February 2016: A Month of Low Expectations

Lydia Powell, Observer Research Foundation

Conventional Fuels

Oil & Gas

February was not the best of months for the Indian upstream oil & gas industry. The price of crude in the global market was below break-even prices but upstream companies announced that this was the right time to invest in deep sea exploration blocks as oil services have become more affordable. Talk on developing strategic reserves picked up as the opportunity cost of storing oil is relatively low now. The loading of Iranian crude on to an Indian tanker after the removal of sanctions on Iran is among the few interesting developments in the oil sector in February. The government announced that it is considering the development of an oil trading platform. This will enable companies to use the spot market rather than long term tender based crude purchase and thus enable them to take advantage of falling prices.

Refiners who thrive on margins had little to complain about as demand for fuels was reported to be growing at the fastest pace in three months. Indian refiners were also said to be joining forces to extract better deals from OPEC oil sellers. The inauguration of the IOC’s Paradip refinery offered photo opportunities for political leaders. Paradip also increased the prospect for shipping oil products to Bangladesh. One of the unexpected developments in the refining sector was the emergence of China as a major exporter petroleum products.  This is unlikely to be pleasant news for export oriented private refineries.

The government is supposedly attempting to reintroduce taxes and levies such as the customs duty on crude imports that were withdrawn when oil prices were high in the budget to be announced next month. Refiners were said to be resisting the move to impose a tax of 5% on the import of crude as it will add to the tax on the import of products. On the other hand, the government is also said to be considering a change of the cess on petroleum to ad valorem basis. The government continued to exempt subsidy payments from PSU companies.

Natural gas prices continued to fall in the global market and consequently domestic prices that were linked to global prices in the hope that global prices will stay high also fell. Unless a new formula is devised that has a component that will increase with the increase in geological and technological complexity of the gas field the fall in domestic prices is unlikely to be arrested. The government is anxious to pursue subsidy auctions for gas based power generation and the hope is probably that they will get bids that will offer a premium to the government rather than a mere discount on the subsidy. The news item that may have puzzled many in the context of gas is that of an India Australia panel for supply of Australian LNG to Indian power plants. In an environment of subdued demand for power and falling prices of coal why would anyone want to use expensive Australian LNG for generating expensive power? Is it a strategy for Indian tax payers subsidising Australian LNG producers under the subsidy auction scheme?

Coal

There wasn’t much to celebrate on the coal front either. Coal block auctions seem to have just replaced an old set of problems with a new set of problems. Continued tinkering of auctions framework did not appear to be helping the situation. It is not without reason that they say markets grasp situations better than bureaucrats: markets have to put their money where their mouth is. The Minister in charge of coal and power sectors said that coal and power were a trillion dollar opportunity but once again markets may beg to differ! Coal imports continued to fall not only because of improvements in domestic production but also because of lower demand for coal.

A special forward e-auction for power producers and non-power producers that was supposed to have been implemented in February is said to have been deferred indefinitely. The official reason for such cancellation is not known but coal buyers are of the view that it was the result of poor demand probably on account of the fact that the base price was about 20% higher than the notified prices.

On the other hand, The Cabinet Committee on Economic Affairs, chaired by the Prime Minister approved the framework for auction of linkages of non-regulated sector. All coal allocations of linkages/Letter of Assurance (LoAs) for non-regulated sector i.e. cement, steel/sponge iron, aluminium, and others (excluding Fertilizer (urea) sector), including their captive power plants, are to be auction based with separate quantities earmarked for sub-sectors of non-regulated sector. The tenure of Fuel Supply Agreement (FSA) will be as decided by Ministry of Coal from time to time. The idea is to ensure all market participants of non-regulated sector have a fair chance to secure coal linkage, irrespective of their size. No new linkages or LoAs have been allocated to non-regulated sector since 2007.

Regarding new initiatives taken for quality improvement of coal, it has been made mandatory to supply 100 percent crushed coal of (-) 100 mm size to power sector consumers having FSA excluding pit head power plants of Northern Coal Fields and Eastern Coal Fields. To further strengthen the system, an independent Third Party Agency is to be empanelled by Central Institute of Mining and Fuel Research at the loading end on behalf of both the power plant and coal companies. The Parliamentary Consultative Committee attached to the Ministry of Coal reviewed the status of implementation of the mandate on coal washeries and measures being taken for improvement of quality of coal by Coal India Ltd (CIL) and its subsidiaries. However, the question of poor capacity utilisation of washeries remains.

Power

The power sector did not make it to the headlines in February as there were no power cuts. There is nothing to celebrate because no power cuts does not necessarily mean power for all. Power that could have lit up over 16 million households remained unsold not because there was no access (wires) but because there was no demand. It is tempting to assign blame on state electricity boards (SEBs) for having destroyed demand but lack of demand for electricity is a clear sign of lack of development. Illiquid SEBs are a consequence of the lack of development not the cause of it. The states enlisting on the Government’s UDAY (Ujwal Discom Assurance Yojana) scheme for financial turnaround of Power Distribution Companies was reported. Though the scheme is being promoted as the answer to all problems at the distribution end of the power sector, there appears to be little that is new in the scheme that has not been tried before.  Some of the more positive news from the power sector included news on India submitting the Instrument of Ratification of the Convention on Supplementary Compensation for Nuclear Damage, 1997 to the International Atomic Energy Agency (IAEA), the depositary of the said Convention which may pave the way for greater clarity on the nuclear liability regime in India. There was also positive news that the nuclear plant in Koodankulam had started generating after repeated delays on account of technical faults but by the end of the month it was reported that generation had terminated on account of yet another technical problem!

Renewable Energy

Apart from the routine stream of news on new renewable energy projects being proposed or implemented there was also news that the United States had won a ruling against India at the World Trade Organization after challenging the rules on the origin of solar cells and solar modules used in India’s national solar power program. So much for make in India!

Views are those of the author                    

Author can be contacted at lydia@orfonline.org

Courtesy: Energy News Monitor | Volume XII; Issue 37

 

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Coal Auctions is really a Game Changer?

Ashish Gupta, Observer Research Foundation

On August 25, 2014 the Supreme Court declared that the allocation of coal blocks was illegal & arbitrary.  On September 24, 2014 it cancelled the allocation of all the 218 coal blocks. Following this, the Indian government issued the Coal Mines (Special Provision) Ordinance 2014. The Coal Mines (Special Provision) Bill 2014 and its subsequent rules were passed in December 2014 and the Coal Mines (Special Provision) Act, 2014 was included in the Indian coal mining legislative framework. The government was then free to auction or allot coal blocks to state owned firms. This is how the idea of auctions was introduced. But the process adopted to lay down the framework of auctioning coal blocks started before the cancellation order. The developments are given below:

  • On September 10, 2010, the government amended the Mines & Minerals Development & Regulation Act to facilitate way for competitive bidding
  • On February 2, 2012, the government drafted the framework for auctions by competitive bidding of Coal Mines Rules, 2012 which was amended on December 27, 2012 and further amended on March 11, 2014
  • On May 30, 2012, 54 coal blocks across seven States identified for allocation by Ministry of Coal (MoC)
  • On November 23, 2013, the Cabinet Committee on Economic Affairs approves the bidding methodology
  • In February 2014, MoC releases draft Request for Proposal and Coal Mines Development and Production Agreement

The government promoted the idea of auctions on the premise that the process will bring transparency and offer an equal opportunity for all consumers of coal. The government also hoped that the process will determine the true value of coal and started the auction process. Selected coal blocks were divided into three categories: Schedule I included all coal blocks; Schedule II included 42 coal blocks ready to operate and Schedule III included 32 coal blocks which have made progress towards development. The auction process was held separately for power (regulated sector) and non-power (non-regulated) sectors. A floor price was set by the Government for each mine based on its intrinsic value and bidders were required to quote above this floor price.

Auction Status

image (1)

 

Source: MSTC

As of now 66 coal blocks have been offered through auctions but only 6 coal blocks are in operational stage. The companies are losing interest in coal auctions because they bid aggressively in the first two rounds and agreed to pay huge additional premiums which cannot be charged to the consumer.  In the first round when Schedule II mines were put up for the auctions, the government received 176 bids for 21 coal blocks (for eg Gare Palma V – 16 bidders). The auction of Schedule III mines in round two also witnessed large number of bidders (for eg Utkal C – 16 bidders, Jamkhani – 11 bidders etc). This clearly shows intense competition for some blocks. The extra premium the bidders quoted for power sector ranged from INR 470 to INR 940 per tonne, all negative. In negative bidding, power producers forego their right to pass on the mining cost to the consumers and instead agree to pay additional premium to the government. For the non-power, the prices quoted ranging from INR 900 to about INR 3000 rupees per tonne.

image (2)

Source: ORF Coal Auction Roundtable

In the first two rounds, the companies were desperate to secure coal blocks as they had invested heavily in the end use plant for which they needed fuel security. Now companies are very cautious in participating in auctions.

Till now, three rounds of coal auction have been conducted by the government. While the first two tranches of the coal auction had fetched the government over INR 2 lakh crore from the auction of 29 mines, the third round saw bidding of only 3 mines as against planned 10 mines. Four blocks were withdrawn due to lack of bids at the technical qualification stage. The government cancelled the fourth round of coal block auction scheduled in January 2016 owing to a lukewarm response. Apart from this firms are reluctant to proceed with the coal block takeover and subsequent operations owing to uncertainty of coal cost recovery. Recently, Monnet Ispat proposed to surrender its Utkal C block due to proposed capping of fixed charge in the judiciary. This is among many reasons why the last two rounds were not able to garner enthusiasm. This also shows that companies now are considering many factors such as savings in development risks, views on alternate fuel cost, fuel security, and realisation of production/returns than just the intrinsic value.

With the inputs negatively priced or priced at a high cost, the economic viability of their project becomes uncertain. The negative prices for inputs for a period of, say, 25 years, may not be a realistic solution, since this will lead to significant cost recovery pressures. Combined with the proposed capping of fixed charges by the government, cost recovery casts a long shadow on the viability of the winning bids. As such, efficient mining, cost control and maximum recovery are key for success. But the question remains as to whether the companies will be able to attract good technology/design at competitive prices and whether the coal auctions will be able to deliver concrete outcomes in terms of efficiency and commercial viability?

Views are those of the author                    

Author can be contacted at ashishgupta@orfonline.org

Courtesy: Energy News Monitor | Volume XII; Issue 36

 

January 2016: Falling Oil Prices haunts Global Energy Markets

Lydia Powell and Akhilesh Sati, Observer Research Foundation

Conventional Fuels

Oil & Gas

The month of January opened with the fall in the Chinese stock market along with the fall in the WTI and Brent price of crude oil to below $34/bbl, the lowest in 12 years. Analysts said that they expected Chinese oil consumption growth to fall to 300,000 bpd in 2016 from 500,000 bpd in 2015. A weaker Yuan was also expected to contribute to the decline in demand as a depreciating Yuan would make imported oil expensive. While the fall in oil prices to below $60/bbl was primarily thought to be on account of over-supply during a period of falling demand, the strong dollar was seen to responsible for its fall from $60/bbl to about $30/bbl. According to Morgan Stanley a 5% appreciation of the dollar could lead to a 10-25% fall in the price of crude oil.

By the middle of January the price of crude dropped below $20/bbl and investment banks such as Morgan Stanley endorsed the position of Goldman Sachs that the price of crude will fall below $20/bbl. Standard Chartered stood out with a forecast of $10/bbl.  Some expect the 3 million bpd loss in production to boost prices early next year on the basis of the much quoted figure of $340 billion reduction in upstream spending by Wood Mckenzie.  Leading this camp is Citibank which expects prices to increase to $52/bbl by the end of this year. According to some analysts one third of US oil and gas producers could be forced into bankruptcy by next year if oil prices do not improve. Meanwhile the hope that OPEC would reduce production to prop up prices began fading.  The anticipated increase in production from Iran is expected to change OPEC position but only when production actually materialises.

The depressing news on oil prices was followed by the sensational revelation from the deputy Crown Prince of Saudi Arabia that his government is considering an IPO of Saudi Aramco. Many interpreted this as a sign of financial crisis brewing in the kingdom. Later the company chairman confirmed the interest and hinted at the possibility of a limited IPO. Aramco accounts for as much as 10% of global production and has about 260 billion barrels of conventional oil reserves under its control. The investment community is said to be eagerly awaiting this opportunity for investment in Aramco as even a 5% listing is expected to be worth trillions of dollars.

The sensational news on the lifting of oil sanctions on Iran led to speculations on how this will play out on positions taken by Saudi Arabia in OPEC and how the geo-political and oil rivalries between the two countries will affect global markets. Iran is reported to have 50 million barrels stored in tankers floating around the Persian Gulf.  Towards the end of January Saudi Arabia announced that it can survive low oil prices for a ‘long, long time’ probably hinting that it is ready to cut off its nose to spite Iran.

The news on natural gas was far more depressing than that on oil. There was news that the Canadian Government had approved a 40 year LNG export licence to Royal Dutch Shell from its proposed terminal in the Pacific coast. A number of others are said to be in the queue for similar licenses. Shell’s final investment decision is not expected immediately but if it does make the decision to invest, the terminal could be operational by 2022. Cheniere Energy is expected to ship the first LNG cargo from the US coast by the end of February rather than in January as anticipated. High cost LNG terminals in Australia also began shipping their first cargoes this month. While Australia Pacific shipped its first cargo in the middle of January Gorgon LNG is also expected to come on-stream soon.  Many expect the problem of over-capacity to hit the LNG industry much harder than that of the oil industry and the high cost terminals in rich nations may be hardest hit.

Natural Gas Prices

image (1)

 

Source: InfoMine.com

In other gas developments, the most notable was Argentina’s reported preliminary deal with an American company to develop its shale gas resources. The $ 500 million deal is expected to include a pilot project that will last till 2018.

Coal 

The Obama administration announced that there will be a moratorium on new coal leases on federal lands until a comprehensive review programme the environmental impact of coal mining is completed.  Coal mining from federal lands accounts for 40% coal mined in the United Sates. This news was seen to be a blow to the coal industry which is already under tremendous stress from falling coal prices. China’s import of Australian coal was reported to have fallen by 30% in 2015. There were some expectations of a revival of coal prices on account of a cold snap in China but this was not expected to reverse the long term trend of terminal decline.

Renewables

The news of the impact of low energy prices on the renewable energy sector is yet to arrive but numbers for 2015 look good. According to Bloomberg New Energy Finance $ 330 billion was invested in clean energy which was a 4% increase from the previous year. Solar installations amounted to 57 GW globally and wind installations amounted to 64 GW in 2015. It is too early to assume that end of the fossil fuel age and the beginning of the alternative fuels age is just round the corner. Behind every solar panel and wind turbine are barrels of oil and tonnes of coal. If fossil fuels go down it is very likely that they will take renewables with them.

Views are those of the authors                    

Authors can be contacted at lydia@orfonline.org, akhileshs@orfonline.org

Courtesy: Energy News Monitor | Volume XII; Issue 34