PHD House, New Delhi September 24, 2009Presentation to Petrofed Members Policy & Regulations on Natural Gas Pipelines& way forward

Presentation covers

drivers for gas markets & models

gas market development stages

Indian gas market

downstream regulatory framework

way forward

drivers for gas markets & models

context drivers for gas marketsdiscovery of substantial quantities of gas in association with oil drilling (USA) or large discoveries of non-associated gas in industrial nations (Europe)

strong desire to reduce urban pollution caused by coal or heavy fuel oil (UK, Germany) supported by GDP levels & personal affluence to make gas a fuel of choice

strong support from government (all countries)

comparative shorter transport distances boosted development of pipelines (Netherlands & UK)

existing coal based town gas grids facilitated market penetration (UK, USA & Germany)

gas was priced competitively against existing fuels (Germany & Netherlands)

use of more polluting fuels was discouraged (UK & Netherlands)

countries that are substantial net importers of energy wish to diversify primary energy supply (Korea & Japan post 1970s Gulf oil crisis)three principal models of market development

gas industry development model 1private monopolies(multiple networks)regulationderegulationopen accessprivate Monopoly (or oligopoly) model is typical of USA (FERC) & to some extent Germany (Self regulated basis)local town gas grids are connected by multiple, privately owned gas networks

gas transportation typically takes place on a monopoly or occasionally contract carriage basis

regulation of market becomes a necessity to promote orderly development, private investment, long term consumer gain & to encourage responsible operators

long-run regulation tends to create distortions & inefficiencies, leading to deregulation & development of open access regimes, typically on a contract carriage basisisolated grids

gas industry development model 2development of State-owned monopolies has occurred in a number of countries, notably UK & Francenationalisationstate monopolies(single networks)privatisationopen accessliberalisationisolated gridslocal town gas grids declined, following development of electric lighting, were later nationalised & consolidated by post-war governments

introduction of natural gas in 60s & 70s sees state funded development of transmission networks & conversion programmes

privatisation of state assets seen in UK & South America (now under consideration in France) typically after up to 30 years of state ownership

UK model has evolved to fully open accesspartial access in France

hybrid monopolies(mixed private/ state)open accesspublic/ private developmentliberalisationseparationgas industry development model 3isolated gridsIn a number of countries a partnership between State & private industry has driven developmentsas seen in Netherlandsdevelopment of industry viewed by government as a national priority

government takes an equity stake along gas chain or is heavily engaged as facilitator or guarantor

no privatisationgovernment retains stake in assets prior to adoption of an open access system typically 30 40 years later

gas market development stages

classification of gas industriesgas industry of any country can generally be defined on two axes of infrastructural or market sophistication 1 2 gas sources. Some high pressure transmission pipelines with

same applies to market sophistication state monopolyprivate monopolyemerging (competitive)emerging (restructuring)liberalisedstate owned transmission assets, municipal ownership of local distribution grids. Strong horizontal & where appropriate, vertical integration. De facto regulation by government ministriessignificant private ownership of transmission & distribution assets. National monopoly or regionally focused oligopoly in transmission, distribution & supply. Limited negotiated TPA to transmission networks. Regulation by statute &/ or state ministrygovernmental or supra-governmental drive for competition & break-up of monopolies. Negotiated access to capacity, rudimentary energy balancing/ settlement mechanism. Government appointed independent regulator and/ or supra-national bodyso for Emerging Competitive but including partial (accounting) or legal separation transportation & shipping. Developing non-discriminatory access to capacity, cost reflective energy balancing & settlement mechanism. Independent regulatory body focused on promoting competition & limiting monopoly powersranging from partial (Industrial & commercial) to full (including residential sector) liberalisation. Full separation between transportation & supply. Horizontal integration with dual fuel suppliers. Fully non-discriminatory access code with mature energy balancing & settlement regime. Regulatory emphasis shifts from competition towards incentivising network efficiencyclassification of gas industries

plotting relationships - markets & regulationno two gas markets are exactly alike, but high level classification is possible along two axes parabolic relationshipsstatemonopolyprivatemonopolyemergingcompetitiveliberalisedbasicemergingsub-maturematuremarket/ infrastructureownership/ regulation(restructuring)(restructuring)infrastructure & market maturitystructure

different stages of developmentnonerelative position of gas markets

gas market development case studies

UKStateMonopolyPrivateMonopolyEmergingCompetitiveLiberalisedBasicEmergingSub-MatureMatureNationalisation of private gas companies1948 - 19861986 - 19921992 - 1998Full unbundling of transportation & supply Full I&C and residential competitionPrivatisation and limited TPAevolution of UK gas marketUK is now an advanced liberalised gas market but how did it get there?extensive town gas system dating back to 1860snationalised in 1948small natural gas network created early 1960s for Algerian LNGgas discovered in North Sea 1965national transmission system constructed 1967 1973 town gas systems convertedBritish Gas privatised -1986full I&C competition - 1992full residential competition -1998now bedevilled by regulatory complexity

EU gas market is not what it used to berecent past

emergent markets

exclusive rights (infrastructure & supply)

national monopolies

demarcation zones

no gas-to-gas competition

gas prices contractually linked to oil

vertically integrated companiesnear future

mature but growing markets

equality of market rights

freedom to invest and sell

several players in all markets

integrated market with TPA

gas-to-gas competition

gas prices also a function of gas-to-gas competition (market-based)

legal separation of transportation.transition towards a new world with new roles, business models & risks

European gas market maturityduring past 30 years, Europe has matured into a large, integrated gas marketmaturity of infrastructure allows progress towards more liberalised market models

evolution of US gas marketdifferent development path in USA - huge geographical scale with strong free market ethicsparallel evolution of natural gas & town gas since early 20th centuryrapid expansion post 1945 via competition between private monopoliesstrict regulation of prices & development introduced to curb excess & manage developmentderegulation of interstate pipelines under FERC 501 in 1986 with progressive deregulation of pipelinesdifferent states moving towards fully liberalised markets at varying speedsregulatory model adapting to meet security of supply issues

gas pipelines in USA (Lower 48)USA enjoys a substantially mature gas pipeline network, linking demand centres with traditional sources of supplyFERC regulates interstate pipelines & SERCs regulate intrastate pipelines

evolution of Dutch gas marketDutch market model follows lines of a unique private industry/ state collaborationsmall legacy town gas industrysuper-giant gas discovery at Groningen in 1959state/ private entities of Gasunie, NAM and Maatschaap created in 1963main pipeline construction phase (internal & export) 1970 - 1980rapid penetration achieved by competitive pricing against other fuelsimplementation of EU competition directives saw unbundling of Gasunie

evolution of German gas marketGerman gas market is unusual in Europe, having no direct State involvement, but self regulationconventional town gas origins, first imports of natural gas in early 1960sGermany has always been heavily dependent upon importsno direct State participation but heavy involvement as facilitator & guarantor multiple transporters, distributors & LDCsmain period of infrastructure growth 1975 1995, undergoing consolidationongoing liberalisation under EU directive though with a weak regulatory model (energy regulation has been made a sub-department of the telecom regulator)

StateMonopolyPrivateMonopolyEmergingCompetitiveLiberalisedBasicEmergingSub-MatureMatureKorea1987 - 2003evolution of South Korean gas market Partial privatisationsplit of KOGAS in 2003Korean gas market is entirely LNG based around State owned transportation infrastructure & private LDCsKOGAS formed in 1983 to develop industryfirst LNG imports in 1987varied State, private & municipal ownership3 LNG import terminals, 20 separate LDCsstrong government involvement in providing subsidy & fiscal relief for infrastructure development, in building regulations & for bus conversiondriven by need for supply diversity & environmental improvementsplanned privatisation & separation of KOGAS into 3 separate supply companies in 2003 but considerable difficulties exist due to political & union resistance

generic gas industry development Pathat a high level, similar patterns emerge around the worldthere is no example of a substantial gas market emerging from a fully liberalised market

theoretical economic attraction is not borne out by evidence

Indian gas market

natural gas demand: latest outlookLatest outlook as per 11th plan document (MMSCMD)

Indian gas industry Power & fertilizer prime consumers (70%)

Captive & industrial consumption (30%)POWERFERTILISERPETROCHEM/ LPGSTEELINDUSTRIESCITY GAS/ CNG

projected imports of natural gas OECD/IEA

LNG sources: India

gas sector infrastructure: current & futureJAGDISHPURPHOOLPURBAREILLYDISPURSURATPATNAAHMEDABADRAJKOTUJJAINAGRAJHANSI DABHOL5 mmtpaBHUBANESHWARKRISHNAPATNAMNELLOREAURAIYAEnnore(proposed)5 mmtpaemerging signs of maturing domestic gas market: plans afoot to have basic gas grid connecting sources of domestic gas, LNG terminals & demand centers

downstream regulatory framework

natural gas pipelines

seek orderly sectoral growth & entry control

promote efficiency

productive: competition & reasonable cost

allocative: who remains in market ?

signaling role of price: cost reflective pricing

equity

fair play: access to natural monopoly assets

managed transition: legacy of controlled market (with state ownership) to robust segmented market

compliance all stakeholders to adhere to rules & regulations, minimum service obligations & civic normsregulatory design: objectives

govt. policy on gas pipelinesupfront provisioning of tax incentive u/s 80-IA (4) for infrastructure benefits: however, IT Act provides for 25% extra capacity, which is at variance with that in GOI policy for pipelines (33% extra capacity)

interchangeable use of common carrier or contract carrier in policy document & PNGRB Act, 2006- yet internationally gas markets have first been contract carriage systems before graduating into mature common carriage or hybrid systems

time frame for unbundling, which is key to creation of independent shipping interest not firmed-up

covers pipelines including spur line for transport of natural gas along with connected equipments & facilities, but excludes

dedicated pipelines for transporting natural gas to specific customer to meet specific requirements (& no re-sale)

pipelines in a CGD network

EOI followed by bidding route (or Suo Motu by Board)

does provide enabling platform with

minimum technical qualification requirements

net worth & bid bond linkage with pipeline length ensures serious biddingauthorization process

PNGRB may modify or accept EOI depending upon gas availability or need to expand an existing pipeline & guided by objective (s) of:

promoting competition among entities;

avoiding infructuous investment;

maintaining or increasing supplies or for securing equitable distribution;

ensure adequate availability of natural gas throughout the country;

protection of customers interest in terms of availability of natural gas at reasonable natural gas pipeline tariff;

incentivizing rapid development of natural gas pipeline infrastructureauthorization process

authorization processbidding criteria (25 years economic life):

lowness of PV of tariff bid for each year (70% weightage)

highness of PV of natural gas volumes (in MMSCMD) proposed to be transported (30% weightage)

Notes:

tariff to be bid zone-wise (TZn >= TZn-1) with 40% weight for TZ120% weight for %age increase over first zone10% weight for %age increase over TZ2 (constant % thereon)

PV to be determined by using discount rate of 12%

bids to be consistent with assumptions considered in approved DFR of project

entity with highest composite score is successful

bidding processillustratedshort & medium term: expected participation from gas producers only- guided by desires to timely reach markets to match gas monetization plans & surety on capacity utilization!

extra capacity provisionsprovision for extra capacity in natural gas pipeline to be made available for use as common carrier by any third party on open access & non-discriminatory basis

capacity of natural gas pipeline = A + B + Ccapacity requirements of entity (?)firmed-up contracted capacity with other entitiesat least 33% of (A) & (B) = extra capacity

(?) should entitys own requirement be clubbed with that of requirement of its own affiliate as well (provisions in PNGRB Act, 2006 does not envisage so; yet authorizations of some of pipelines do not suggest so)

extra capacity provisionsboth government policy & PNGRB have same objective of having competitive gas markets key is progressive unbundling along gas value chain

to create new authorization on bundled basis only to be unbundled later may have serious consequences in future

clubbing provision may have potential of serious monopoly abuse, in case authorized entity were to create an affiliate to be used as surrogate for blocking capacity booking by others

consumer may have only bundled contract option restricting it to either authorized entity or its affiliate

provisions in affiliate code of conduct may come in conflict when affiliate capacity requirements are to be assessed

section 21 of the PNGRB Act 2006 emphasizes need for fair competition & availability of natural gas

extra capacity provisionsproviso to sub-section (1) of Section 21 of PNGRB Act, 2006 provides for application of provisions of affiliate code of conduct for separating activities of marketing from transportation of natural gas for pipelines

mention of right of first use for its own use in sub-section (1) of section 21 of Act is with reference to an entity laying, building, operating or expanding a natural gas pipeline

further, definition of entity under sub-section p of Section 2 of Act implies that reference is to type or constitution of an entity & clearly an entity cannot and does not include its affiliate

therefore, it logically follows that assessment of own capacity requirements of an entity does not envisage inclusion of capacity requirements of its affiliate

tariff determinationtariff model: cost of service (discounted cash flow)

historical cost of assets to be considered on rolling basis

efficiently incurred capex & opex with linkage with capacity (existing pipeline capacity determination an issue ?) & operating parameters of pipeline: to be considered over economic life of project (replacements factored)

norms for capacity utilization & variable costs linked to actual throughput

returns linked to12% post-tax on capital employed (implying project funding & fund re-engineering flexibilities available)

infrastructure benefits u/s 80-IA allowed to be retained: shall incentivize pipeline investments

capital employed = net fixed assets (gross fixed assets less depreciation at SLM rates as per Companies Act + normative working capital (30 days of opex: at variance with product pipelines at 20 days during APM days)

tariff determinationtariff model: cost of service (discounted cash flow)

no change in tariff in case of capacity expansion by up to 10%

in case of capacity expansion >10%, entity to submit proposal to PNGRB & same may be allowed provided entity agrees to reduction in tariff by sharing fifty percent of proposed incremental tariff revenue calculated based on applicable tariff before expansion & incremental volumes

non-discriminatory charge of tariff & tariff to be reflected in invoice in energy equivalence terms (Rs./ MMBTU) making system more transparent from consumers standpoint

PNGRB, in medium term, should focus on evolving best standards & practices in pipeline laying, building & operations to enable development of benchmarks for efficient capex & opex in pipelines

tariff recovery system potential disconnect300 km eachTZ 1TZ 2TZ 3TZ 4TZ 550 km bandInterconnecting pipeline1.201.351.451.531.601.201.351.451.351.45two-way gas flows physical impossibility- may result in unofficial swap positionsinadvertently netback advantage could flow away from inter-connected pipeline into interconnecting pipeline resulting in:pre-mature gas-to-gas competitioninterconnecting pipeline opts for postalized tariff for entire pipeline length & customer closer to starting point sufferscustomer pays different tariffs based on gas source in same pipeline in same zone!new pipeline development gets adversely impacted as two-way gas flows cannot be envisaged in economics of pipeline design as volume flows may not be same in each tariff zonerationale of tariff recovery similar to a railway line where passenger getting-off closer to starting point does not want to pay fare for distance not traveledflexibility of volume variations in tariff zones allowed as pass-through in tariffprinciple based on pay for distance traveled alone may make inter-connection proposition unattractive for inter-connected pipeline.maybe tariff recovery system should be dynamic to gas grid concept & not vice-versaInjection point

way forward

some issues in way forwardcalibrated movement required (considering nascent stage of Indian gas market) from zonal postalized basis to full fledged entry-exit model for tariff recovery system, which is hallmark of most developed gas markets (Netherlands & U.K.)

regional network of pipelines may sometimes resemble CGD networks, yet CGD regulations cannot be applied due to legacy issues & impracticability, like, AGCLs NE network of pipelines catering to small tea gardens; Charottar co-operative catering to small villages in an area along small industrial customers belt; Vadodra municipal corporations pipeline network catering only domestic PNG segment, etc.

applicability of tariff system yet to be articulated for regional network of pipelines, like GAILs pipeline network in KG basin

some issues in way forwardmonitoring mechanism for ensuring transparent contracting based on access code provisions

impact analysis of provisions of direct tax code on new natural gas pipeline projects

notification still awaited on regulations for basis of capacity determination for existing pipelines & declaration of pipelines as common carrier or contract carrier as envisaged in PNGRB Act, 2006 & in pipeline authorization regulations

thoughts on evolving trading platform for trading in pipeline capacity & gas supply contracts

way forward for Indiapossible alternative routes to be guided by degree of

non-discriminatory access allowed to CC capacity

effective unbundling of transportation & marketing activities

& during such period, adherence to ACOC provisions, regulatory maturity in handling complex access code issues & GOIs forward looking policies shall be keenly followed by industryCurrent

Thanksviews contained in this presentation are expressed in personal capacity Vijay Duggal, DGM Commercial (CGD), BPCL duggalv@bharatpetroleum.in

Each energy economy tends to act as a precursor for next variety of catalysts initiating development of natural gas industries.

Natural gas is not a fungible commodity as its storage and transportation is always difficult and expensive. This considerably impacts the monetization of stranded gas. Technology was developed in 1960s for liquefying natural gas in units called trains at 260 degree F thereby gas contracts by 610 times so as to facilitate LNG storage in cryogenic tanks mounted in vessels for transportation to a distant LNG receiving terminal, where the same is re-gasified for onward transportation by pipelines. Over the years, technological advancement has considerably brought down the liquefaction and freighting costs. This development is responsible for increasing LNG share in world gas trade to around 13%. India would be looking at Australia & Malaysia, besides Qatar for securing additional LNG volumes on long-term contracts.Basic gas grid would imply cross-country high pressure gas pipelines in the first stage. Second stage would require intra-state medium pressure gas pipelines emanating from cross-country pipelines. Line-pack volumes in pipelines would offer basic security from disruption of supplies, but would require creation of expensive storage systems (cavern storage, abandoned gas fields, salt domes, etc.). India offers an excellent gas tolling options (whereby LNG vessel could offload in multiple LNG receiving terminals). With infrastructural maturity, Indian gas market is expected to become sophisticated and we would see launch of many new trading systems, such as a) commodity and pipeline capacity trading; b) emergence of Asian gas reference point (for pricing) on the lines of NYMEX, Henry hub, Zeebrugge (The Belgian interconnection point); c) LNG swap option, whereby ex-Qatar LNG supplies to Japan (entailing high freighting cost) could be swapped with Indias stake in Shakhalin gas fields.