RILs pricing formula

Print edition : October 19, 2007

THE formula adopted by Reliance for evaluating bids from prospective customers is at the heart of the controversy. The price is defined as a function of a constant and three other variables the dollar-rupee exchange rate, crude oil prices, defined in terms of Brent grade crude (North Sea oil), and C, a positive integer expressing the premium that the bidder is willing to pay for the gas. The constant ensures that RIL will get a minimum price of $2.5 per million metric British thermal units (mmbtu).

The actually biddable parameter that Reliance sought from bidders was the positive integer, after it defined the price range at which prospective bidders would get their gas allocations. In fact, this price range was rather narrow bidders were asked to bid between $4.54 and $4.75 per mmbtu. This is very unlike a normal auction process. Bidders are normally asked to quote a price they are willing to pay for the commodity on offer. Here, RIL set the price and found the buyers it wanted.

Moreover, the price was determined at the point where the total bid quantity amounted to 17.6 million metric standard cubic metres a day (mmscmd), whereas the gas from the D-6 block is projected to increase to 80 mmscmd in three years time from the start of operations.

Girish Sant, coordinator, Prayas Energy Group, pointed out in a recent study (in the Economic and Political Weekly, August 25, 2007) that by taking less quantity than is actually available, RILs method seems to yield a price which is much higher than the market-clearing price. Moreover, the contracts were to be for only three years unlike a normal gas contract, which is usually of a long-term nature, typically 10 years.

The formula caps the oil price variable at $65 a barrel (the floor is at $25 a barrel). However, since prices are currently high, any decrease in prices will have only a marginal impact on the price that RILs buyers will have to pay. Moreover, as Girish Sant and his team have pointed out, the impact of foreign exchange variation is also asymmetric. If the rupee appreciates as it has done in the past few months, those who bid for RILs gas will end up paying more.

The EGoM made much of the fact that it had managed to wrangle a discount from Reliance from $4.33 per mmbtu to $4.2 per mmbtu a reduction of about 3 per cent. It also announced that it had lowered the cap on crude oil prices from $65 to $60 per barrel in the RIL formula, and had removed the biddable parameter C, reflecting the premium, from the formula, ostensibly to penalise Reliance for its failure to ensure transparency.

However, it later became clear that the panel had only assigned a value of zero to the existing bids that RIL had invited; RIL will be free to make it a biddable parameter in subsequent bidding rounds.

V. Sridhar

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