GAS WARS: CRONY CAPITALISM AND THE AMBANIS

by Paranjoy Guha Thakurta

  RIL was to later claim that the CAG, a constitutional authority set up to oversee public finances, had used the benefit of hindsight to drill huge holes in the deal between the company and the government. RIL had been pushed to the wall. The heat generated by the earlier CAG report on the 2G (second generation) telecommunications spectrum scam had not yet died out, when this one was leaked to the press. Predictably, the company claimed the auditor had exceeded its brief—a similar criticism had been levelled against the CAG after it presented the report on the 2G spectrum scandal. There were other similarities as well between the two reports—both had pointed out how the government lost out on revenues since corporate houses had been allowed to make use of loopholes in the processes used to award contracts, or in the contracts themselves. These scams were not about kickbacks but about favours granted, about cronyism.

  With the ‘India Against Corruption’ agitation led by Anna Hazare, Arvind Kejriwal and Prashant Bhushan picking momentum across the country, prime minister Manmohan Singh and his Cabinet ministers could ill afford to come out strongly against the CAG. When the CAG came out with its final report titled ‘Performance Audit of Hydrocarbon Production Sharing Contracts’, which was presented in Parliament on 12 September 2011, at first glance it appeared to have watered down the draft version. But a closer look revealed that while the tone and tenor had been diluted a bit, the essence of the content of the report had not changed ; in fact, it was more damning.

  While the CAG report looked at the RJ-ON-90/1 and Panna-Mukta and Mid and South Tapti fields, the bulk of the 203-page document (which now ran into an extra six pages) dwelt on the KG-DWN-98/3 block, better known as KG-D6 block. There were differences in the way in which the two reports were presented. The final report highlighted most of its recommendations in bold type or in boxes to attract attention. Almost all the criticism of the government’s policies made its way into the main text of the report. The important findings of the CAG are summarised here (See Appendix 6 for details).

  RIL was allowed to enter the second and third exploration phases without relinquishing 25 per cent of the total contract area at the end of the first and second phase. The government had approved the entire contract area of 7,645 square kilometres as ‘discovery area’, thus enabling RIL to avoid relinquishment. This was ‘land-grab’ of a different kind.

  In the case of 13 out of the 19 discoveries between October 2002 and July 2008, RIL had without furnishing the initial details of the discoveries, directly given written notifications regarding the potential commercial values of the discoveries.

  RIL had submitted an IDP in May 2004 for an estimated capital expenditure of $2.4 billion. This was followed by the AIDP for an estimated capex of $5.2 billion for Phase-I and $3.6 billion for Phase-II of the project. Most procurement activities were undertaken late as per the IDP, while many of those under the AIDP were initiated even before it had been approved.

  There were gross irregularities in procurement-related activities. There were instances of huge procurement contracts where there was no reasonableness of costs incurred, primarily due to lack of adequate competition since these were awarded on single financial bids. There were other irregularities like major revisions in scope, quantities and specifications.

  Among the new chunks of text that were added in the final report of the CAG was an explanatory note in the Executive Summary—that it had been asked by the government of India to carry out the special audit. It said that in November 2007, the secretary, MoPNG, requested the CAG to conduct a special audit for PSCs for eight blocks for which regular audit had been carried out earlier. ‘MoPNG’s request was made in the context of large stakes of the government in the form of royalty and profit petroleum, and concerns raised in some quarters about the capital expenditure being incurred by some contractors in the development of projects awarded under NELP.’

  The reason for this insertion was not difficult to guess. All along— before, during and after the leak of the draft CAG report—RIL had been saying that the auditing of its accounts was out of the purview of the CAG. This was the auditor’s way of putting the record straight. It also referred to the political storm that had raged in 2007.

  In his 7 September 2009 interview with Business Standard, RIL’s top executive P.M.S. Prasad had been asked why his company had for two years stalled providing information to the CAG in 2006–7 if RIL was confident that it had valid explanations for the cost escalations and increases in capital expenditure. Prasad said that he had interacted with CAG officials first in April 2009 when there was ‘a meeting in the petroleum ministry to which eight operators were invited’ and the government had told all of them that the CAG would ‘audit contractors’. He added that he had another meeting with the CAG later that year, in August, that was ‘specific for D6’ where he welcomed the audit but said that the government (MoPNG) had already appointed an internal auditor for auditing the company’s records for 2006–7 and that as per the official agreement, that is, the PSC, ‘only one audit’ was provided for. In the meeting attended by Prasad, he said he had suggested that the CAG could start the audit on a ‘prospective basis’, that is, after 2006–7.

  The CAG’s report was replete with critical remarks about the way the PSCs had been structured. The executive summary of the report clearly stated that the CAG audit’s main objectives were to verify whether:

  The systems and procedures of MoPNG and DGH to monitor and ensure compliance by the operators and contractors of the blocks with the terms of the PSCs were adequate and effective.

  The revenue interests of the government (including royalty and the GoI’s share of profit petroleum) were properly protected, and adequate and effective mechanisms were in position for this purpose.

  The CAG had apparently learnt its lessons from the reactions to the leaked draft report. It wanted to categorically specify that it was only doing its job. This also sent out a clear signal to RIL—the CAG’s mandate was to look into the performance of the PSCs, and the need to go through the books of the company headed by Mukesh Ambani was only a means towards achieving this end. The PSC, which came across as a leitmotif in the draft report with its recommendations and observations, now became the central theme of the final report of the CAG. The final report was strident in its indictment of the government and its officials, insinuating how the PSC itself had deliberately been kept pliable and was thus responsible for promoting crony capitalism, though it did not use such language. The government auditor played it safe in case it was accused of picking on RIL. The CAG’s final report stated:

  Audit also wishes to firmly emphasise that all our enquiries and findings emerge from, and are limited to the PSC. We do not profess to go into any procedure or policy related aspects leading to the conclusion of the PSC. Taking the PSC as given, we have merely examined the contractual obligations of the signatories to the contract, viz. the government and the private contractors. Our findings are totally guided by the ‘written word’ of the contract.

  The section on ‘scope limitation’ in the executive summary of the final CAG report held that its scrutiny was consistent with the provisions of the PSC. There was even an undertone of sarcasm:

  Verification of charges and credits relating to the contractor’s activities and other documents considered necessary to audit and verify the charges and credits, is not merely limited to arithmetical totalling of charges and credits or tracing of charges/expenses from the accounting statements to the contracts/expense vouchers. Such an exercise would extend to verifying whether the costs being depicted in the PSC accounts by the contractor, which would critically affect the determination of profit petroleum and (the) GoI’s share within, are correctly determined, and in particular, costs incurred for procurement of goods and services through a competitive process, so as to minimise costs (and ultimately maximise the GoI share of profit petroleum).

  The CAG did not simply want to confine itself to criticising RIL. Its final report was precise. Every flaw or infrin
gement was pegged to the relevant clauses in the PSC that had been signed between RIL and the government. The voluminous report documented both the flagrant violations of the PSC by the contractor as well as alleged acts of negligence and connivance on part of the MoPNG as well as the regulator, the DGH. Comparing the draft report with the final report of the CAG, one finds that the ‘conclusions and general recommendations’ in the executive summary have also been altered. Besides merging the bold-type boxes with the main text, the final report made the following observations:

  The PSC, as it currently stands, is based on a scaled formula for profit-sharing between the GoI and the private contractors. This is based on a critical parameter—Investment Multiple (IM)— which is essentially an index of the capital-intensive nature of the E&P (exploration and production) project i.e. the amount of ‘capex’ on exploration and development activities relative to income. The slabs of profit-sharing are so designed that the more capital intensive the project (i.e. lower IM), the lower the GoI share of ‘profit petroleum’ (which could be as low as 5 to 10 per cent). Contrarily, the higher the IM (i.e. less capital intensive vis-à-vis income), the higher the GoI share of ‘profit petroleum’ (which could be as high as 85 per cent). In practice, however, the private contractors have inadequate incentives to reduce capital expenditure—and substantial incentive to increase capital expenditure or ‘front-end’ capital expenditure, so as to retain the IM in the lower slabs or to delay movement to the higher slabs.

  Some readers may find this explanation too technical. A simpler explanation is provided here. The point that the CAG and others have repeatedly made as far as the structuring of the PSC is concerned, can be simply (if somewhat simplistically) put as follows: the contract is such that there is a perverse incentive on the part of the contractor to spend more on equipment and other forms of capital expenditure. Why so? The contractor can recover all the extra money thus spent on ‘gold-plating’—even bathroom taps—by selling the gas produced. Put differently, the contractor hardly stands to gain by economising on capital expenditure. Who loses? The exchequer, of course.

  The CAG subsequently invoked the report of the Ashok Chawla Committee on allocation of natural resources, and said that it had drawn similar conclusions on the IM-based profit-sharing formula. The Chawla panel, headed by the former finance secretary (who went on to head the Competition Commission of India) was a committee of bureaucrats including, incidentally, representatives from the ministry of petroleum and natural gas, the same ministry which was indicted by the government auditor. The Chawla committee had referred to the KG-DWN-98/3 project thus:

  The relationship between the pre-tax IM and the share of the contractor ‘profit petroleum’ changes dramatically once the pre- tax IM crosses 2.5, with the government’s share increasing from 28 per cent to 85 per cent. It is useful to remember that this schedule is bid by the operator, and not determined by the Government.

  Since the Ashok Chawla Committee had reached similar conclusions, the CAG felt there was enough ground to revisit the formula. It did agree that this knowledge was gained by hindsight, and called for a course correction in future PSCs. The ‘hindsight’ argument that had been repeatedly voiced by RIL did eventually find resonance in the audit report. Even on the issue of existing PSCs, the CAG conceded that some of its recommendations could be ‘misconstrued’ as hampering operational flexibility, but the importance of the overall objective of protecting the government of India’s revenue interests could not be ignored.

  In his September 2009 interview with Business Standard, Prasad defended RIL’s record on allegations of reducing the payment of the government’s share of revenue—profit petroleum—by raising the capex cost even as the gas price was ‘fixed’ in favour of the company. When asked whether RIL would have earned profits with the price of gas at $2.34 per mBtu (that had been offered to NTPC), Prasad took cover under the cloak of the PSC saying that under its norms, the contracting company first recovers its investment, following which the government’s share of profits increases. He said that assuming an output of 10 tcf of gas, the volume equals 10 mBtu, which when multiplied by $2.34 works out to total revenue of $23.4 billion from the field. RIL would have to recover all costs, which amounted to about $9.5 billion. The government would start earning profits thereafter, its share climbing ‘progressively from 10 per cent, up to 80 per cent’. Prasad agreed that if there was lower revenue on account of a lower price, it was ‘government profit that would get impacted most’ while RIL would recover its costs over a longer period. If the price was $4.20, the total revenue would go up to $42 billion, and the government’s profit share would go up while RIL’s cost was fixed.

  It was pointed out to Prasad that both RIL and the government had a ‘stake’ in a higher gas price except that for the government, it would result in more subsidies on the end products of the user industries, fertiliser and power. His reaction was an ambivalent ‘yes and no’ depending on what is used as a basis for comparison. He said that ‘typically’ natural gas equals the price of crude oil divided by 10 or 15 depending on market conditions. Prasad continued:

  When we bid for (supply gas to the Kawas and Gandhar power plants of) NTPC, oil prices were $27 and we looked at the forward curve. After we recover costs, we do make money but it takes me longer to recover costs, and time is money. If NTPC had signed the contract in December 2005, we would have submitted the contract to the government. If approved, we could have been supplying at $2.34.

  When asked by T.N. Ninan and Jyoti Mukul of Business Standard why, at $4.20 per mBtu, RIL was not able to ‘meet production targets’ and sell gas ‘because prices were lower elsewhere’, Prasad gave what apparently seemed to be an innocuous reply:

  If the government frees me to sell the gas, or alternatively establish a mechanism to give a list of customers, I can guarantee you the balance of 30-40 mscmd that we are ready to produce, we can contract immediately. I need 15 mscmd for my own captive plants. That’s what we have requested the government.

  Prasad also tried to discredit the CAG in the process of the interview, albeit subtly. He refuted allegations that RIL’s independent ‘experts’, independent reservoir expert, Dr P. Gopalakrishnan and later the US- based Mustang Engineering—who had said that RIL’s capex was low when compared internationally—had in any way benefited from RIL beyond the scope of their contract with the company. Prasad said: ‘We didn’t know Mustang. We never considered buying them. We are in the business of plants and assets, we do not want to buy engineering companies.’ He refuted reports quoting Mustang to the effect that it was ‘awarded a multi-million contract’ after the audit. The contract was in the Panna-Mukta-Tapti project where British Petroleum (BP) group is the operator. ‘We are only a 30 per cent partner and BG (British Gas, part of BP group) is awarding contracts on the basis of competitive bids,’ said Prasad.

  The head of RIL’s oil and gas exploration operation sounded hurt in the BS interview. Prasad said it was bad to ‘tarnish people’s reputation’. He said that he had met Gopalakrishnan ‘only once when he came to audit’ and that he did not think that the auditor would have met Mukesh Ambani, even at the Pandit Deendayal Petroleum University (in Gandhinagar, capital of Gujarat) where Gopalakrishnan was a visiting faculty member and Ambani the honorary chairman of the private educational institution. Prasad said that Gopalakrishnan ‘had a good reputation as reservoir engineer’ and had worked for many years with ONGC and then with Kuwait Oil. Finally, he aimed a couple of barbs at the CAG: ‘If you put such linkages, and rubbish people’s reputation, you won’t find anybody. There are four or five people in this space. They might have worked somewhere or the other. Does the CAG have an industry expert? For that, they will need to get somebody.’

  Prasad was asked to comment on the then petroleum minister Murli Deora’s closeness to the Ambani family. The interviewers described Deora as a ‘friendly minister’, to which he said: ‘I do not know’, adding defensively: ‘I am sure he is known to the
(Ambani) family and both the brothers equally.’

  He put a caveat:

  A friendly minister does not mean that he is going to favour us. If that is the perception, I would wish that there was a different minister, because if this perception would not have been there and things would have moved faster. Today, because of this, you have put the minister on the defensive.

  Prasad said the government had ‘tied itself in knots’ by saying different things at different points of time and that is why there was a ‘credibility issue’. The way he defended the government’s actions seemed almost as if he was conflating the government’s moves as RIL’s own. He said:

  This is a path-breaking exercise, and the government is also interpreting as it goes along. We are the first. We ourselves did not understand what some things meant. We did not know what price approval meant. We thought a gas utilisation policy was something in broad terms. We did not know that it was not only sectoral priorities but constraints on our marketing freedom and also that they can allocate customers in each segment by volume and then say you cannot give more or less.