Understanding the ongoing gas-pricing dispute
D. Murali
Chennai: In the ongoing gas-pricing dispute, is the Government partial to either of the Ambani brothers, as claimed? No, it is not, avers Bhamy Shenoy, a senior advisor to the Center for Energy Economics at University of Texas, Austin.
“It is the bounden duty of the Government to safeguard the interests of the taxpayers. Billions of dollars are involved in this deal and the Government cannot be a mute spectator,” he adds, during a quick email interaction with Business Line.
Shenoy argues that the Indian Government should legally resolve the violation of basic terms of production sharing contract (PSC) – that is, not trying to get the arm’s length market price – and try to make null and void the original contract itself to safeguard the national interest. “Even otherwise, the Government is likely to have the legal rights to refuse a lower gas price allegedly negotiated between the brothers based on the PSC. If the brothers were on good terms, no one would have found out about this deal.”
Excerpts from the Q & A. Link of the original article
What is the dispute between the bhais about?
When the partition took place between the Ambani brothers, Mukesh and Anil, the settlement involved Krishna Godavari basin (KG) D6 block gas reserves. Discovery took place in 2002; reserve estimate is as much as 30 trillion cubic feet (TCF) of gas and 14 TCF has already been proven. Oil reserve proven is 140 million barrels. Peak gas production is 80 million cubic meters per day.
The alleged settlement was for Mueksh Ambani’s RIL (Reliance Industries Ltd) to supply 20 million cubic metres per day for 17 years as per the High Court, at $2.34 per million Btu (British thermal unit) to Anil Ambani’s RNRL (Reliance Natural Resources Ltd). The High Court might have found that RIL needs to supply gas as per the private settlement between the brothers.
Since PSC is an overriding contract, which controls the sharing of gas reserves between the investor (RIL) and the Government, RIL is bound by the terms of the contract terms. Once RIL gets its share it can decide how to share with RNRL. But the total pie of gas revenues and how it is shared between the Government and RIL have to be as per PSC.
Isn’t it normal that the gas can be sold to any one?
PSC usually does give the right to sell gas to any one. But it is not clear if this particular PSC has that clause or not. But PSC definitely will have the clause of selling gas at arm’s length and be market-based.
A price agreed by brothers cannot be considered to be arm’s length. Even if RIL agrees to sell gas at a lower price, the Government is not bound by such a clause since the Government owns all gas reserves, and PSC gives the right to take some portion of those revenues.
For starters, can you explain what a PSC is?
It is the PSC or ‘production sharing contract,’ which provides the legal framework for exploration, development and production of gas reserves. PSC was used for the first time by Indonesia. It is a legal framework used by several countries today for oil and gas exploration.
If properly administered, PSCs are most suited for profit-sharing when crude oil price can swing widely. When prices go high, as it happened in 2008, it can force the government to take recourse to windfall profit taxes. PSCs will anticipate such problems.
While PSC thus gives a stable tax regime for investors, the government gets a bigger share of the profits when the investment generates ‘windfall’ profits if the PSC terms are structured properly. However, it needs considerable expertise on the part of the government to implement a PSC.
PSC also gives considerable scope for ‘rent seeking’ officers and ministers since it is not easy for outsiders to detect possible sweetheart deals. It is for these reasons that some countries adopt the simple ‘concession’ type of contracts.
A well-negotiated PSC provides protection against the oil companies from gold-plating the investment. It can also prevent excessive operating costs. PSC provides for a coordination committee consisting of the representatives from the government and investors to approve all the major decisions.
PSC can provide checks, as follows, against selling oil and gas below the ‘market prices’:
* The title of hydrocarbons stays with the government.
* The state maintains the management control, and the contractor is responsible for the execution of petroleum operations.
* The contractor is required to submit annual work programmes and budgets for the scrutiny and approval of a state institution, usually the national company.
* The contract is based on product-sharing, not profit-sharing.
* The contractor provides all the financing and technology required for the operations and bears the risks.
* During the contract term, after allowance for up to a specified percentage of annual production for the recovery of costs, the remaining production is split between the contractor and the state.
* The equipment purchased and imported by the contractor becomes the property of the state. Service company equipment and leased equipment are exempt.
Is gas pricing critical to the current dispute?
Once the investment of the investors are recovered and also when their return exceeds some benchmarks, the Government gets a bigger share of the so-called ‘profit oil and gas.’ The most important factor to be monitored for ensuring the proper share of the profits generated in any PSC is the price for oil and gas.
Since there are no well-defined benchmarks for assessing the market prices for oil and gas, there is a lot of judgment involved to assess the correct prices, requiring considerable experience in international oil and gas trade. This is precisely where the Ambani brothers’ dispute can result in huge losses to the nation if the Government does not act diligently.
On the market price or the right price for gas.
Depending upon what the crude oil prices would be in the next 20 years and also the relationship between crude oil and gas (it could get a premium or be discounted as much as 30 per cent with respect to crude oil equivalent price), total profits generated over a period of 20 years could be between $156 and $48 billion.
Usually, the Government’s share of these profits is about 70 per cent and thus it can vary between $109 and $34 billion from the KG reserves. For example, if average crude oil price were to be about $100/b (per barrel), then crude oil equivalent gas price would be $16.7 per mmbtu (million BTU). On the other hand, if oil prices were to be $50/b, and gas prices are discounted as much as 30 per cent in relation to oil prices, then the gas prices could be $5.83. When the gas prices can vary over such a wide range (perhaps even more) it is not prudent to sign a fixed price contract.
What is now at stake, therefore?
If the Government were ‘forced’ to accept a lower price that RNRL is demanding, then profits would be just $13 billion. Thus what is at stake are billions of dollars depending upon how PSC terms are implemented. I am presuming that the PSC is negotiated for the Government by experts in accordance with the international best practices without hiding any sweetheart deals. This is a big assumption. Since PSCs have commercially-sensitive terms, the public do not have access to them even under the RTI (Right to Information) Act.
Your views on the gas market in the country.
The total control of the gas market today in India by the Government is a problem. Despite the recommendations of many high-powered committees, the Government has not liberalised the gas market.
Gas prices are fixed on an arbitrary basis by the bureaucrats in the petroleum ministry without allowing the market to decide. Even when India was paying international price to import LNG (liquefied natural gas) at as high as $12/ million British thermal unit (mmbtu) in 2008, the Government-owned gas production was sold at a throwaway price of less than $2.00/mmbtu.
Two important lessons that have been learnt by oil companies are: Never sell gas at fixed prices on a long-term basis, and gas prices move in sympathy with oil prices.
Anyone who gets access to cheaper gas can monetise it by making use of it in industries where the final market prices are not controlled by the Government. There is ample scope for such diversion. It is very unfortunate that the Government has not liberalised the gas market knowing fully well that some are making money by diverting cheaper gas to industry where they get higher netbacks.
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Bio: Dr Bhamy Shenoy, an alumnus of IIT Madras, has over 30 years of experience in the international oil sector, first for Conoco and then as a USAID consultant in the former Soviet Union countries. In India, he has been associated with the consumer movement, and education reform. He has field experience of implementing PSCs (production sharing contracts). And, as a board member of National Oil Company of Georgia, he played a key role in reducing oil sector corruption.
Dr Shenoy is the convener of Mysore Grahakara Parishat