Harshit Tiwari is a student of UPES, Dehradun. This article was submitted as a part of a blogging contest which may lead to his selection as an iPleaders Energy Law Fellow. The fellow will be selected on the basis on engagement on these posts as well as quality of writing and research. We emphasise on engagement because it shows one’s ability to generate interest in an otherwise arcane subject like energy laws. The selected fellow will receive a paid internship with a boutique energy law firm in Delhi (stipend of INR 7000), an opportunity to be mentored by very senior lawyers and a free course worth INR 5000 from iPleaders. If you want to participate, write to email@example.com for instructions.
Time and again it has been rightly stated that the resources of India belong to the people of India and government’s role in this regard is that of merely a custodian. In consequence of this notion Government of India has come up with various policies to effectively govern and regulate this sector with primary motive of attracting the foreign/private investment, in addition to already existing public entities, dealing in exploration and production (E&P) of hydrocarbons. The idea behind private and/or foreign investment is the lack of availability of funds for investment in the high risk-high gain sector of Oil & Gas exploration.
The current policy in force, New Exploration and Licensing Policy (NELP), was conceptualised during the year 1997-98. The business model as iterated in Production Sharing Contract, requires capital investment for the development of the field and production of oil by the contractor. Therefore the risk is borne solely by the investors and not the government. Government is free from any requirement to invest. The role of government is limited to regulate and promote the level playing field for the stake holders and to increase the exploitation of natural resources while safeguarding the environment.
What is KG-D6?
In the very first round of bidding under NELP the Krishna-Godavari basin gas block, KG-DWN-98/3 (referred to as KG-D6 block), was awarded to Niko Resources Limited (NIKO) and Reliance Industries Limited (RIL), together as a consortium. The participating interests were 10:90 in proportion. Subsequently the Production Sharing Contract (PSC) was inked and entered on April 12, 2000 between the consortium (with RIL as operator) and Government of India.
In the total contract area of about 7645 km2, around Nineteen (19) discoveries have been made. These discoveries comprise of One (1) oil discovery and Eighteen (18) gas discoveries made between 2002 and 2008.
Where does the issue lie?
The beginning: Government lays down a certain criteria for the prequalification of bidders to bid for the blocks or to participate in the bidding. Prior experience of the bidders plays crucial role in making the award. However, Reliance Industries Limited, despite of lacking any prior experience or even exposure in E&P sector was awarded the block which lead to few allegations of lowering of standards by the government to accommodate RIL.
The Gold-Plating: Gold-plating in simple words can be described as unnecessary increase in price of production while the utility remains constant. As Professor S.P. Sethi puts it, Gold-plating is selling a Tea worth INR 3/- in a silver cup instead of disposable one, leading to selling price of INR 150/- per unit. In the year 2004, RIL came up with a field development plan with estimated production of 40 mmscmd (million metric standard cubic meters per day) at the investment cost of $2.39 billion. Subsequently, in period of 2 years, RIL submitted a renewed estimate production of 80 mmscmd for an investment cost of $8.8 billion.
In brief, the production estimate merely doubled (2x), while the expenditure quadrupled (4x). This was clearly contrary to basic economics principle whereby, increase in production brings down per unit production cost.
A valid query which rises at this moment is how will the contractor benefit by investing unnecessarily more money than actually required?
Investment Multiplier: “The term investment multiplier refers to the concept that any increase in public or private investment spending has a more than proportionate positive impact on aggregate income and the general economy. The multiplier attempts to quantify the additional effects of a policy beyond those that are immediately measurable.”
In gist, more is the capital invested higher is the amount recoverable. PSC provides for 100% cost recovery for contractors in case of commercial discovery. This recovery amount is not payable by government of India; instead the contractor is allowed to sell gas or oil, whichever is discovered, of certain worth. This worth is calculated by use of investment multiplier. Under the PSC entered between RIL and UOI the investment multiple has been defined as IM = Gross Revenue/Gross investment. PSC states that as long as the IM is below 1.5, more than 80% of profit will belong to RIL and government will be entitled to less 20% of total profit. But, if the IM crosses 2.5 government will get 85% of total profits.
This has been acknowledged by Comptroller and Auditor General (CAG) in its report on performance audit of hydrocarbons Production Sharing Contracts wherein it concluded, “The private contractors have inadequate incentives to reduce capital expenditure– and substantial incentive to increase capital expenditure… so as to retain the IM in lower slabs.”
Non–relinquishment: Model Production Sharing Contract under NELP IX mandates relinquishment of “entire area (excluding Discovery and Development area)” at the end of 7 consecutive years of exploration period as per Article 4.1. This provision manifests the intention of government to allow a ‘time bound’ exploration. Thereafter at the expiry of period the rest of area (other than in which discovery is made) is forfeited back to the government.
This serves dual purpose. First, it prevents these resources from being merely hoarded by a private entity without tapping them; as was seen in coal and spectrum cases. Second, since the discoveries were made in neighbouring areas, it helps in getting better bids in the next bidding round for the same area due to increase in the probability of discovery in the relinquished area.
In the PSC signed between RIL and UOI the process of exploration was segregated into three parts. PSC provided for relinquishment of 25% of total area once the first two phases end. It further provided for another step of relinquishment at the end of 3rd Phase. After which the only area to be held by contractor was the one, where the commercially viable discovery has been made by it and which the contractor intents to develop. Remaining are as mentioned before needs to forfeited by government.
However, as per the CAG report, RIL notified the government of beginning of 3rd Phase in 2005 without relinquishing any part of the originally contracted area. As per the given notification the due end date of 3rd Phase was June 2007 which was extended by the government to July 2008. And throughout this time period RIL did not relinquish any area. It continued its hold over the entire 7645 km2 although the area in which the commercial tapping commenced, was of only 390 km2.
Thereafter the government decided to declare the entire area as ‘discovery area’ which in practical sense amounts to awarding RIL with rights of future exploration. However the ‘discovery area’ has been defined in PSC as that area from which contractor expects of producing commercial quantity of hydrocarbon, based upon the wells drilled by it. It is noteworthy here that, the contractor has drilled wells only in specific region which is in the North-West of the entire area, till 2010. In mid-2006, RIL was permitted by Directorate General of Hydrocarbon (DGH) to enter 3rd Phase without adhering to the requirement of relinquishment under PSC. DGH relied on the data presented by RIL which showed ‘continuity of discovery’. This step of government is a gross violation of PSC.
In this regard observation of CAG can be an apt concluding remark. It observed, “The
contractor’s opinion that petroleum was ‘likely’ to exist in the entire contract area and ‘could be produced after an exhaustive exploratory/appraisal programme’ is not in consonance with the PSC definition of ‘discovery area’ which is centred on ‘existence’ of petroleum, based on wells drilled in that par”. After this report of CAG, two Preliminary Enquiries (PEs) and a Regular Case (RC) has been registered by CBI against the apprehended collusion between RIL and DGH.
The committee was constituted by Government of India in May 2012 to examine the mechanism of PSC. It also aimed at suggesting structure and elements of the guidelines for developing a calculation formula to compute the domestically produced gas’s price. It was headed by the then Chairman of the Economic Advisory Council to the Prime Minister. Based on the formula suggested by this committee, government doubled the price of gas from $4.2/mmbtu (Million British Thermal Unit) to $8.4/mmbtu.
Interestingly, in 2004 a contract for supply of gas was signed between NTPC and RIL. Reliance has agreed to supply gas to the power plants of NTPC at $2.34 / mmbtu. But later RIL refused to supply at this rate and urged (pressurised) government to revise the price in 2007. Shockingly, government almost doubled the price to $ 4.2 / mmbtu. In the case ((2010) 7 SCC 1) that followed the apex court held that price fixed by the government shall be binding on all the parties.
The actual cost of production is much less than $2.34 / mmbtu and this is also evident from the fact that RIL had entered long term contracts with RNRL and NTPC for supply of gas at this rate itself for 17 years. NIKO also, had entered a long term contract of 25 years with the government of Bangladesh for the supply of gas at this very rate of $2.34 / mmbtu. It is quite reasonable to presume that even at this price, substantial profits were being made by contractor. And price increment demand and its acceptance had no valid grounds.
Former Principal Adviser Energy of Government of India, Shri Surya P. Sethi, thoroughly criticises the formula recommended by the Rangarajan Committee. To begin with, the fixing of price of domestically gas in dollar terms seems without any explanation especially, in the light of the fact that whole gas consumed internally. The fluctuation in the exchange rate has effectively added to the price of the gas.
In his article dated February 7, 2013 Shri Sethi says that numbers used for deriving the formula do not highlight the prices which the gas producers in the three markets covered obtain. “The absurdity of its formulation is best demonstrated by the inclusion of Japan that has no natural gas producer/supplier.” There were no attempts made by the committee to accurately figure out the actual figures or to reflect the price of gas at the well-head internationally. Several experts have admitted that maximum well-hear price of gas could not be above $ 1.43/ mmbtu. The price provided in this case i.e $4.2 /mmbtu is among the highest in the world.
The pro-RIL manner in which the handling of hydrocarbon resources is being carried-out, stinks of collusion between the private contractor and the government. Time and again laws were bent and rules were broken to accommodate the interest of RIL. In context of increment of the price government has come up with the argument that providing higher returns to the investors will attract even higher investment in the upstream sector which shall lead to higher domestic natural gas output.
This argument is fallacious in multi-fold manner. The drop in the country’s gas production despite of multiple price increments has been admitted by the government itself. Even in the KG-D6 basin itself the production has dropped down to around 27.44 mmscmd from the claimed 80 mmscmd. This drop is primarily the result of deliberate inadequate production in the block. Even at the present rate of $8.4/mmbtu there exists no way by which government can guarantee increase in gas availability. The only FDI was 30% stake acquisition made British Petroleum (BP). This too was made at the price at earlier price of $4.2 /mmbtu. Conclusively, it will be right to state that there existed practically no reason to re-double the price to $8.4 /mmbtu while the actual cost incurred is merely around $1.43/ mmbtu.
This increase in the gas price will cost approximately INR 54,500 Crore / year to a country where a vast majority dwells below poverty line.