The cost-recovery model of the old system whereby an explorer would first recover the entire expenditure in development of the fields before sharing profits with the government, was junked in favour of a system where share of revenue would accrue to the government from the first day of production onwards. The government had apparently realised that its dispute with RIL had been perceived as particularly unsavoury with allegations of deliberate inflation of costs and hoarding of gas, all of which had vitiated the investment climate. According to the Cabinet note quoted by the Economic Times, of the 254 blocks auctioned under the nine NELP rounds, commercial production had started in only three blocks with major gas discoveries mired in litigation and controversy. The new policy regime exempted deepwater operators from paying royalty since such operations are highly cost- intensive. Companies producing oil and gas from ultra-deepwater and frontier blocks also got exemption from payment of income tax for periods up to 10 years, against the present tax holiday system which is limited to seven years from the date of commencement of commercial production. The new policy further extended the exploration period from seven years to eight years for on-land and shallow water blocks and to 10 years for deep water and ultra-deepwater blocks. Under the new policy regime, the government can levy specific financial penalties for defaults by the contractor which was not possible under the ongoing PSCs. According to the existing PSCs, the petroleum ministry can only terminate a contract if the contractor deliberately causes harm to the government’s financial interest. The ministry had imposed a penalty of more than $1 billion on RIL in May 2012 (disallowing capital expenditure) because of a sharp fall in gas output from the KG-D6 block till 2011–12. The company had initiated arbitration proceedings against the government’s move claiming the contract did not provide for such a ‘punishment’. In addition, the petroleum ministry imposed an additional penalty of $792 million in November 2013 on the contractor (taking the total amount due from RIL to nearly $1.8 billion) on the recommendation of the ministry’s regulatory body, the DGH.
On 7 January 2014, a committee appointed by Moily in March 2013 to provide a ‘roadmap’ for increasing domestic oil and gas production, submitted the first part of its report to the minister. The Hindu on 8 January reported that the committee headed by Vijay Kelkar (a former petroleum secretary who had also played an important role in the design of the earlier PSCs) favoured retaining the production-sharing model for deep sea exploration. The panel held that guarantees for recovery of development costs would be important to attract international oil corporations with proprietary technology. It may be recalled that the CAG had criticised the PSC regime precisely on the ground that the contracts encouraged companies to increase capital expenditure and delay payment of the government’s share. The Kelkar committee, however, favoured the revenue-sharing model for shallow and on-land blocks that were less cost-intensive than deep-sea exploration. It also reportedly called for moving to an ‘open acreage’ regime whereby companies could pick exploration areas through the year rather than wait for periodic auctions for areas to be offered after these were identified by the government. To facilitate the new regime, the panel called for the setting up of a National Data Repository that would preserve and promote data on the country’s natural resources. The committee suggested that PSCs be administered without any changes and the DGH strengthened for better administration.
The Kelkar panel’s recommendations were clearly contrary to the royalty-sharing system suggested by the Rangarajan Committee which required companies to state upfront the quantum of oil or gas they would share with the government from the first day of production. Royalty sharing without cost-recovery would remove the possibilities for companies to increase capital expenditure and deny the government its share, as had been highlighted by the CAG. The government and RIL would continue to go by the terms and conditions laid down in the ongoing PSC, the Indian Express had reported on 23 December. Soon after the Cabinet clearance permitting RIL to sell gas from D1 and D3 at a higher price subject to the company furnishing a bank guarantee, the Indian Express quoted a government source saying that the existing contract with the contentious clause of the ‘investment multiple’ would continue. However, this would not be followed for other companies whose renewal would come up from the financial year 2015–16 onwards under the norms of the next, that is, the 10th round of auctions under the NELP. RIL was again being given a break.
On 7 January, the Supreme Court decided to hear the petitions of Common Cause, a public interest NGO, and CPI MP Gurudas Dasgupta against the government’s decision to allow RIL to raise natural gas prices. Earlier, on 30 September, a bench of the Supreme Court headed by Chief Justice P. Sathasivam and Justice Ranjan Gogoi had issued notices to RIL, the DGH, and the CBI on the petitions. The top court’s decision could break or make the fortunes of RIL as it could rule on allegations relating to hoarding of gas and deliberate cost inflation. Dasgupta claimed the Chief Justice had commented that every decision of the government could be reviewed subject to the outcome of the legal proceedings. Reliance executives, on their part, claimed that the court had not issued any order reversing the Cabinet’s decision on gas prices. An unnamed ‘top’ executive of RIL was quoted as saying the following by various newspapers including the Economic Times (1 October 2013):
We are yet to understand the full implications of the Supreme Court’s observations, but under no circumstance do we see it as a restraining order on the previous decision to allow us to charge the new gas price on the condition that we furnish bank guarantees in case it’s proven that we were hoarding gas or gold plating our costs. But I’m yet to get a clearer picture from my legal team. We are yet to discuss this with the petroleum ministry and have not had any formal communication on the issue.
Surya Sethi, former principal advisor on power and energy in the Planning Commission, again recorded his apprehensions about the government’s alleged moves to favour RIL, this time in the form of an ‘open letter’ to the prime minister published in the Business Standard(23 December 2013). He slammed the decision to double the wellhead price of the KG basin gas. ‘Given the already muddied performance criteria, enforcing the guarantee will be akin to recovering water from a sieve,’ Sethi wrote. He further added:
The Comptroller and Auditor General’s findings and other independent reports reveal how crony capitalism benefited RIL. The pre-qualification norms were diluted to ensure RIL qualified. The claimed size of gas discoveries, the field development plans and the investment outlays proposed escaped rigorous due diligence. Above all, RIL’s commitments under the PSC and the field development plans were not enforced.
Sethi recalled his time with the government when ‘RIL’s clout was on full display’. He disclosed for the first time that despite objections raised by him and the then cabinet secretary (K.M. Chandrashekhar), the 2007 empowered group of ministers (EGoM) had approved the price of $4.20 per mBtu, based on an ‘RIL-crafted formula that was unique in the world for pricing natural gas’. This was first time that gas prices had been doubled. ‘The $2.34/mBtu bid by RIL, in a global tender, for the same gas was ignored. A sham price discovery exercise was permitted to justify the higher price that the approved formula delivered,’ Sethi wrote, adding that the ‘present largesse’ was also driven by ‘another indefensible formula’, reiterating his apprehensions about the Rangarajan Committee’s gas pricing formula.
There is no doubt that the Cabinet’s decision to increase administered prices of gas using the Rangarajan Committee’s formula rode roughshod over many voices of dissent. The finance ministry had reportedly raised a query about whether allowing RIL to sell gas from its old fields at the higher prices against bank guarantees would compromise the arbitration proceedings that were under way. In November 2013, Dasgupta had written to the prime minister pointing out that the finance ministry had endorsed demands for deferment of price fixation. He cited an internal note which had recorded ‘continuous default’ of contractual obligations by the contra
ctor and which had even suggested that the petroleum ministry consider termination of the contract under Article 30 of the PSC. Dasgupta had also claimed that RIL’s offer to give a bank guarantee against the enhanced price would be unprecedented. In November, the petroleum ministry had moved a Cabinet note to allow RIL to raise the price of gas produced from its D1 and D3 fields by furnishing a bank guarantee.
Petroleum minister Moily was, however, clear that there would be ‘no going back’ on the decision to hike gas prices and this is what he told reporters in Mumbai on 26 November 2013 on the sidelines of an investors’ conference. Nevertheless, the dispute over cost-recovery continued to fester between the government and RIL. The Times ofIndia (18 December 2013) reported that petroleum secretary Rae had acknowledged that RIL had recovered its costs and was making profits. According to the government’s calculations, till March 2012, RIL had recovered $8.9 billion even as gas production stood at 10 mscmd, registering a fall of 87 per cent from projected levels while gas reserves were at 3 tcf, having fallen 72 per cent. While RIL had invested some $5.7 billion, it had earned some $2 billion from gas sales and the company had also recovered $7.2 billion from the sale of a 30 per cent equity stake to British Petroleum. This worked out to a return on investment of $18 billion or over 300 per cent.
But the Mukesh Ambani-headed company stuck to its stand. It would rather have its profits from the D1 and D3 blocks not be seen ‘in isolation’ since the company was making overall losses in its gas exploration and production (E&P) business into which inflows of fresh investments had been frozen till there was ‘clarity’ on the gas price hike. The Times of India quoted an unnamed company source who argued that the company had made an investment of $11 billion in E&P thus far. Then, the cost of capital would work out to $7 billion assuming an annual interest rate of 13 per cent for 13 years. In addition, there was another $3.5 billion of ‘sunk’ costs, all of which put together added up to $21.5 billion—which apparently meant that not even half the amount invested by RIL had been recovered. The company claimed that the money it had obtained from BP should not be considered ‘revenue’ since 30 per cent of future profits would have to be given to BP. The government had cleared investments worth
$7 billion proposed by RIL for exploration but the recent investment plans of $1,50,000 mentioned by Mukesh Ambani at RIL’s annual general meeting did not specifically mention any investments in E&P activities.
It may be recalled that the suggestion made by the Rangarajan Committee had come under severe criticism in July 2013 in a report prepared by the Parliamentary committee attached to the ministry of finance headed by BJP leader and former finance minister Yashwant Sinha. The report called for a review of the Rangarajan Committee’s suggestions on gas pricing, alleging that these would only benefit the producers of gas, not the government or users of gas. A few months later, more damaging facts were highlighted in another report of a Parliamentary panel, the Standing Committee on Petroleum and Natural Gas, in its report on ‘Allocation and Pricing of Natural Gas’ (Report No 19) that was finalised in October but presented in Parliament only on 10 December. The panel, headed by Aruna Kumar Vundavalli from Andhra Pradesh—who, interestingly, is from the ruling Congress party—asked the petroleum ministry to declare Reliance a ‘defaulter’ on account of the fall in gas output from the KG-D6 block. The committee did not agree with RIL’s contention that the fall in output was because of ‘failure’ in the well but on account of the contractor not adhering to the approved field development plan which it felt should be construed as default. In essence, the committee disbelieved RIL’s oft-mentioned claim that geological complexities were among the main reason for the shortfall of gas output. Here are a few excerpts from the report
The committee has taken serious note of the statement made by the ministry that the contractor (RIL) failed to adhere to the approved field development plan both in terms of gas production as well as drilling and putting on stream the required number of wells, even after repeated reminder. The committee also note that the action taken by the ministry in respect of cost disallowance of $1.005 billion to the contractor was based on arbitration procedure. In view of the above, the committee is of the opinion that non- adherence by the contractor to approved field development plan should be construed as “default” and not just failure and remedial action by the ministry in this regard must be premised on “default” by the contractor and not on ‘failure’.
The committee also sought changes in the gas allocation policy that in effect blocked KG-D6 supply to power stations:
The committee, however, note(s) that due to less supply, allocation to the sectors have been much below the demand. In case of (the) power sector, the allocation has been only 42.53 mscmd against demand of 135 mscmd in 2012-13 which is projected to go up to 207 mscmd in 2016-17. The committee, therefore, recommend(s) (to) the government to indicate the clear picture regarding the availability of gas for power sector in the next 5 to 10 years so that before making the investments in gas based power plant, the gas availability is factored in by the companies.
The committee also backed the demand of states for a share in the gas output and the royalty earned from offshore fields, an issue that had earlier been raised by the late chief minister of Andhra Pradesh, Y.S. Rajasekhara Reddy, soon after gas was first extracted from the Krishna- Godavari basin in 2009. The panel headed by Vundavalli suggested what it called a ‘dynamic’ approach to gas allocation. Further, it said at least half the gas produced should be supplied to the home state (making Andhra Pradesh the biggest beneficiary of KG gas), which should also get a share of royalty:
The committee observed that total gas production during 2012-13 was 40,678 million cubic metres, out of which the share of private/ JV (joint ventures) in the KG D6 basin located in coastal area adjoining Andhra Pradesh was 13,700 million cubic metres. This accounts for 30 per cent of the total natural gas production of the country. However, the allocation to Andhra Pradesh is pegged at 29.02 mscmd in 2012-13, out of a total allocation of 216.27 mscmd which works out to less than 15 per cent. The committee note(s) that only regional preference given to Andhra Pradesh is that the power plants (in the state) have been allocated KG-D6 gas based on 75 per cent plant load factor (an indication of capacity utilization) whereas power plants outside Andhra Pradesh have been allocated (gas on the assumption that these will)... operate at 70 per cent PLF (plant load factor). The committee (is) ... of the opinion that this is an insignificant privilege given to Andhra Pradesh considering the quantum of gas produced in the state. Further, though the gas producing and nearby states have enough demand for gas, it is transported from (the) east to (the) west coast and vice-versa thus entailing extra expenditure increasing the cost of gas. The committee feel(s) that utilization of gas in nearby areas or states, could be more pragmatic and economical than transporting it to longer distances until a nationwide gas pipeline network is in place....
In the case of (the) KG-D6 basin which is one of the biggest discoveries of natural gas in recent years, the royalty on the production accrues only to (the) central government and no revenue is earned by the Andhra Pradesh state government. As the royalty payments to states where the natural resources are located and produced is substantial, as seen in the case of Rajasthan where (the) state government is earning to the tune of Rs 5,000 crore per annum by way of royalty from (the) Barmer (gas and oil) fields, depriving other states of (their) rightful share of royalty from offshore fields is unjustified. Even though, the offshore fields lie in coastal areas, the contractors would set up offices and source other infrastructure to carry out the work in adjoining states.... Hence, it is reasonable for the state to expect some benefits from such economic activities being carried out adjacent to their coast (which) will incentivize the states to extend all cooperation to carry out the exploration and production activities.
The committee also opposed the Rangarajan formula that included high LNG rate as one of the parameters while calculating gas prices; and q
uestioned the strategy of trying to attract investments on the basis of high gas prices because the earlier increase in the administered prices of gas rates did not attract investors. The committee also recommended that pricing domestic gas be denominated in US dollars and sought a review of the recommendations of the Rangarajan Committee. In other words, the Parliamentary committee concurred exactly with what all the critics of the government and RIL had been arguing or claiming. The panel stated:
The proposed formula is a simple average of two methodologies. In the first method, it takes the price of imports of LNG into India by different suppliers while in the second method, the weighted average of prices of natural gas prevailing at Henry Hub (HH) in USA, National Balancing Point (NBP) in London and netback import price at the well head of suppliers into Japan in the preceding quarters is considered.
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