Archive for September 10th, 2007

Indian Gas Sector: Some Basics

September 10, 2007

Most newspapers In India these days are full of reports about India’s gas sector. The newspapers focus mainly on how much the price of gas would be and the possible impact.

I never understood the sector and could not follow the developments at all. As Natural Gas is the fuel of the future, understanding it is critical as oil/gas is crucial for any economy.

However, I discovered this wonderful paper in EPW which explains the mechanics of the sector. It is written by a team that works for Prayas, an NGO based in Pune.

The paper starts by first using a bit of statistics to show the importance of gas in Indian economy:

Moreover, the quantum of gas finds from the first three rounds of NELP can supply about 77 billion cubic metres (bcm) of gas per year, which is equivalent to about 50 per cent of our oil consumption and about 72 per cent of our net import of crude and petroleum products in 2006-07.

Given the energy-hungry economic growth of the country, gas can form up to 22 per cent of the total energy basket by the year 2031-32 [KPMG 2007]. The Planning Commission (2006) estimates that all of India’s urea-based fertiliser would be gas-based in 2031-32. Therefore, it is an important fuel from the point of view of energy and food security of the nation.

India launched New Exploration and Licencing Policy (called NELP in newspapers) in 1997 which basically ushered competition in the sector by allowing private players. This would have solved two purposes- one, it would lead to exploration of vast regions in India and above all, help mitigate the energy needs of a growing country.

So, the paper first discusses pre-NELP regime Govt. controlled everything then exploration, production,and distribution all was done by govt. entities.

Then came NELP and this is where paper gets interesting. Under NELP blocks (of certain areas where gas could be found) were auctioned based on bidding process .

The bids were based on a “model production sharing contract” (MPSC)that stipulated the responsibilities of the contractor and the government respectively. The contractor would then bid for block(s) by presenting its credentials, submitting a work programme (that outlined the time frames and details of different phases of exploration and development) and declaring how it would share its profit with the government. These bids were then evaluated using different weightages for the different components such as technical ability, fiscal package and work programme, and the highest bidder won the contract for a block.

So far there have been six such auctions called NELP I, II and so on till NELP VI. The paper shows how government has evaluated bids in each different auction. The government offers 3 kinds of blocks: onshore, offshore and deepwater blocks and the paper also shows the bids in each.

The paper also tells that Gas is mostly found in deepwater blocks and hence the paper discusses only deepwater blocks later on. That is a nice bit of general knowledge.

The paper reveals that gas finds have so far been in NELP I,II & III and ONGC and Reliance Industries have formed a kind of duopoly:

Three players, RIL, ONGC and Cairn Energy, won the bids in these three rounds and, as shown in the first column of Figure 3, the duopoly of ONGC and RIL was prominent as they won 97 per cent acreage from these blocks, with RIL winning about 45 per cent and ONGC 52 per cent.

Who has been more effective?

If one compares the “effectiveness” of different contractors in finding gas, i e, the number of bcm of gas found per 1000 sq km of area explored, it turns out that Cairn Energy was the most effective, finding almost 6.7 bcm of gas per 1000 sq km, while RIL found 5.5 bcm per 1000 sq km. As against this, ONGC found just 1.1 bcm of gas per 1000 sq km. So, Cairn Energy was about six times as effective as ONGC and RIL was about five times as effective. This is so in spite of RIL and ONGC having roughly equal acreages in the fertile KG and Cauvery basins. It follows that either ONGC’s blocks are less rich than RIL’s or ONGC’s exploration approach is not as sound as RIL’s.

The paper then goes on to discuss the demand-supply conditions and projects the same in future. There are problems with demand projections so not much clarity on the same.

Then it focuses on the contentious issue – Gas pricing. It explains the basics of pricing and how the entire issue has come about and embroiled into a controversy.

Read the whole paper to get more details. The way it is written is pretty easy and absorbing. Great Stuff.

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Reasons for high US Household debts

September 10, 2007

I have posted a number of posts on issues related to this subject. US has huge current account deficit and this poses huge problems for the entire global economy. For a summary of problems see this.

The source of high current account deficit is US households (HH) spending more than their incomes. In order to finance their expenditure they borrow leading to high indebtedness.  The natural question to ask is what has contributed to the rising debt? In other words, how have households managed to spend more than their incomes?

This recent Federal Reserve paper seeks answers to some of these very important questions. As it is co-authored by Donald Kohn, the Vice Chairman at Fed it automatically carries a lot of weight as well. The vice chairman at Fed also does active research; it shows how much research is respected in US.

This paper is one of the most popular papers being discussed because of the consequences involved. There are 2 ways to reduce current account deficit as Feldstein has put in his paper, one let dollar depreciate and two to increase US households savings. Now, if you need to increase US household savings you need to first understand what has led to this problem. 

How much is the indebtedness?

The ratio of total household debt to aggregate personal income in the United States has risen from an average of 0.6 in the 1980s to an average of 1.0 so far this decade!!

So for every $ of HH income there is a $ of debt.  

What explains this rise? Let us look at possible reasons and the evidence found for the same: 

1. Consuming more today and saving less for tomorrow: In other words have HH become more impatient? The paper says no, they have not become more impatient and are saving for retirement.

2.Have they become less risk averse? i.e. if you become less risk averse you might borrow.But the paper does not find any evidence of the same

3. Changing demographics: The logic is that you tend to spend more in your middle age and youth compared to old-age as your needs are more. As US baby-boomers (born between 1946 and 64 in US) have moved to mid-age, their debt-income ratos should move up. The paper suggests this has led to rising debt but not by as much.

4. Housing Prices and Financial Innovation: The paper says these two have contributed max to the rising debt.

The most important factors behind the rise in debt and the associated decline in saving out of current income have probably been the combination of increasing house prices and financial innovation. We noted a number of channels by which higher house prices can lead to higher debt. And causality probably runs to some extent in the other direction as well, especially in light of financial innovation that has reduced the cost and increased the availability of housing finance. Innovation has opened up greater opportunities for households to enter the housing market and for homeowners to liquefy their housing wealth, thereby helping them smooth consumption of all goods and services. One implication of this analysis is that a portion of the rise in debt relative to income probably reflects a shift in the level of spending that is not likely to be repeated unless house prices continue to increase as quickly as in the past and financial innovation continues to erode cost and availability constraints at a rapid pace.

So, housing prices alongwith financial innovation has led to the increasing HH debt. The consequences are even more interesting:

For one, household spending is probably more sensitive to unexpected asset-price movements than previously. A higher wealth to income ratio naturally amplifies the effects of a given percentage change in asset prices on spending.

Further, financial innovation has facilitated households’ ability to allow current consumption to be influenced by expected future asset values. When those expectations are revised, easier access to credit could well induce consumption to react more quickly and strongly than previously. In addition, to the extent that households were counting on borrowing against rising collateral value to allow them to smooth future spending, an unexpected leveling out or decline in that value could have a more marked effect on consumption by, in effect, raising the cost or reducing the availability of credit.

Another caution involves the distribution of credit and, in particular, a tendency for some households to become very highly indebted relative to income and wealth. The spending of those households is likely to be constrained by negative income or asset-price shocks as well as by households’ capacity to service their loans. Although these households represent a relatively small share of the population, in some circumstances such developments could have effects large enough to show through to the macroeconomy.

The paper tells us indirectly, why housing sector matters so much for the policymakers and why it poses a dilemma for them.

Rising housing prices along with financial innovation let HH to satisfy many of their demands which they otherwise would not have been able to meet (see last pages of  this speech to see how much they have risen in various countries) .

Now, firstly policymakers have little ideas to gauge whether price rise is as per market conditions or it is a bubble. So if they do something to correct the price rise the free-marketers say let markets correct themselves, and if they do not, the natural economic cycle takes over and in case of a slowdown, the housing prices crash, and this leads to insolvencies and foreclosures (as many purchases have been financed based on house price rise) and leads to difficult economic conditions (as we see in sub-prime markets today). To mitigate losses from second situation you need effective supervision which is generally ignored when times are good.

Coming back to the paper, it is a very simple one and pretty lucid and full of interesting facts. It is a must read to fill the missing block from the global imbalance jigsaw puzzle.

Highly recommended.

 

Assorted Links

September 10, 2007

1. Participate in the poll: What should Fed do in the meeting on Sep 18.

2. TT Rammohan has a good column in ET called the Big Picture. He has a blog as well. He points out to a nice article – Economists who left a lasting impact- and who didn’t.

3. Ajay Shah says:

A deep flaw of the intellectual landscape in India is that if you picked one topic, it isn’t easy to find six good quality authors to debate.

4. PSD Blog points to a new book that says development organisations like World Bank would be extinct like dinosaurs.

5. AV Rajwade shares more insights on financial markets:

Some instruments are so complex that it can take investment banks’ computers entire weekends to value them!

6. Subir Gokarn on education:

We can confine Mahesh Tutorials and its peers to training more and more people to compete for a fixed number of seats and let Helix Investments and its peers profit from that very juicy market scenario. Or, we can create an opportunity for both Mahesh and Helix to profit while expanding the capacity of the educational system to serve the interests of both students and employers. Our policy generates the former, but our compulsions clearly warrant the latter.


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