Sethi elaborated on the Cabinet-approved integrated energy policy which, by and large, follows the policy introduced in 2006. It is categorical that pricing of energy should be at trade-parity prices. We are however, ‘following some archaic form of approach’. The policy says that India needs more competition in every step of the energy value chain, but abounds in monopolies, ‘usually largely government monopolies’. There is a strong nexus between energy and water but, whereas one can live without energy, one cannot do without water. Good regulation, enforced properly, is the key to efficient provision of essential utilities and services. Sethi argues that the regulatory regime may be good and still fail for lack of enforcement; or there may simply be a deficient regulatory framework. The oil and gas sector, unfortunately, suffers from both maladies. The government (the principal owner) conducts upstream regulation; the less said about the downstream regulatory regime, the better. The domain expertise of regulators remains a cause for concern. Such lacunae are at the core of accusations of gold-plating, lack of transparency, cornering of concessions and predatory pricing of transportation and distribution services. If India does not realise that 40 per cent of energy is required to pump one or other kind of fluid, meaning water or oil, economic development would be comprehensively obstructed.
Sethi also emphasised the need for conservation of energy. If India adopts the right approach from the 11 scenarios that have been developed for an integrated energy policy, energy requirement would reduce by 30 per cent, decreasing import dependence. If one looks at the total primary energy import, India may end up at about 35–36 per cent from about 28–29 per cent. There is a view that by 2030–32, import dependence could be 58–76 per cent for commercial energy— if one looks only at oil and gas. But if one takes into account the total quantum of primary energy, which includes coal as well; and if India does things correctly, as has been recommended in the integrated energy policy, that is, if those policies are truly implemented, ‘our import-dependence can at best be reduced to at least 39 per cent’.
Sethi asserted that there is indeed a kind of monopolistic control over India’s natural gas. The public sector GAIL, which was set up as a transportation company for gas, now also controls the distribution of gas. As of now, there is a kind of duopoly between GAIL and RIL. There is inadequate regulation and, so far, it has been limited to the government. Upstream regulation remains under the petroleum ministry and there are serious concerns about its capacity to handle the complex issues involved and the legitimacy of such regulation. As mentioned, India’s downstream regulatory regime is one of the world’s weakest, floundering under its own contradictions, lack of capacity and understanding. The Petroleum and Natural Gas Regulatory Board looks at downstream operations, and has no authority over upstream operations in the hydrocarbon sector: it cannot regulate gas prices, and even its power to allocate gas pipelines and determine gas transmission tariffs have been withdrawn at crucial junctures through de-notification of the relevant clauses.
Sethi had been bringing the issue of GAIL’s operations to the notice of the government since 2002. Today GAIL is a marketing company; it uses gas and controls gas. Even RIL wants full control over production, transportation and distribution, either directly or with GAIL. Oil India Limited (OIL), a relatively small producer, has a similar monopolistic and integrated structure in the country’s northeast. The monopolistic structure of the sector, in turn, suffers from a huge demand-supply imbalance, thereby necessitating a very strong and independent policy and regulatory regime which is conspicuous by its absence. And while unbundling the generation, transmission and distribution in the electricity sector was an important element of power sector reforms, there has been so far no such attempt in the gas sector. Gas and electricity compete for a share of the energy markets in developed countries and, indeed, are beginning to do so in Indian metropolitan areas with city gas networks. The private sector, before the emergence of RIL, produced about 20 per cent of the gas and sold 35 per cent of it to the gas authority. But the ONGC is a major stakeholder. These private fields are but old wells of the ONGC that were handed over to foreign private investors in 1991. ONGC is still a 40 per cent shareholder of these fields.
The MoPNG does not have the capacity to handle the complex issues of regulation. Sethi pointed out that if one looked at any utility service anywhere in the world, nowhere did a system exist where the producer of gas controls the transport and distribution of gas; because, if the producer were involved in transportation and distribution, the producer could indulge in predatory pricing. These are common carrier services and are often called natural monopolies. A case in point was the RIL gas row: a particular price was offered at the wellhead, but transportation and distribution costs added another 35 per cent to the price.
One must not, therefore, have the same entity control production as well as transmission and distribution. Here we have another peculiar situation: the company is also the end-user of the gas. So the regulatory system must make sure that transactions are kept at arm’s length. If you do not do that, you can do self-dealing in the system. This is evident from the introduction of city gas distribution systems and the rush to corner those concessions. The integrated structure of India’s natural gas sector violates the unbundled feature of well-regulated utilities. This concern has been highlighted repeatedly since 2002.
Sethi was also asked for his thoughts on the Union budget of 2009–10, when the then finance minister Pranab Mukherjee held out a tax incentive for RIL to gain Rs 20,000 crore as a tax break for laying gas pipelines. He said this was not the first time that gas pipelines were being laid. If the intention were to construct more gas pipelines through this tax incentive, it could have been done earlier. ‘Why did we not think of this concession at that time?’ Sethi asked rhetorically. ‘Why has this concession become critical so suddenly?’ He was not sure whether this concession is available for all time to come or just a temporary window. If we need infrastructure to be developed, this is not the only infrastructure that could do with concessions. This surely is a cause for concern.
Then again, there was the controversy over PSCs. Sethi argued that a formula-driven methodology, as adopted for pricing LNG (liquefied natural gas), should be avoided when pricing natural gas. The two are different commodities and have separate markets. The vacuum in government policy of a regulatory framework caused this problem. The same PSCs hold good for gas as well as oil. Yet, there is a world of difference between the two. Oil is internationally traded while natural gas is not. Natural gas is different because to trade in it, huge investments are needed (both to liquefy it and to build long pipelines to transport it). Less than 20 per cent of natural gas actually gets traded—the international average. The rest of the gas is consumed at the place where it is produced.
Sethi felt that despite the availability of a clear legal opinion and court orders, the provisions of the PSC that governs the RIL concession were grossly misconstrued. The PSC gives full freedom of marketing to the operator (in this case, RIL) and limits the role of the government in pricing to simple ‘valuation’ for the purposes of determining its share. Irrespective of the PSC, the government does not have a clear and unambiguously enunciated gas pricing policy; multiple pricing policies are concurrently in force. The PSC protects the government on two counts. The government has a share of the product after the costs are recovered. As the company recovers more of its capital expenditure, the share of the government keeps increasing ( with more profit gas for the government to share). What does this mean? This is not a cost-based formula for capital expenditure as it is in the power sector. It is important for an independent audit body like the CAG to see that the capital expenditure of the company is arrived at properly, Sethi pointed out.1
He pointed out that the PSC says, for example, that you first retrieve your investment in the project. The share of the government keeps rising as you recover higher multiples of the capital expenditure. So, capital expenditure becomes crucial in d
etermining the government share in the gas. The PSC gives the government the right because its share depends on the price of the gas, and the government has gone on record insisting that its share in pricing is purely for the purpose of valuation, and not for deciding the market price of gas, because the seller cannot have marketing independence if somebody else decides the price of the gas.
The government has done a flip flop on the issue of whether the formula being used determines the ‘selling’ price or the ‘valuation’ price. Business valuation takes into account the prevailing conditions under which assets are priced (these are macro evaluations of the national/regional economy and the state of the industry) and assumptions about the future conditions (future prices, levels of output, comparative profitability, all of which are related to forecast of trends). All these are based on application or extrapolation of hard facts. However, selling price is what is ‘perceived’ by the buyer, in terms of future revenue (as a running concern) or through sale of assets, etc. This can differ on the terms of the transaction itself: one-time payments reduce the selling price; long-term/instalment payments increase the selling price, etc. To explain by example: a property can be assessed by a government valuer who arrives at a value based on a host of criteria for the purposes of levying taxes, duties and so on; this valuation remains constant whether the owner sells the property at half the price (in a distress sale) or at double the price (during a property boom).
A PSC does not negate the possibility of the selling price being different from the valuation approved by the government. The government has two levels of authority. First, for valuation purposes, it can decide the right price so that no more than the rightful share of gas is taken away by the investor. In the absence of a pricing policy, the government has a framework to prevent sellers from either under- pricing or over-pricing it. So, if the government has a policy whereby it entails that gas for the power sector has to be provided at a certain price, gas should not be sold to this sector at a higher price. If there is an explicit pricing policy, the price at which the gas is sold must correspond to this policy. The valuation and selling price are two separate things. The Bombay High Court brought this out clearly and explicitly in its June 2009 judgement.
The PSC between RIL and the ministry of petroleum & natural gas binds the government to accept any price for gas determined on the basis of a transparent, arm’s length process. Price discovery under an international competitive bid, such as the one in response to NTPC’s global tender, cannot be questioned under the terms of the PSC as the contract gives the government the right to review a pricing arrangement only if the arrangement is construed as determined by less than an arm’s length process. The PSC of the government has no role in questioning the price established on the NTPC bid. The PSC is clear that if the price is established on a pro rata basis, through an international competitive bid as was done, that price is sacrosanct. RIL is contractually bound to supply gas at that price to NTPC. The PSC limits the government’s power to place checks on such a price. In any event, such pricing can be reviewed in the context of valuation of gas to determine the government’s share, or of a pricing policy that the government may announce from time to time.
Much was made of the fact that RIL had to wait for the government to finalise this price. How the $4.20 price came into place therefore invites explanation. GAIL explained this at length at that time, taking the example of 39 countries. In none of these countries, for which information was obtained, were natural gas prices determined by a formula. Only the prices of LNG are arrived at on the basis of a formula worldwide, but in this instance as well, the nature of the formula approved by the government is very different from the typical formulae used worldwide to price LNG.
Natural gas is priced using a formal limit as per international standards. In India, the formula is different from that used worldwide. This formula ensures that our value-addition for gas would remain above $4. This is an exponential formula. In most countries, there is a base price for gas, and with a rise in the price of crude, the gas price gradually rises. In the Indian formula, the gas price rises exponentially. So if $25 (per barrel) is the base price, at $25 and 1 cent, it comes very close to the peak itself. So in the relevant range, for example, the $40–$60 crude oil value, the price varies by about 20 cents. Through this formula it has been ensured that the value-addition for gas never falls below $4 per mBtu. This is the highest value-added price for natural gas anywhere in the world today. So it is not correct to say that gas has been under-priced if the seller sells it at $2.34, Sethi argued.
The documents submitted by RIL to the DGH estimated the cost of production at about $0.90 per mBtu. This meant that RIL stood to make a net profit even at the NTPC-tendered price of $2.34 per mBtu. According to Sethi’s view, (which is similar to Anil’s) the price of $4.20 is calculated by a peculiar formula not followed by any other country. Given the normal calculations, the $2.34 per mBtu selling price is good enough. However, according to RIL, the cost of crude had risen over the last decade and so had the leasing cost of rigs. There is some truth in the latter argument, since crude prices have increased exponentially. The spot price of crude was less than $25 per barrel in March 2003, but by May 2005 prices jumped to just below $55 per barrel. By December 2007, the price of crude went above $100 per barrel; hitting a record of $147 per barrel in July 2008. However, as a result of the global economic meltdown, oil prices fell to less than $40 per barrel in January 2009. Since then, prices climbed back steadily during the period July 2009 to July 2010, though they fluctuated between $70 and $90 per barrel. Indeed, never before have oil prices fluctuated so much. However, despite products linked to oil prices witnessing major price fluctuations, the present prices are much higher than those prevailing during the agreement between RIL and RNRL.
Article 21 of the PSC gives the government the right to have a gas allocation policy. Such a policy was announced by a Group of Ministers in 2008. However, the allocation policy remains ad hoc and is not based on any sound and defensible economic analysis. Article 15 of the PSC allocates the bulk of the gas produced (in physical units) in the initial years of extraction to the operator (in this case, RIL) for recovery of costs incurred (the cost gas). Freedom to market the gas, foreseen under the PSC, is compatible with allowing such cost recovery. In addition, the operator gets its share of ‘profit’ gas in kind. Technically, the government could acquire the entire gas (say, from the D6 block in the KG basin) at a price that permits full cost recovery as well as recovery of the value of the operator’s share of ‘profit’ gas. Short of doing this, any claim that RIL has committed to sell gas belonging to the nation to RNRL is not tenable under the PSC. The PSC allows the operator to dispose of the ‘cost gas’ and its share of the ‘profit gas’ at any price, provided the government’s share of the gas is based on a valuation price transparently determined and/or approved by the government. At present, the government’s statements purporting to place the facts on ownership of gas before bemused and uncomprehending taxpayers leave much to be desired. The price obtained by the operator for the cost gas and the profit gas allocated to it must conform to any pricing policy announced by the government but, as pointed out above, there is no such clearly laid down policy, and multiple pricing regimes are in force.
The policy vacuum here creates serious implications for the rule of law, Sethi explains, for transparency and for accountability in the current regulatory regime and governance in the gas sector. There are, besides, several key issues that characterise this unseemly controversy. First, gas is not a tradable commodity in its natural form. As already mentioned, trading in gas involves, among other things, huge investments in infrastructure, such as pipelines or liquefaction facilities, to convert natural gas to LNG. In other words, pricing of natural gas is based on considerations quite different from those that go into the pricing of LNG.
There was an ‘embarrassing delay’ by NTPC in pursuing its ‘legitimate claim’, he says. This delay occurred
despite NTPC’s board of directors as well as the government’s top legal officers (the solicitor-general and the attorney-general) all advising NTPC to pursue its appeal against RIL, independent of the latter’s dispute with RNRL. A shareholder of NTPC had also filed a public interest litigation in this regard. For Sethi, it was intriguing to learn that the government was reportedly concerned about the need to protect NTPC’s interests. If indeed this was done, the government was essentially proposing to have different gas prices for different power producers in different states. Would such a policy be tenable in our polity, except to the extent that actual costs of transportation and distribution are different for different end-use locations? The good news is that NTPC has gone to court. They have a legitimate cause to take to court: there is a legitimate contract that needs to be serviced, he stated.
Sethi had pleaded, for as many years as he had worked with the government, for a projection of targeted production for a period of about 20 years. Unlike a system of ‘cost-plus’ recovery of expenditure, or a ‘regulated’ return over the life of a project followed in the case of power plants, the oil and gas PSCs allow full and upfront recovery of the entire capital expenditure. There is no cap or ceiling on capital expenditure in gas production. Thus, a higher capital expenditure leads to a higher proportion of ‘cost gas’ and consequent reduction of ‘profit gas’—all other factors remaining constant. Hence, it is of utmost importance that the capital expenditure on the KG basin projects is scrutinised meticulously to ensure that the operator does not get an excessive amount of cost gas, thereby reducing the quantum of profit gas available as the government’s share.
RIL is often rhetorically described as having ‘gold-plated’ its capital expenditure to earn higher revenues while depriving the government of its share of profit gas. Suspicions about an undue rise in capital expenditure on the RIL discovery are widespread. Questions have been raised about the process which required junior government officials to approve increases in capital expenditure running into billions of dollars. There have been conflicting claims about the government’s take from the KG-D6 gas field. Gas reserve numbers have not been certified independently in full. Hence they are, at best, ‘speculative’; capital expenditure has not been ‘finalised’ and the sale of as much as 40 mscmd of gas is legally disputed. Hence, the final price for a quantity of gas that is roughly half of the reported likely peak production is unknown. Besides, as there is no committed and/or approved production profile and gas prices remain highly volatile, ‘the likely investment multiples remain guesstimates at best’, Sethi argued. Therefore, ‘determining and announcing the government’s take from RIL’s D6 field is akin to counting one’s chickens before they are hatched’.
GAS WARS: CRONY CAPITALISM AND THE AMBANIS Page 24
