Assessing new oil and gas sector policy steps
Govt seems to be active and on the right track in the energy sector
PHOTO: Reuters
ISLAMABAD:
The government seems to be quite active in the energy sector or hard work of the last year of the Energy Task force has started yielding results. Earlier, a draft of the Alternative Energy Policy was circulated which attracted stakeholders’ interest, and now the ingredients, if not policy, of the oil and gas sector has been revealed.
Simplifying and activating the petroleum concession, incentives for local gas production, carrot-and-stick approach with old refineries, opening up LNG sector and privatising LNG terminal business relieving the government from onerous financial risk and responsibilities are some major policy thoughts. The article will examine the sector issues in some detail.
Freeing up LNG Terminals business?
We will take the issues one at a time but let us start with the most important and probably contentious issue of LNG terminals. Currently, the government or its nominee public sector companies have to enter into a take-or-pay contract with the LNG terminal developers and owners under a competitive bidding process.
Although take-or-pay contracts are not uncommon in the energy sector, there is political controversy about it and public opinion is turning against such liabilities. Senior members of the previous government are under investigation on it and are behind bars. There is a lot of private sector interest in LNG terminals, if not the sector, as is evinced by five international companies that have shown keen interest. Almost riskless, LNG terminal business in the form of take-or-pay contracts and sovereign guarantees should and has evinced a lot of interest. However, it would be of interest to see if that interest would sustain in the new policy.
The CNG sector had earlier been granted an open policy which the sector has not yet been able to avail. However, now the CNG sector may be able to form some coalition with international companies in this respect. Associations have problems in decision-making and there are always usurpers ready to exploit.
There is no free lunch. The government is shifting the risk and risk cost money. However, an additional advantage is the flexibility and supposedly higher efficiency of the private sector. There are problems and issues, however. Firstly, we will have to decide whether over-supply is better or some-under supply can be afforded.
If the current capacity trap in the power sector is a guide, one would be more inclined to suffer, say, an hour of short supply in a day than having to pay for two or more hours of surplus. The competition requires a surplus which has costs. Cyclical crisis of capitalism is well known.
Secondly, the side-by-side management of the regulated sector and existing term contracts have to be handled somehow. For example, LNG-Qatar contract of $10-12 vs seasonally variable lower spot prices of $4-14. Some back-to-back contracts would have to be there to absorb the supply under these contracts. Or the government would have to resell the gas to the market at acceptable market price, earning and losing money seasonally. However, this issue is more related to opening up the whole LNG and gas sector than liberalising LNG terminals business.
Thirdly, would regulators have any oversight role or not? LNG terminals capacity may be more than demand and pricing may be based on 60-70% capacity utilisation. It would not be a pure competition situation of many buyers and many sellers. There are allegations or fears of collusion even in the cement and sugar where possibly much more competitive ingredients exist? Moreover, it would have to be assured that there are no restrictive practices and that there is third party access to the LNG terminals and the associated transmission facilities. And finally, should the other two LNG terminals be eventually brought under market mechanism? Maybe eventually under a negotiated settlement?
Streamlining concession
The local gas production scenario does not appear to be very hopeful. It appears that LNG will form an increasingly higher share in our gas supply. It is already 40% and known reserves can hardly survive beyond 10 years. There is potential if exploration activities are incentivised and enhanced and bottlenecks of the sector are removed. The new policy approach intends to do this. They want to reduce or eliminate red-tape and simplify the concession approval process.
It appears that they want to cut the feathers of petroleum concession bureaucracy and bring in the regulator to solve the grievances of E&P companies. It is hoped that the new arrangement would be better than the existing one. How about an Energy Tribunal which handles a wide variety of issues of the whole energy business, developers, contractors, etc? The scope of existing electricity tribunal (B-to-B), although not yet implemented, may be broadened?
Incentivising local production
There is a possibility of incentivising and expanding output from the known oil and gas resources. There are marginal fields or the ones that have been closed down or may be about to be closed, which could have produced more under an incentive programme of slightly higher prices, after all, we import LNG at higher prices. There are existing policies in this respect, which have not been able to attract enough interest and increase local gas supply. The new policy approaches appear to be acting in this direction, streamlining and further incentivising. Surely, some short-term improvement would come by.
The need for a market manager
There has to be some market manager which currently, Petroleum division is doing directly. In the power sector, there is NTDC and CPPA-G which are doing these functions. Demand and supply management and balancing the cost and price and managing subsidies etc could be better done in a corporate setup. While gas system operator may take time to implement along with other sector restructuring issue, there should be no problem in bringing about this central agency.
Role of Pakistan LNG may have to be broadened along with its capacity building or it is merged in a new company. The first or second step in gas market liberalisation would be and should be the parting away of spot purchases function from the public sector to the private sector.
Replacing old refineries through
a tax holiday
Fortunately, there is no more import of furnace oil. However, there is a lot of infrastructure of local production in the form of refineries and of consumption in the form of furnace oil power plants. The nexus and matching of this demand and supply do create some rationale and market pressure for not undoing the furnace oil totally. The problem is the high cost of furnace oil and low efficiency of old furnace oil power plants. In the intervening period, local refineries must manage to export furnace oil at some loss? The government seems to have made its mind to show the door to the old, inefficient and market incompatible refineries and has offered them tax holiday incentive for new investments.
This appears to be a step in the right direction. Alternative energy would be able to able to fill the gap, if any, at lower prices. There is thinking that some rules should be developed to maintain the availability of the efficient ones of FOPPs in one form or the other to take care of possible LNG emergencies.
Concluding, the path from the public sector to competition, the private sector and market liberalisation is a difficult one. Some further home work may be required with respect to LNG terminals. LNG/gas storage issue has to be resolved and many others. The positive news is coming from other areas as well. It appears that we are moving in the right direction.
The writer has been, Member Energy, Planning Commission
Published in The Express Tribune, September 9th, 2019.
The government seems to be quite active in the energy sector or hard work of the last year of the Energy Task force has started yielding results. Earlier, a draft of the Alternative Energy Policy was circulated which attracted stakeholders’ interest, and now the ingredients, if not policy, of the oil and gas sector has been revealed.
Simplifying and activating the petroleum concession, incentives for local gas production, carrot-and-stick approach with old refineries, opening up LNG sector and privatising LNG terminal business relieving the government from onerous financial risk and responsibilities are some major policy thoughts. The article will examine the sector issues in some detail.
Freeing up LNG Terminals business?
We will take the issues one at a time but let us start with the most important and probably contentious issue of LNG terminals. Currently, the government or its nominee public sector companies have to enter into a take-or-pay contract with the LNG terminal developers and owners under a competitive bidding process.
Although take-or-pay contracts are not uncommon in the energy sector, there is political controversy about it and public opinion is turning against such liabilities. Senior members of the previous government are under investigation on it and are behind bars. There is a lot of private sector interest in LNG terminals, if not the sector, as is evinced by five international companies that have shown keen interest. Almost riskless, LNG terminal business in the form of take-or-pay contracts and sovereign guarantees should and has evinced a lot of interest. However, it would be of interest to see if that interest would sustain in the new policy.
The CNG sector had earlier been granted an open policy which the sector has not yet been able to avail. However, now the CNG sector may be able to form some coalition with international companies in this respect. Associations have problems in decision-making and there are always usurpers ready to exploit.
There is no free lunch. The government is shifting the risk and risk cost money. However, an additional advantage is the flexibility and supposedly higher efficiency of the private sector. There are problems and issues, however. Firstly, we will have to decide whether over-supply is better or some-under supply can be afforded.
If the current capacity trap in the power sector is a guide, one would be more inclined to suffer, say, an hour of short supply in a day than having to pay for two or more hours of surplus. The competition requires a surplus which has costs. Cyclical crisis of capitalism is well known.
Secondly, the side-by-side management of the regulated sector and existing term contracts have to be handled somehow. For example, LNG-Qatar contract of $10-12 vs seasonally variable lower spot prices of $4-14. Some back-to-back contracts would have to be there to absorb the supply under these contracts. Or the government would have to resell the gas to the market at acceptable market price, earning and losing money seasonally. However, this issue is more related to opening up the whole LNG and gas sector than liberalising LNG terminals business.
Thirdly, would regulators have any oversight role or not? LNG terminals capacity may be more than demand and pricing may be based on 60-70% capacity utilisation. It would not be a pure competition situation of many buyers and many sellers. There are allegations or fears of collusion even in the cement and sugar where possibly much more competitive ingredients exist? Moreover, it would have to be assured that there are no restrictive practices and that there is third party access to the LNG terminals and the associated transmission facilities. And finally, should the other two LNG terminals be eventually brought under market mechanism? Maybe eventually under a negotiated settlement?
Streamlining concession
The local gas production scenario does not appear to be very hopeful. It appears that LNG will form an increasingly higher share in our gas supply. It is already 40% and known reserves can hardly survive beyond 10 years. There is potential if exploration activities are incentivised and enhanced and bottlenecks of the sector are removed. The new policy approach intends to do this. They want to reduce or eliminate red-tape and simplify the concession approval process.
It appears that they want to cut the feathers of petroleum concession bureaucracy and bring in the regulator to solve the grievances of E&P companies. It is hoped that the new arrangement would be better than the existing one. How about an Energy Tribunal which handles a wide variety of issues of the whole energy business, developers, contractors, etc? The scope of existing electricity tribunal (B-to-B), although not yet implemented, may be broadened?
Incentivising local production
There is a possibility of incentivising and expanding output from the known oil and gas resources. There are marginal fields or the ones that have been closed down or may be about to be closed, which could have produced more under an incentive programme of slightly higher prices, after all, we import LNG at higher prices. There are existing policies in this respect, which have not been able to attract enough interest and increase local gas supply. The new policy approaches appear to be acting in this direction, streamlining and further incentivising. Surely, some short-term improvement would come by.
The need for a market manager
There has to be some market manager which currently, Petroleum division is doing directly. In the power sector, there is NTDC and CPPA-G which are doing these functions. Demand and supply management and balancing the cost and price and managing subsidies etc could be better done in a corporate setup. While gas system operator may take time to implement along with other sector restructuring issue, there should be no problem in bringing about this central agency.
Role of Pakistan LNG may have to be broadened along with its capacity building or it is merged in a new company. The first or second step in gas market liberalisation would be and should be the parting away of spot purchases function from the public sector to the private sector.
Replacing old refineries through
a tax holiday
Fortunately, there is no more import of furnace oil. However, there is a lot of infrastructure of local production in the form of refineries and of consumption in the form of furnace oil power plants. The nexus and matching of this demand and supply do create some rationale and market pressure for not undoing the furnace oil totally. The problem is the high cost of furnace oil and low efficiency of old furnace oil power plants. In the intervening period, local refineries must manage to export furnace oil at some loss? The government seems to have made its mind to show the door to the old, inefficient and market incompatible refineries and has offered them tax holiday incentive for new investments.
This appears to be a step in the right direction. Alternative energy would be able to able to fill the gap, if any, at lower prices. There is thinking that some rules should be developed to maintain the availability of the efficient ones of FOPPs in one form or the other to take care of possible LNG emergencies.
Concluding, the path from the public sector to competition, the private sector and market liberalisation is a difficult one. Some further home work may be required with respect to LNG terminals. LNG/gas storage issue has to be resolved and many others. The positive news is coming from other areas as well. It appears that we are moving in the right direction.
The writer has been, Member Energy, Planning Commission
Published in The Express Tribune, September 9th, 2019.