India faces a herculean task: to cut smog and greenhouse gases while modernizing its energy systems and growing the economy. Traditionally, pollution has been the price of progress. However, the recent five million tons per year deal between Petronet and Tellurian suggests India is pinning its hopes on liquid natural gas (LNG) as an economically viable, clean alternative. Both companies are in prime position to provide India—one of the world’s fastest-growing energy markets—with a significant portion of its natural gas needs. While newsworthy, will the deal really herald a new era of clean energy? And what will it take to make it work?
As ICF works with stakeholders to develop a strategic framework for gas in India, we spoke to ICF’s Harry Vidas, Vice President, Energy Markets, and Gurpreet Chugh, Managing Director, India, to get their take on this new energy partnership and its nuances.
Q. What factors will influence the success of the deal long-term?
Harry: For India, the deal will be a success if the price is lower than the prevailing market price—or at least not substantially higher. Typically, deals like this require the LNG price to track a variable market price—oil, natural gas, or an LNG index. Although details have yet to be finalized, this U.S./India collaboration will likely see Petronet paying a fixed cost that provides greater stability and control. It’s a basic risk mitigation strategy. However, by swapping an uncertain price for a stable one you run the risk that the fixed rate will be higher than the market. Of course, the hope is that it’s below or close to future market value.
Gurpreet: This is a one-of-a-kind deal that hasn't been seen before in the LNG world. Consequently, there are many firsts but also many risks. Success over the long term will happen if both parties gain from the transaction. Tellurian will want a substantial amount of the 27.6 million tons per annum (MTPA) capacity tied up long-term, equity locked in, and financial closure (FID) completed as soon as possible. Petronet will push for project development to proceed to committed timelines and within budget, to ensure that the promise of this being the cheapest U.S. LNG materializes. Once the project is developed and LNG production starts, the remaining risk exposure of PLL to the deal will be that of operations—and the price of alternate LNG in the market. New suppliers could emerge with cheaper supplies or alternate formula (from the U.S. or other countries). Crude prices could also remain depressed (below $50/BBL). This price risk is potentially the largest threat to the success of this deal long term.
Harry: Developers of LNG terminals and natural gas reserves from the U.S. end are interested in finding markets and accessing capital. This deal provides both. India is a fast-growing market for LNG, but with Petronet contributing part of the capital needed, it makes the project far more viable.
Gurpreet: Should the deal go through, Petronet will have an opportunity to diversify its portfolio and add a fixed price (cost) LNG to its existing crude-linked LNG portfolio.
Q. How will it work? What responsibilities will fall to India and the U.S.?
Harry: It’s a private sector deal so there aren’t any direct government-related responsibilities. It boils down to the affiliated parties. Petronet is providing upfront capital and guaranteeing that $4.25 billion of debt will be paid back. Tellurian is responsible for operations—for making sure everything happens on time and to budget.
Gurpreet: I agree with Harry. Since this is a private sector deal, neither government will have a role to play. Petronet is contributing equity and thus has a right to receive equity returns and offtake LNG from the project.
Q. Why did India’s Petronet and U.S.-based Tellurian collaborate on this deal?
Harry: India wants price stability, but it’s also looking for investment opportunities. This deal not only gives Petronet a fixed price but also the ability to invest and learn about the industry. For Tellurian, the driving factors are finding a market outlet and financing.
Tellurian founders wanted to create a new business model after their departure from Cheniere—and test the model in the market. It’s a model that helps Tellurian raise the financing needed for this LNG project, which would typically require deep pockets. For Petronet, the driver is to gain an equity position in an upstream LNG project and thus secure long-term LNG supplies at a known cost and remove the market risk from the portfolio.
Q. When will the project begin and what does it mean for the future of natural gas in each country?
Harry: A significant component of the deal would be for Petronet to pay part of the capital cost of the project upfront. It will need to put the money together to finance the project before it begins, although when payment is expected and how much, I don't know. When production starts, it also needs to market the gas within India and find buyers and investors. Of course, no one could have predicted the outbreak of COVID-19, which is fueling uncertainty in world markets. It’s a reminder of the volatility of energy prices, particularly during unexpected events. Falling prices must be delaying action right around the world.
Gurpreet: The project has yet to achieve financial closure. Sealing a deal with Petronet will be a major step in the right direction for Tellurian. The definitive agreements were due to be signed by March 31, 2020. However, under the current lockdown due to COVID-19—and other uncertainties—this hasn’t happened. In addition, the OPEC price war between Russia and Saudi Arabia has resulted in lower oil prices than expected—something that could create further delays for the deal. With significant long term, uncommitted LNG available from established suppliers—at a very attractive price—doubts are emerging in India about the value to Petronet from this deal.
Q. What does the future of clean energy in India look like?
Harry: All developing economies are faced with similar challenges when growing their economies. They want to industrialize and need energy as they move away from agriculture towards manufacturing. Generally, when you’re in that mode of growth and you’re establishing a larger middle class, that’s hugely energy-intensive. In higher-income countries like the U.S., the incremental GDP tends to be in less energy-intensive sectors, notably service industries. Energy increases but not at the same rate as countries switching to an industrial model. Right now, India is making this transition while personal incomes are fairly modest—and there isn’t a lot of extra money for environmental protection. That’s a quandary. How do you ensure you have the energy you need to grow the economy and industrialize in an environmentally sustainable way that doesn’t become cripplingly expensive or stifle growth?
Gurpreet: India is aggressively embracing renewable energy. It has very ambitious targets of setting up 450 gigawatts of renewable energy capacity in the next 10 years. In India, renewable energy is seen as true energy independence. The low cost of renewables in recent bids is supporting this aggressive shift. However, balancing such large volumes of renewable energy will be essential in ensuring the success of this strategy. This is a sweet spot in which gas can play a balancing role. Also, gas plants out-compete coal plants in providing fast response generation swings. Such fast ramp generation is needed to maintain grid reliability and manage the variability of renewable energy.
Q. To what extent will politics, economics, and infrastructure play into India’s clean energy goals?
Harry: India has a substantial need for more energy to grow the economy. However, it doesn’t necessarily have the income levels or purchasing power to do everything it would like to. There's a premium on efficiency and using energy wisely. There's a discipline required to ensure you avoid building facilities based on ‘pie in the sky’ demand projections—and estimates of people using energy at levels they simply can't afford. The government is working on a significant forecast need for natural gas and is trying to get the infrastructure in place. However, they’ll need to avoid overbuilding or ending up with stranded or in-debt assets.
Gurpreet: India is a political economy. Building public opinion on matters of national importance, such as energy, is critical to success. Socioeconomics will play a vital role in deciding how fast India can reach its clean energy goals. Ensuring a cost-effective, clean, and secure energy supply will guarantee sustainable growth in the country. Natural gas as a clean fuel could play a very important role in cleaning up the energy mix. Developing infrastructure will also be important in channeling energy to the deep interiors of the country. There will be debates around how much of this infrastructure would be economically justified and how much would need to be funded in the national interest through viability gap mechanisms.
Q. Why is India focusing on clean energy now? What’s its role in the clean energy movement?
Harry: Twelve of the world’s most polluted cities are in India. Poor air quality is a common affliction for developing economies where simply inhaling can be the equivalent of smoking 50 cigarettes a day. The focus on clean energy is, in part, a bid to curb this public health crisis. We know that India plans to use LNG to fuel industry and transport, but it may also be used as cooking fuel since it’s safer and healthier than burning charcoal and wood. To date, natural gas use in India’s power sector has been limited by low coal prices and a push toward more electricity from renewable energy sources. However, LNG can play a significant role in the future by supplying intermediate, peak load electricity and providing ancillary services—spinning reserves, load following, voltage regulation, and so on. Like many developing countries, India has a sophisticated non-governmental infrastructure of people who are concerned about the environment and sustainability. There’s interest amongst people from all walks of life in making sure that India chooses a pathway to growth that avoids the pitfalls encountered by Western countries. Both the middle-class and workers want a clean future for India.
Gurpreet: In the last few years, India has taken bold and rapid strides towards making its energy sector cleaner and greener. This has been brought about by a mix of energy generation and consumption-related measures. Generation-wise, significant steps have been taken to increase renewable power generation capacity—both wind and solar. On the consumption side, energy efficiency measures such as nationwide replacement of incandescent bulbs with LEDs, appliance standards, industrial energy efficiency (PAT scheme) have been hugely successful. The pursuit of a cleaner, greener, and leaner energy sector will meet multiple objectives for India. Energy is a considerable cost to India’s economy. Oil forms the largest commodity import by value. Moving to renewables and more energy-efficient technologies provide an excellent opportunity for India to achieve energy independence over time. Not only this, but pollution from the burning of solid and liquid fuels is choking Indian cities where air quality is the poorest on earth. Renewable energy provides an opportunity to clean up India’s air. India wants to be a global leader in the clean energy revolution. It’s been instrumental in setting up the International Solar Alliance (ISA) alongside France, which is taking the solar revolution to other countries—most notably in Africa. For centuries, the Indian civilization has lived in harmony with nature. Therefore, its current drive towards harnessing the power of the sun and wind finds favor with the remotest communities.
Q. What challenges and opportunities can be expected on the road to clean energy?
Harry: This deal gives India the chance to learn from global best practices and adopt them from the start. They’re trying to be smart, avoid mistakes, and enable rapid growth. India wants to use less polluting, more efficient technologies and renewables to limit the use of fossil energy. Natural gas is part of the mix because its environmental impacts are comparatively benign relative to other fossil fuels. When methane leaks are controlled by modern technologies, it's a low-emission fuel. It’s also reasonably priced so it won’t stifle economic growth.
Gurpreet: There will be many challenges along the road towards clean energy, but opportunities also abound. Some of the biggest obstacles India will face in the transition will be socioeconomic. Guiding the public through this rapid evolution will challenge the best change management theories. However, the opportunities promised by the transition will ultimately trump all opposition. Therefore, the role of India’s government will be to ensure that the existing opportunities are made available for all to benefit from.
Q. What’s the business case for the deal—does it add up?
Harry: Since the emergence of coronavirus, oil and natural gas prices have collapsed. Oil has dropped from the 60s to the 30s, and natural gas, which was trading at $7, is now at $2.50. When you make these deals, guaranteeing a price by prepaying is often a good idea. However, in the current environment, which nobody would have anticipated, you can buy gas at $2.50. It’s not been that low in decades. The fact is, there’s always a potential downside to these deals. You have to be ready to pay $5 or $6 today while everyone else pays $2.50. It looks bleak at the moment, but it’s likely to be fine in the long run. There’ll be plenty of times when the situation will be reversed—and that’s what you pay for.
Gurpreet: The business case for the deal is quite simple: Tellurian gets an equity investor who underwrites the project while Petronet gets the right to lift LNG at a cost de-linked from market prices. Whether the business case adds up or not is entirely based on the companies’ risk appetite and view on future LNG markets. For buyers who believe that oil will remain low (< $50) for a long time—and that LNG will be a surplus market—this wouldn’t represent a sound deal. Buyers who believe oil will always remain above this benchmark—and that LNG markets will tighten—will see it as a great deal. For those who’re unsure about where oil will be or how LNG markets will behave for the next 20 years, this is a risk diversification strategy. Only after the next 20 years' have played out will we truly be able to judge whether this deal was a great deal, a dud deal, or like all others—just another deal.