Mohd. Haris for BeyondHeadlines
“We are energy secure when we can supply lifeline energy to all our citizens irrespective of their ability to pay for it as well as meet their effective demand for satisfy their various needs at competitive prices, at all times and with a prescribed confidence level considering shock and disruptions that can be reasonably expected.” This is the definition of energy security adopted by the government of India. The most important aspect of the definition is ensuring energy supply to all the citizens “irrespective of their ability to pay for it”. The objectives of the definition can be realized if and only if we have an efficient energy system in place which satisfies the different aspects of the definition, viz. “effective demand”, “at competitive prices”, “at all times”, “shocks and disruptions”. Here two challenges, inter alia, turn out. One, to establish efficient energy system, and second is to supply the energy generated thereof at prices that could be easily afforded by every citizen.
It is thus imperative to raise the oil and gas production capacity in the country in order to achieve energy security. Therefore, promoting the public-private partnership began to be felt after globalization in oil and gas sector, which was yet to be opened up to private companies. New Exploration Licensing Policy (NELP) was formulated in 1998-99 as a step towards the direction. Nine rounds of bidding have completed so far under which Production Sharing Contracts (PSCs) were signed as the basis for sharing revenues and profits between the companies and the government of India. In the first round of bidding under NELP (NELP-I), 24 (out of 48) blocks offered were signed, 23 (out of 25) in NELP-II, 23 (out of 27) in NELP-III, 20(out of 70) in NELP-IV, 25(out of 25) in NELP-V, 52(out of 55) in NELP-VI, 41(out of 52) in NELP-VII, 31(out of 70) in NELP-VIII, 13(out of 34) in NELP-IX. NELP has been able to attract private companies and spur the production of oil and gas in India.[1] Before NELP, a total of 35 E&P (Exploration and Production) companies were working in India while the number has increased to 117 after the conclusion of NELP-IX (2012). This has resulted in increased production of oil and gas in India. However, the shortcomings of the PSCs will be discussed in the article later.
In addition to it, gas prices have always been an apple of contention. The Rangrajan committee’s recommendation that the present prices of gas produced from the KG D-6 Basin be raised to $ 8.4 per mmBtu (million metric British thermal unit) from the present $4.2 per unit earlier this year again grabbed the attention of media and the experts about whether the hike suggested by the committee is appropriate or has been done under the pressure of market forces. The new price was to be implemented from 1st April this year on which Election Commission of India (ECI) put ban due to election model code of conduct.
The proposed price hike in gas prices and the role of big capital
The Cabinet decided to double the natural gas prices from $ 4.2 to $8.4 per mmBtu in an unprecedented decision earlier this year. Price increase was to be effective from April 1, 2014 which was barred by the Election Commission of India. This decision was made in line with the recommendation of a committee headed by C. Rangrajan, chairman PMEAC (Prime Minister’s Economic Advisory Council). The committee recommended that the methodology be shifted to single gas pricing formula for all forms of gas and all consuming factors with domestic gas prices being determined on an ‘arm’s length’ basis. The ‘market friendly’ formula was reached by averaging the prices of imported gas across sectors over a 12-month period and that of prices in the three major international gas trading hub – US Henry hub, UK National Balancing point and Japan’s custom-cleared rate to arrive at the final prices for gas in India. The present price hike is based on this formula.
Predictably Sensex soared by 520 points within a day of the price announcement and shares of energy companies surged. Apparently, FIIs who were on the selling spree all through the month of june, reversed the trend, and rupee started gaining.
The government and Industry bodies came up with several reasons for the massive price hike. The primary reason why Reliance and the Industry have been seeking higher prices now for more than a year, it seems, is the high international price of $ 14 per unit.
But if we look closely at international prices, we realize that the international gas markets are highly fragmented and that there is no one international price as such. Prices depend upon the fast changing demand-supply situation in various local markets, which is why current prices range from $4 in the US to almost $ 15 in Japan. Ostensibly, that is the reason why Rangrajan committee recommended an average of prices at three different places to arrive at the ‘arm’s length’ price.
Here I am totally confused as to why the committee included Japan’s Custom-cleared rate to reach the domestic prices whenJapan has little relevance for Indian prices as most of India’s imported gas is being brought from countries like Qatar where the current price is around $ 2.5. Even more starkly, at the time when a majority of oil and gas experts are predicting a sharp fall in the prices due to the discovery of shale gas in US, Japan and China, and the price are already facing downward pressure; India has decided to double the prices.
Second reason by the Reliance and the government was that it would usher in FDI and technology. If the purpose of the price hike is to attract the FDI, why should the domestic producers, who have already been incentivized as per the PSC, need to be a part of this hike? In any case, if price hike from $2.34 per unit to $4.2 per unit in 2007 could not lead to investments, how would this new hike lead to the desired outcome?
Reliance invoked that the price must be increased as it has quadrupled the investments in the basin to raise the production. The increment of four times the capital cost for a mere doubling of production has always seemed highly suspicious. No logic can explain why the doubling of capacity should lead to such an increase– ‘economies of scale’ normally ensure that a doubling of production capacity would increase capital cost by about one and a half times.
The government said that the hike would result in additional royalties and profits for the government and public sector producers, like ONGC and Oil India. The logic has been countered by many, Prabir (2014) pointed out that power plants and fertilizers industries are the major buyers of gas and calculated that if the cost of production of fertiliser and power goes up, so does the government subsidy. So while the RIL would pocket the benefit of the higher cost of gas, the government would have to pay out a much higher subsidy of around Rs 75,000 crore for a gain of Rs 20,000 crore and therefore incur a net loss of more than Rs 55,000 crore.
Moreover, NIKO, RIL’s third partner, is selling the same gas in Bangladesh at $2. Reliance defended by saying that NIKO is not selling any KG D-6 gas in Bangladesh. It sells gas produced from its on-land fields in Bangladesh, as per price formula agreed with the government of Bangladesh. It further points out that (a) KG D-6 is a deep water not an on-land block unlike that of Bangladesh. (b) The NELP blocks were awarded to the bidders on the basis of the highest profit share for the government at market price, not the lowest gas price[2]. Neither of the logics that run through the RIL’s explanation strongly justify the demand for raising the prices. First of all, was the block an on-land when RIL entered into an agreement with NTPC for supplying the gas at $2.34 in 2003!However, even if the prices stand higher of the gas produced from an offshore block, it will not be more than $1 per unit. According to RIL itself, the post-production cost between the well head (at the sea bed) and delivery point (at onshore terminal) in (2009-10) was $0.89 per unit, less than $1[3]. That is the price which Mr. Arvind Kejriwal refers to in his rallies while targeting Reliance on gas prices. RIL says that $0.89 is just a post-production cost which does not include expenditure incurred by RIL on exploration, appraisal, development production, maintenance, etc. I acknowledge this statement. But even if one goes by the RIL statement itself, the prices still cannot surpass the existing $4.2 per unit prices.
KG D6 basin: An episode
The gas and oil field in question is known as KG-DWN-98/3(Block D-6), and covers an area of 8,100 sq km offshore in Krishna Godavari basin. Block D-6 was awarded to the reliance under NELP-I, where BP and Niko being its partners. BP is a UK based company, while Niko is based in Canada. Reliance announced its first commercial discovery of massive gas finds in the Krishna Godavari (KG) Basin in 2003-04.
Initially, the D6 was to produce 40 mmscmd (million metric standard meters a day) Gas which was subsequently revised to 80 mmscmd.[4] Presently, the production has precipitously declined to nearly 16 mmscmd, most likely in the quest for the high price which was going to be implemented from April, 1 this year which The ECI imposed bar on due to the enforcement of model code of conduct. However, after BJP’s stunning landslide victory on 16thmay in general elections, news of increased production has started coming.
The CAG report in 2011 had revealed that more than 7,000 sq km area of the basin where no gas discovery has made has not been given back to the government. Reliance is keeping it. According to section 4.2 of the PSC under NELP-IX, at the end of the Exploration Period, the Contractor shall retain only Development Areas and Discovery Areas. Only 350 sq km was to be retained by the Reliance.
Moreover, the reliance has also been accused of gold-plating the investments (wrongfully showing huge capital expenditure). The initial development cost in the contract was $ 2.4 billion which was revised to $ 5.2 billion through an ‘addendum’ in the first phase and to $8.5 billion in the second phase. The CAG observed in its report that $ 8.5 billion has every possibility of being hiked up in the same ways as the first phase. It seems clear that the company has gold plated the Capex (Capital expenditure) to take benefits from Pre-Tax Investment Multiple (PTIM) provision under PSC. PTIM implies the more the capital cost, the larger the share of profit of the private companies. The increment in the capex was accepted by DGH which need not has adopted under the contract. In November 2009, preliminary investigation by the CBI had found evidences of “gross abuse and misuse of the public office” by VK Sibal, the then Directorate General of Hydrocarbon (DGH), responsible for the implementation of such contracts. Numerous links had been found between Sibal and Reliance.
Misuse of PSCs
Recent media reports have highlighted the misuse of PSCs by private companies experienced by DGH. From underproduction of gas to the persisting demand by the private companies to raise the prices, have undermined the efficiency of PSCs. It was substantiated by the CAG report on the audit of the PSC for the onshore and offshore fields, showing nexus between the government and big capital in the country. The report has shown instances where Directorate General of Hydrocarbons (DGH) allowed Reliance industries to gold-plate capital costs of plant, allowing them to make huge profit. It is important here to note that the present pricing mechanism in the PSC is based on the Pre-Tax Investment Multiple (PTIM) methodology and the cost-recovery mechanism. PTIM implies the more the capital cost, the larger the share of profit of the private companies. Cost-recovery mechanism allows oil & gas producing companies not to share any profits with the government until the companies recover their entire capital cost through revenues earned to the tune of 2.5 times the investments.
In 2012, a committee under the chairmanship of Dr. C Rangrajan was set up and amongst the terms of reference was the review of PSC, including in respect of the current PSC with the PTIM as the base parameter. The committee recommended a new contractual system and fiscal regime based on a post-royalty-payment revenue-sharing to overcome the difficulties in managing the existing model based on the Pre-Tax Investment Multiple (PTIM) methodology and the cost-recovery mechanism. The committee notes that in the proposed system, the Government will be able to capture economic rent in the form of royalty and revenue share of hydrocarbons, right from the onset of production.
Both of these provisions have provided ways to the companies to skim off the earnings without sharing it with the government and have created possibilities to gold plate the investments by showing wrongfully inflated capital costs. Therefore, it has been felt by experts that the PSCs should be reviewed and appropriate change must be carried out to set the anomalies right.
Management committee (MC) should also be reformed. Presently, two members out of four in the management committee are the nominees of the government. The role of the MC or of the government nominees on the MC is largely related to monitoring and control of technical aspects. The committee observed that there is frequent criticism that presence of Government nominees on the Management Committee (MC) results in a conflict of interest between regulation and proprietorship. However, a similar situation prevails in many sectors of the economy, including the banking sector. The committee further recommended that to facilitate smooth functioning of the MC, both the representatives of the Government on the MC may devise an internal mechanism to act collectively in the decision-making process and address the issues jointly, in a firm manner. DGH and MoP&NG should firm up Government’s stand before the MC meeting.
All what the whole KG D-6 event does is decline in faith among people in well established democratic institutions in the country. Had the government had stronger political will and ardent attitude to introduce the policies that can appropriately be transmitted to the ground for the betterment of the society, the problem wouldn’t be so worsened that it stands now. At present there is no way to reason with the government and hold the special interest group accountable for their blatant profiteering and its facilitation by the state. The real reason is that in the times of neo-liberalism and monopoly capital, the corporate agents and their apologists like the present state, will keep seeking the highest possible price for their produce and the lowest price for inputs like labour. The new BJP-led government, often alleged of crony capitalism, has to take a call on the matter so as to live up to the expectation of the people who bet on Narendra Modi and catapulted him into the power. It has to deal with Public Interest Litigation (PIL) filed by the likes of Gurudas Dasgupta and Prashant Bushan, long-term baiters of business, seeking to cancel the PSC for the KG D6 block. Now, the new government has to decide whether the gas price should be raised or not.
Readings
- Singhal, Robin (2014): “Aspects of Energy Security: Trends and Policy Framework”, Yojana, May 2014.
- Summary of the recommendation of the kelkar committee, 2014 (https://bit.ly/1kWox0i)
- Report of the committee on the PSC mechanism in Petroleum Industry, Government of India, 2012 (under the chairmanship of C Rangrajan)
- Varman, Rahul: “What lies behind the doubling of gas prices?”,People News Network (PNN), Volume08, Number04, January 08, 2014.
- Industries, RIL (2014): “Demystifying E&P”, www.ril.com/downloads/pdf/demystyfying_ep.pdf&sa=U&ei
- Report on Common Pool Pricing by Mercados Energy Market International and GAIL.
- Purkayashtha, Prabir, Delhi Science forum (2014) : “Krishna Godavari Gas Scam”, http://aeea.org.in/upload/circulars/kg%2520gas%2520scam_1309510105.pdf&sa=U&ei=87hsU8-XGYi3O5yZgZAF&ved=0CB8QfjAB&usg=AFQjCNG42EYvMOrfYklbV721JQ
- Kanani, Harsh (2011): “Pricing of Natural Gas in India”.
- Report on Risk and compliance for today’s global oil and gas companies by Ernst and Young, July 2012
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[1] Report of the committee on the PSC mechanism in Petroleum Industry, Government of India, 2012
[2] Industries, RIL (2014): “Demystifying E&P”, www.ril.com/downloads/pdf/demystyfying_ep.pdf&sa=U&ei
[3] Ibid.
[4] Purkayashtha, Prabir, Delhi Science forum (2014) : “Krishna Godavari Gas Scam”, http://aeea.org.in/upload/circulars/kg%2520gas%2520scam_1309510105.pdf&sa=U&ei=87hsU8 XGYi3O5yZgZAF&ved=0CB8QfjAB&usg=AFQjCNG42EYvMOrfYklbV721JQ
