape within the coal mining sector - with inefficient Coal India holding a monopoly position - are among the direct causes of the country's coal shortages and have contributed to a growing reliance on imported coal. Meanwhile, the recent Coalgate Scandal, under which the Indian government allegedly allocated 142 coal blocks arbitrarily rather than putting them up for competitive bidding, has further dented confidence on the sector and deterred investment.

Gas Starts To Rise

While gas-fired power plants account for a much smaller proportion of generation capacity, the power crunch has exacerbated by falling production levels at RIL's giant KD-G6 field. While the initial development plan for the field estimated output of 29bn cubic metres (bcm) per year, with the block's fields capable of meeting more than 40% of India's gas consumption needs at 2011 consumption levels of 64.0bcm - geological problems raised the breakeven cost of output. As such, RIL, had long argued that a rise in government mandated gas prices - from US$4.2mn British Thermal Units (BTU) to 8.4mn BTU - was needed to make greater investment (and larger production volumes) viable. With this price rise having been agreed at the beginning of July (and set to be implemented for private companies in April 2014), the move is likely to benefit producers like RIL, and could spur investment in tapping more of India's considerable gas potential - creating upside to our gas production forecasts if the price rise is substantial enough to offset production costs.

Furthermore, BMI's Oil & Gas team has long highlighted that pricing was key to a greater rate of commercialisation at KD-G6 ( see 'KD-G6 Fortune Rests On Gas Prices', May 28), and that the moves were needed to push domestic gas prices closer to globally traded prices - in turn spurring imports of liquefied natural gas (LNG) into India to meet surging demand for gas across the country. Yet while we note that gas will account for around 11.7% of electricity generation in 2013 (according to our forecasts), and we highlight that the India government wants to raise this to closer to 20% by 2020, it is far from clear that higher gas production will translate into fewer power shortages without reform of the Indian electricity wholesale market.

Government Prices Capping Potential
India - Gas Production, Consumption and Reserves

But Will Sparks Fly In An Election Year?

While higher gas prices are good for gas producers, we are not necessarily convinced that the move will create upside to our power forecasts. To this end, raising gas prices (notably, the government did the same thing with coal in May, allowing Coal India to raise low-grade coal prices by 10%) will undoubtedly raise the cost of power generation for many of India's debt-laden utilities. With strict price controls in place, which limit distributors from passing on higher prices to Indian consumers, generators and distributors are already shouldering the financial burden that arises from selling at retail prices that are lower than the cost of generation. The situation has spiralled to a point where state electricity boards are contributing to power shortages by refusing to purchase electricity because they can't recover their costs.

As a consequence, we believe moves to hike gas prices will likely widen the gap between tariffs and the cost of generation further, unless the government hikes prices for consumers (unpopular in an election year in 2014) or subsidises utilities. This dynamic certainly has the potential to curtail any benefits that arise from better gas supply for power generation. Furthermore, while we note that India's finance minister has mooted some form of gas subsidy for utilities, with the country's nominal account deficit hitting an all-time high of US$32.5bn in May, such a move may not be feasible - creating a great deal of uncertainty and deterring investment at the generation and distribution end of the power supply chain.

This article is tagged to:
Sector: Oil & Gas, Infrastructure, Power
Geography: India

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