A good deal

The 25-year deal that Petroleum Minister Mani Shankar Aiyar has inked with Iran for the supply of natural gas is a welcome breakthrough in terms of assured supply, and perhaps at the best price that could have been obtained in today’s market. While Brent crude oil prices are in the region of $50 a barrel, the maximum price that can be used for pricing the Iranian gas is $31.

In other words, while most analysts expect the price of oil to stay at current levels or rise further because of the way Chinese and to a lesser extent Indian demand are growing, the price of liquefied natural gas is unlikely to rise above the current ex-ship price of $3.5 per million British thermal units (million Btu).

To be sure, $3.5 per million Btu (to which have to be added the import duty, costs of re-gasification and transportation, and sales taxes) is much higher than the $2.83 negotiated by Petronet LNG from Qatar (the price cap here is $20 a barrel).

But that deal was negotiated in 2000 and ends in 2008. What makes the current gas deal sweeter is the fact that it is linked to India getting a stake in Iranian oilfields, vital since India’s own hydrocarbon reserves are limited.

The pity is that, a year ago, the same Iranians were offering gas to India at $2.6 per million Btu, but the Indian negotiators at the time were not willing to go beyond $1.8 since that was the price considered acceptable to the subsidised power and fertiliser industries (the largest users, who in turn have controls on their downstream pricing).

As a result of the distorted pricing of fuels such as gas, Indian companies have found it difficult to ink gas deals overseas, and users (like power stations) continue to use the more expensive naphtha or simply stop production.

A related problem is how this restricts India’s flexibility in gas pricing. Qatar, for instance, has inked a deal with Belgium’s Distrigas based not on any oil price indexation but on a domestic gas-price index; and Ras Gas officials are on record saying this will probably be the first of many such deals.

Exxon Mobil, similarly, has talked of the possibility of linking gas prices to that of coal, its natural substitute—but as long as India’s gas and coal pricing remains as distorted as it is, there is little question of anyone using anything but a crude oil indexation.

Naturally this is to India’s long term disadvantage since a coal-based indexation of gas prices is likely to keep prices more reasonable; certainly it gives negotiators more flexibility in negotiating prices and price indexation.

There are some fears about whether the deal will even fructify (supplies are to commence only in 2009), given the US position on Iran and its willingness to use force to achieve its aims. On the positive side, the fact that Iran is set to become a large gas supplier to Europe, Japan, Korea and China, among others, could temper the US reaction.

While the current strong-arming is restricted to the proposed pipeline from Iran and not to gas supplies of the type contracted, the fact is that both result in the same thing: the sale of gas.

It must be presumed that the minister of petroleum has factored in the associated risks, and has also ensured that the penal take-or-pay clauses in the deal do not apply to the country in the event of force majeure situations.