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Gas price reductions harm upstream industry

The Energy and Mineral Resources Ministry recently announced the reduction of certain gas prices for specific industries to US$6 per million British thermal units (mmbtu) at the consumer level effective on April 1

Yusak Setiawan (The Jakarta Post)
Jakarta
Fri, May 8, 2020

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Gas price reductions harm upstream industry

T

he Energy and Mineral Resources Ministry recently announced the reduction of certain gas prices for specific industries to US$6 per million British thermal units (mmbtu) at the consumer level effective on April 1.

The gas price cut was based on Presidential Regulation (Perpres) No. 40/2016 on the determination of natural gas prices. Consequently, the gas price at the producer level will automatically be reduced as well, taking into account the costs of transporting the gas from its point of origin to where it will be consumed.

But according to ministerial decree No.8/2020, the cut in the gas price at the wellhead – the producer level – will not affect the revenue of gas production contractors in the upstream business. The price reduction will be compensated for by government revenue under the production-sharing contract scheme.

To better understand the impact of the reduction in gas prices, we need to examine the following formulas:

Gross revenue = gas volume x gas price per unit volume

Net revenue = gross revenue – expenditure – tax

Contractor net revenue = percentage of contractor share x net revenue

Government net revenue = percentage of government share x net revenue + tax

In calculating revenue in an upstream gas project, several economic scenarios are computed to identify the project’s key economic components. The scenarios below take into account all appropriate details commonly used in oil and gas economic projections.

The first set of scenarios considers the effects of varying the volume of gas production between low, middle and high levels, with the government share of the contract cut to zero. These projections keep all other components constant, including price, expenditure and tax. The results indicate that the volume of gas production plays an important role in the economic viability of a gas project. If the volume of gas output were not material, the contribution of the increase in the contractor’s split to the contractor’s net revenue would be negligible.

The second set of scenarios considers the effects of varying the gas price per mmbtu at the producer level from $6 to $4.9 to $3.9 with the government share cut to zero. All other components, such as the volume of gas production, expenditure and tax are kept constant.

The results indicate that a reduction of gas price by $1.1 from $6 to $ 4.9 and a further reduction of $1 from $4.9 to $3.9 will have a significant impact on the contractor’s net revenue. In this case the contractor’s net revenue decreases by between 44 and 51 percent for the first $1.1 decrease and decreases from 75 to more than 100 percent (after which it becomes negative) with the further reduction of $1.

Additional calculations show that every 5 percent decrease in the government share adds only about 13 to 15 percent to the contractor’s net revenue, which is significantly less than the amount of revenue lost by the contractor due to gas price reduction.

From the exercises above, it is obvious that the volume of gas production and the gas price are major contributors to the economics of a gas project.

Although the government’s willingness to reduce its share to compensate for the decrease in contractor revenue caused by the gas price cut, as required by the ministerial decree, should be commended, such a gesture will not be able to cover contractors’ losses from the reduction of the price of gas.

While it is appreciated that the government’s initiative in reducing the gas price for domestic industrial users to $6 is designed to make it competitive with the global market, a delicate balance needs to be made to mitigate the economic impact of the price cut on the domestic upstream gas industry, especially small projects with low gas volumes where margins are already slim.

The question is, will the government consider selectively excluding marginal gas projects with small production volumes from the ministerial decree on the price cut?

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Executive at PEXCO Energy, a Malaysian oil and gas company. The views expressed are his own.

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