India's LNG Spot Purchases Hit by Cheaper Naphtha

LNG vs. Naphtha

India is scaling back spot purchases of LNG in favour of cheaper naphtha. Since July naphtha has shed three quarters of its value and can now be purchased at a rate of around US$5.80/mmBtu compared with LNG spot rates of between US$9.50 and 10.50/mmBtu. In November demand for gas from Petronet's Dahej LNG terminal fell by almost 43% as naphtha undercut gas prices, according to an unnamed Petronet official cited by the Economic Times of India. The terminal also bought four spot cargoes this year, around half the number purchased last year. While Petronet's term contract with Qatar for 5 million t/y of LNG remains competitive, with naphtha at rates of around US$2.50/mmBtu, Petronet also pays US$7.90/mmBtu for a short contract of 1.25 million t/y due to expire at the end of this year. The steep fall in demand for LNG and the more competitive rate of naphtha raises the possibility that this contract will not be renewed. Shell and Total's Hazira LNG terminal in Gujarat also bought half as much LNG in November and so far in December compared to the final two months of 2007. Hazira has been particularly affected by the falling price of naphtha, given its overwhelming dependence on more expensive spot LNG purchases as opposed to cheaper term contracts. Moreover, over summer the Hazira terminal purchased LNG spot cargoes at record rates of around US$20/mmBtu, given high demand and aggressive bidding by European and Asian consumers. Buyers are now unprepared to purchase LNG at prices reflecting the purchase cost, meaning that Hazira is having difficulty selling its cargoes. This is likely to reduce the likelihood of further purchases given that tanks at the Hazira terminal are already reportedly full. According to one unnamed LNG buyer that usually purchases one cargo per month from Hazira: "We are buying nothing now because naphtha is so much cheaper". Falling naphtha exports due to increased domestic demand are a further sign of naphtha's growing competitiveness in relation to spot LNG. IOC normally sells six naphtha cargoes per month from the ports of Dahej and Kandla. So far in December, this has fallen to two cargoes from Kandla and one cargo from Dahej.

The fall in LNG demand comes at a time when Shell and Total are expanding the capacity of the Hazira LNG terminal from 2 million t/y to a planned capacity of 3.75 million t/y by end-2008, mainly through debottlenecking existing infrastructure. While the work is nearing completion, the falloff in demand could cause project partners to put on hold (temporarily at least) longer term plans to build a US$500-million multi-cargo terminal in order to help Hazira serve industries in the Vapiankleshwar-Baroda belt in Gujarat, as well as the expansion of the terminal's capacity to 10 million t/y (see India: 2 December 2008: Shell India and Total to Expand India’s Hazira LNG Terminal). Over the short term, the fall in naphtha is likely to have a marked impact on LNG demand from India's power plants given their relatively unique ability to switch between naphtha and natural gas. As a sign of the increased demand for naphtha from power plants, Indian Oil Corp. (IOC) has plans to sell 100,000 tonnes of naphtha to a new client, Gujarat Industrial Power Corp. which runs two power plants with a combined generating capacity of 310MW in western India. Essar Power is also talking with IOC about sourcing naphtha for its 1,015-MW power plant that up to now has run exclusively on gas. These agreements are likely to undermine sales from the Hazira terminal that also strives to serve western India's market. Naphtha demand is also increasing from India's fertiliser industry, which along with the power sector, enjoys the benefits of receiving gas under the Administered Pricing Mechanism (APM) by which the state subsidises quotas to NOCs and other state buyers. APM buyers generally pay a low base rate of around US$1.90/mmBtu regardless of production or transportation costs. However, imported LNG is not sold under the APM which undermines its ability to compete in sales to state enterprises.

The threat to spot LNG has been compounded by the government's recent decision to lift import duties on naphtha in an attempt to bring down power prices and encourage industries to boost output in the context of the global economic slowdown. Since petroleum products such as naphtha are priced on an import parity basis (which includes import duty rates), the lifting of import duties is expected to lower naphtha prices by an expected US$1.5/mmBtu. In turn, this is expected to result in a 50-55 paise reduction in the cost of power generated by naphtha—according to R S Sharma, chairman and managing director of the state run National Thermal Power Corp. (NTPC)—which will further undermine spot LNG purchases.

Outlook and Implications

Overall, the outlook for LNG appears rather negative although there are some positive indications which suggest that demand will persist, although it will remain considerably lower than the highs seen over summer. Firstly, power plants primarily geared towards gas (like those owned by Gujarat Industrial Power Corp.) are likely to continue using at least some LNG or natural gas as long-term reliance on burning naphtha may result in a degree of technical damage. Secondly, LNG spot prices are likely to decrease over the next few months as prices catch up with the fall in international crude prices, possibly helping to increase the competitiveness of LNG. Thirdly, LNG term contracts are less likely to be affected by the recent fall in naphtha prices given the longevity of these contracts and because term contract prices remain relatively competitive. Indeed, many buyers are now moving towards long-term contracts given higher LNG spot prices and recent price volatility in the spot market. Demand for LNG overall may therefore be less affected even if demand for spot LNG slows down sharply.