Added risks in gas exploration

The Supreme Court’s verdict on the Ambani dispute is likely to stifle private sector participation in future exploration and production.

The dust has settled on the Ambani vs Ambani imbroglio. However, the Supreme Court judgment along with the current set of policies will have far-reaching implications on the future of the exploration and production business in India.

First, the view held by the Supreme Court that exploration of oil and gas resources needs to be carried out exclusively by public sector undertakings (PSUs) is in contradiction to the very spirit of the New Exploration Licensing Policy (NELP). Most of the reserves over the course of the policy have been discovered by private enterprise (domestic as well as foreign)-led consortia.

Second, production-sharing contracts have been structured in such a manner that the contractor, who has taken all the risks in attempting to discover and bring gas to the market and has incurred a huge capital expenditure, has the first call on the revenue stream that flows from the sale of the gas. The contractor then needs to be reimbursed his operating costs and gets a share of the profit. Over a period of time, this share comes down and the government’s share of profit gas (it is the government’s share of gas under the production-sharing contracts in the gas fields awarded under various rounds of NELP) correspondingly goes up. The contractor is, therefore, encouraged to market gas, since the sooner he recovers costs, the earlier the government gets its share of gas/oil.

According to the model production-sharing contracts applicable from the first to the sixth round of NELP, the contractor of the block has to value the gas at arm’s-length prices that benefit the parties to the contract. Moreover, the production-sharing contract provides the contractor the freedom to market gas and sell its entitlement. However, according to the Supreme Court verdict, the contractor has to sell the gas at a price approved by the government and only as per the government’s gas utilisation policy. This verdict may stifle private sector participation in future exploration and production.

Third, the Union Budget for 2008-09 excluded natural gas from the definition of mineral oil, thus taking away the income tax holiday enjoyed by the operators under the NELP regime. Such an ad hoc change in policy is unfair, as it is not known in advance whether oil, gas or both will be discovered. The impact of this was felt when NELP-VIII was delayed and a number of investors expressed their concern over the issue.

Fourth, foreign companies are needed not only for their technical expertise but also to bear part of the investment risk involved in the exploration of oil and gas under a joint-venture agreement. While Indian companies will ultimately cave in to the government pressure, foreign companies will take their business elsewhere. British Gas, Norway’s Statoil and Brazil’s Petrobras walked out of the Oil and Natural Gas Corporation (ONGC) block in the KG basin due to procedural delays and lack of clarity on major policy issues.

Fifth, some commentators have recommended a pan-India gas pipeline network to be a prerequisite to encourage upstream investments. This is like putting the cart before the horse. Gas pipelines, unlike roads and railways, are not public goods and need to be commercially justified through an assured source of supply, guaranteed demand at a price and a pipeline tariff policy that gives them a reasonable profit.

Finally, as recommended by the Supreme Court, the government must clearly lay down a natural gas pricing policy. In the RIL case, the government tweaked the price formula determined by RIL through limited competitive bidding to arrive at a price of $4.2/mmBtu. There has to be clarity on the price discovery process. Usually, a production-sharing contract clearly spells out the price discovery process that will be adopted for gas, such as linking domestic prices to free-on-board prices of gas, or to crude oil, or to alternative fuels like fuel oil. The government also needs to clarify the meaning of “at arm’s length” and “competitive bidding”. The pricing formula, which varies from field to field, will have to be finely balanced, as a high price could deter customers from buying the gas, thus impacting the volumes. A low price, on the other hand, will delay the investment recovery, and the profit share of both the contractor and the government will reduce. What is surprising is that with the ink hardly dry on the Supreme Court judgment, the government raised the current prices ex ONGC/OIL’s nominated fields to equate them with RIL’s $4.2/mmBtu — this decision has no logical basis and seems more driven by the one-size-fits-all concept.

RIL recently clarified that prices of gas from other fields in the KG basin will be higher than those from the current producing fields. Similarly, the ONGC chairman has stated that gas from ONGC’s wells in the KG basin will need to be priced at around $7/mmBtu to compensate for the investment that the company will be making. The country should, therefore, be prepared to pay higher prices in the future, and the consumer has to be sensitised that the Reliance price ($4.2/mmBtu) is by no means a benchmark for the future natural gas prices.

The government needs to draw some lessons from the events pertaining to the KG basin gas discovery, so that we do not have a similar situation arising again, which will ensure that the development of the exploration and production sector proceeds smoothly, for the benefit of not only the contractor but also the government, infrastructure developers and the ultimate consumer.

RK Batra is a distinguished fellow at The Energy and Resources Institute (Teri) and Ruchika Chawla is fellow, the Centre for Research on Energy Security, Teri

Source: Business Standard

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