Transportation Tariffs for Natural Gas Pipelines

Natural Gas Business

By Udit Agarwal(M-10-33), Rajat Gupta(M-10-25), Venu Vijay(M10-35), Swarbhanu Handique(M-10-32)

Factors affecting NG Pipeline Tariff Determination

Large upfront investments. Long gestation period. Risk of low utilization. Relative economics of alternate fuels. Constitutes upto 25% of the end price of the gas.

Prevalent methodologies of tariff determination

Cost Plus approach Indexation Market based rate setting Tariff based on bidding

Cost Plus approach

Tariff is determined on the basis of: Capex investment Opex investment Taxation Return on capital Normative Parameters Best for developing Gas Markets.

Indexation
Tariff is fixed on the basis of pre-set performance target. Tariff rate is allowed to be updated. Updation depends on achievement of performance targets. Adopted by UK and many EU countries. Not suitable for developing Gas markets.

Market based rate setting

Tariff is fixed on the basis of market based rates. Gas market should have enough competition. Adopted by markets having developed pipeline infrastructure. Approved basis for setting tariff in USA.

Tariff based on Bidding

Bids are invited for setting up of tariff. Entities can bid tariff based on there real cost of capital. Transparent and fair for all. Suitable for emerging markets. Provided enough competition exists in bidding.

NG pipeline tariff in India

Two methods are prevalent in India for determining NG tariff: Zonal-Postalized System. Postalized System

Zonal Postalized Tariff

Zones of length 300 km & width of 50 kms or 10% of pipeline length(whichever is lesser) each Same zone pay the same tariffs Entity to supply gas to all techno feasible customers in the zone. 300 KM 300 KM 300 KM

50KM Zone 1
50KM

Zone 2

Zone 3

Example
Zonal tariffing : An illustration (rates in Rs per mmbtu)
Particulars Zone 1 (closest to gas source) Zone 2 Zone 3 Zone 4 Zone 5 (farthest from gas source)

EWPL (East west pipeline of RGTIL) 15

42 54 59 61

HVJ-GREP-DVP

20
22 25 28 na

Source :: http://www.equitymaster.com/detail.asp?date=04/19/2011&story=4&title=Zonal-tariffBlockage-in-the--gas-pipeline

Bidding criteria
Lowness of PV of tariff bid for each year (70% wt)
tariff to be bid zone-wise (TZn >= TZn-1) with
40% weight for TZ1 20% weight for %age increase over TZ1 10% weight for %age increase over TZ2

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

An Illustration
Tariff Zone First Tariff Zone Second Tariff Zone Tariff Tariff bid for the first tariff Zone for first year Tariff bid for the first tariff Zone for first year X [1 + (PF2/100)] Tariff bid for the first tariff Zone for first year X [1 + (PF2/100) + (PF2/100) X (PS2/100)] Tariff bid for the first tariff Zone for first year X [1 + (PF2/100) + (PF2/100) X (PS2/100) + (PF2/100) X (PS2/100)^2]

Third Tariff Zone

Fourth Tariff Zone

PF2 - % increase bid for Zone 2 PS2 - % increase bid for Zone 3

Zonal Postalized system

Merits:
To balance the perspectives of the entities Incentive for the entities Ensure transparent bidding process

Zonal Postalized system

Demerits: Imbalance in economic growth. Industries that are located far from gas sources becomes uncompetitive Unfair penalty on retail consumers located far from the gas source

Complex issue
Tariff determination in intersection of pipeline
Z1 Z2 Z3 Z4 Z5 Z6 Z7 Z8
0.50 0.53 0.55 0.58 0.61 0.64 0.67 0.70 5.90 3.70

Gas A

3.00
0.61 0.58 0.55 0.53 0.50 0.53 0.55 0.58

5.78

Z5 Z4 Z3 Z2 Z1 Z2 Z3 Z4
5.20 4.20

Gas B

Postalized tariff system

Example: HVJ Pipeline Based on Discounted Cash flow (DCF) methodology . The rate of return on capital employed shall be the rate of return on capital employed equal to 12% post-tax. Reasonable rate of return on the total capital employed to determine the return on capital employed in the project over its economic life. Total capital employed shall be equal to the gross fixed assets in the project less accumulated depreciation plus normative working capital (equal to thirty days of operating costs excluding depreciation and eighteen days natural gas pipeline tariff receivables).

Postalized tariff system

The volumes of natural gas is considered as divisor in the determination of the unit natural gas pipeline tariff over the economic life of the project.
Year of natural gas pipeline operations First Second Third Fourth Percentage Utilization 60% 70% 80% 90%

Fifth

100%

Postalized tariff system

Merits: Ideal for Attracting New pipeline investments in developing NG markets. Return rate being risk related is a fair way of compensating capital investment. Simple to operate. Perceived balanced economic development. Uniform tariff policy can easily work for gas transmission pipeline business where capital cost rather than the operating expenditure holds the key.

Postalized tariff system

De Merits:
Multiple inefficiencies in the form of cross-subsidies. Uniform tariffs, if taken a closer look at, are same as Freight equalization policy adopted in 1948 by GOI. Factories were set up all along the ports or around big cities except Bihar ( one of the richest in mineral resources) . The policy simply destroyed Bihar's huge competitive advantage of holding minerals. Significant deviations in estimating cost.(example: HVJ Pipeline)

HVJ Pipeline Case

Government fixed HVJ transportation tariff at Rs 1150/tcm based on the recommendation of Sankar Committee on Natural Gas Pricing(December 1996). When reworked, transportation tariff of natural gas works out to Rs 679/tcm.(In 2004). Significant deviations due to changes in capital investment, debt-equity ratio, cost of capital, and transportation volume.

Analysis
Zonal Postalized seems to be a better option. Allows freedom to the bidding entity to bid tariff based on its real cost of capital. Demand-Supply and Market Dynamics of end-produce shall take care of (any) tariff-based advantage that is likely to accrue to any natural gas consumer in zones located near to the source of natural gas. Why should consumers of a natural gas-rich state subsidize consumers in other states L Mansingh.

Recommendations
Each zone to be given proportionate weightage as per the formula: S = n/2[2a + (n-1)d] S = 70%(Total Weightage), a= Farthest Zone, n= no. of zones, d= 6%( increase in tariff in subsequent zone) Example: Let no. of Zones = 5, d = 6%, then a= 2% TZ1 = 26%, TZ2 = 20%, TZ3 = 14%, TZ4 = 8%, TZ5 = 2%. SD ( ) of PV across the five zones should not be zero. Bidders are not allowed to keep same tariff across all the five zones. Final Calculation = K* Composite Score * When arranged in ascending order, the bidder placed in the median will win. In case of even number of bidders, the one with lower wins.

Contributions:
Udit Agarwal(M-10-33)- Introduction and various methodologies of tariff determination. Rajat Gupta(M-10-25)- Introduction to zonal postalized & Postalized tariff Venu Vijay(M-10-35)- Rationale, Merits, and De-merits of zonal postalized tariff.

Swarbhanu Handique(M-10-32)- Postalized tariff rationale, merits, demerits. Analysis of the tariff recovery basis on the development of gas markets in India, and Recommendations (Conclusions).

References:
Energy Security Insights(Volume 4, Issue 2, April-June 2009). Infralines paper on Transportation Tariff of HVJ and DahejVijaipur Pipeline. Provisional gas transmission tariff for Reliance, GAIL networks approved (Hindu Business Line April 20, 2010). GAIL to benefit from PNGRB tariff revision(The Financial Express October 28, 2011) PNGRB Regulations GSR340(E), GSR594(E), GSR480(E), GSR38(E), GSR769(E), GSR802(E) PNGRB Regulations GSR807(E), GSR986(E).

Q&A