Energy firms warn against cost-plus pricing for gas

Aug 24 2014, 12:04 IST
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SummaryIn a Production Sharing Contract (PSC) regime, the risk of failure is borne by the contractor for which the investor does not get any compensation.

Ahead of a panel of secretaries beginning work on a new gas pricing mechanism, an association of top energy firms has warned that going back to cost-plus pricing will be a retrograde step that will lead to rewarding inefficiencies.

The Association of Oil and Gas Operators, which is made up for over two-dozen members including the likes of Reliance Industries, ONGC, Cairn, BP, BG, BHP and Essar, on August 18 wrote to Oil Minister Dharmendra Pradhan listing out pricing challenges and how a market driven pricing will boost output.

In an uncertain and highly probabilistic business like oil and gas exploration and production where only one in 10 efforts is successful, it is best left to the market to decide which fields under what conditions will be viable, it said.

In a Production Sharing Contract (PSC) regime, like the one under which RIL got KG-D6 block in Bay of Bengal, the risk of failure is borne by the contractor for which the investor does not get any compensation. Only upon a discovery is a contractor allowed to recover his cost from sale of oil/gas.

In a cost plus regime, all costs of failed exploration, appraisal as well as development efforts besides the cost of capital will be factored in to calculate the gas price, AOGO wrote.

A four-member panel of secretaries from different ministries will hold its first meeting on Monday to work out a new gas pricing mechanism, as the Rangarajan formula of doubling rates to USD 8.4 per mmBtu did not find many takers.

Stating that the government bears real risk in a cost-plus regime, AOGO said: "It is incomprehensible that the same people who oppose cost recovery system under present PSCs on the ground that the investment multiples gets affected, should be arguing for cost plus pricing where the attendant risks are far higher for the government.

"It is indeed to be considered that when the government is finding it difficult to manage PSCs run on a Cost Recovery basis, introducing cost-plus pricing will only further atrophy the process of grant of approvals and bring decision making to a standstill."

The government had disbanded cost plus prices even for nomination acreage given to state-owned firms way back in 1997 due to unending disputes about cost which needs to be considered for calculated price.

Stating that gas pricing cannot be based on vintage of production, it said such a move

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