People's Democracy

KG Basin: How Govt Allows Daylight Robbery

S R Paranjpe

THE Comptroller & Auditor General of India (CAG) has already submitted its draft inquiry report into the dealings of the ministry of petroleum and natural gas (hereafter, MPNG) with three contractors, namely the Reliance Industries Ltd (RIL), Cairn India and British Gas --- in connection with the production of crude oil and natural gas from the Krishna Godavari Basin (KG Basin) and other areas. Now it is learnt that the CAG is in the process of finalising its report, and it is understood that the final report would be placed before the parliament soon. It is in this background that we venture to make the following submission for consideration by one and all, in response to some comments that have appeared in public domain on behalf of the MPNG and in defence of the RIL’s inflated cost for KG Basin block.

LAME-DUCK

DEFENCE

One of these comments says that the increased capital cost is the result of increased production capacity from 40 to 80 million standard cubic feet per day (mscfd) but that the CAG did not take into account the increased production capacity while making its comment. The government had earlier approved a capital expenditure of 2.47 billion dollars to explore 5 trillion cubic feet (tcf) of gas at 40 mscfd, which was then increased up to 8.8 billion dollars to explore 10 tcf gas at the production capacity of 80 mscfd. Thus the increase in capital expenditure is 3.5 times for an increase in gas production by 2 times, which is highly disproportionate. The economy of scale is a well proved theory and applies in every sector, and there is no reason why the RIL’s KG block should be an exception to this theory. This disproportionate increase in the capital expenditure, which is popularly known as “gold plating” of the approved capital expenditure, brings out the collusive nexus between the RIL of Mukesh Ambani and the government of India (GoI).

We have at hand a copy of the quarterly progress report submitted by the RIL to the ministry, giving the details of the expenditure on exploration and development of the production wells up to March 31, 2009. The report also gives the details of the expenditure on exploration, development of the wells and production cost incurred during the period April 1 to June 30, 2009. It may be recalled that the production of natural gas in the KG Basin began in April 2009 while the production of crude oil began from June 2009.  Extrapolation of these data to the end of the fourth quarter, i.e. March 31, 2010, indicates that the total expenditure on exploration, development of the wells and production cost incurred would have been less than 8.8 billion dollars. Therefore, to claim a capital expenditure of 8.8 billion dollars amounts to “gold plating.”

The ministry has also said that an increase in the capital expenditure (capex) did not cause any financial burden on the exchequer.  This again is another crucial half-truth. It is true that the government of India (GoI) did not finance the capital expenditure and therefore the increased capital expenditure did not directly result in a burden on the exchequer, but the complete truth is that any increased capital expenditure would result in a decrease in the government’s share in the profit for any given quantum of gas production. For any increased capex would mean that the gross profit would get reduced by an identical amount. Moreover, an increase in the capex would add to the RIL’s share in the profit and cast a corresponding burden on the national economy. This increase in the RIL’s share in profit would come from the consumers’ pockets. According to an estimate, for example, a falsely claimed one billion dollar increase in the capital expenditure would benefit the RIL by at least 1.5 billion dollars.

In this connection, the parliament too has to look into whether the ministry officials breached the privilege of the parliament by offering the abovementioned comments to the press before the report could be presented to the parliament.

UNFAVOURABLE

TERMS FOR GOVT

It is understood that some kind of competitive bidding was adopted for award of each of the blocks and that the RIL won the KG-D6 block through competitive bidding. But at each stage of the utilisation of natural gas, the RIL’s share in the profit is higher than the GoI’s share. While the GoI’s share of profit is a mere 10 per cent in the first stage and it is scheduled to rise to 85 per cent in the last stage, there is a chance that this share may never reach the 85 per cent level due to the uncertain nature of the crude oil and natural gas reserves. Moreover, even if that stage is reached, the cumulative share of the RIL in the profit would still remain higher that the GoI’s. Taking into account the fact that the product sharing contract (PSC) between the RIL and the GoI is only one contract out of 220 contracts of a similar type, it is reasonable to assume that many blocks have been awarded on terms that are more or equally unfavourable to the GoI. Such contracts, while being unfavourable to the GoI, also result in a concentration of wealth in the hands of a few contractors, which is against the letter and spirit of articles 39(b) and (c) of the constitution of India.

It is thus clear that if the loss due to one such single contract is in the range of 100 million dollars, then the loss for 220 such contracts would run into thousands of millions of dollars.

This also means that the new exploration and license policy (NELP), under which all these contracts were signed, allows undue benefits to private developers of the natural resources of our country and needs to be urgently reviewed. There is no reason why the NELP should deviate from the “normative cost plus” methodology which has been effectively implemented in other sectors. 

There is still another aspect to it. International market prices are given in case of imported products, which implies utilisation of external resources. But when internal or our own resources are being utilised, there is no logic of giving the producers international prices as it amounts to granting them an undue share of internal natural resources. Thus there is no need of mentioning the international prices of crude oil and natural gas in these product sharing contracts.

UNJUSTIFIABLE

PRICE OFFER

In order to estimate the reasonable price for gas production, one may suggest the adoption of an equated monthly instalment (EMI) approach in which loan is repaid in equal monthly instalments covering the interest.

One may estimate the expected price of gas production in KG D6 block by assuming the entire capital expenditure as loan with an interest rate of 8 per cent for a period of 10 years. The estimation also allows for an operations and maintenance cost at 2.5 per cent. The gas prices with different capital expenditures are given in Table A alongside.

It may be seen from the above table that, even with an inflated capex, the expected price of the gas would come to around 2.47 dollars per million British thermal units (MMBTU or MBTU). Thus, offering a price of 4.2 dollars per MMBTU is in no way justifiable or explainable. It is therefore not surprising that when one E A Serma asked information about the same from the MPNG, he did not receive any reply or explanation about how it arrived at such a high gas price. It is evident that the gas price determined by the government needs to be reviewed, considering the production cost of gas with a reasonable return for the developer.

And now we have the year-wise RIL’s share and the government’s share in profit petroleum for a period of 10 years for utilisation of 10 trillion cubic feet of gas. Table B alongside shows the two shares with the gas price of 4.2 dollars per MMBTU. 

The table shows that if the inflated production cost is allowed, it would notionally reduce the profits of the RIL and the GoI but in real terms the RIL’s profit will increase while the GoI’s profit will fall.

We have also estimated the impact of gas price as a parameter on the RIL’s share and the government’s share in profit, with assumptions like 5 per cent royalty, a production cost of 230 million dollars per year and a production rate of 80 mscfd (Table C).

These figures do tell us that all the product sharing contracts need to be reviewed, irrespective of whether it is a pre-NELP or a post-NELP contract. The concept of paying to the contractor internationally market determined prices for our national resources, including natural gas and crude oil, allows a producer an increased profit with a rise in the international prices of gas and crude oil. Any such concept needs to be replaced by an administered price mechanism (APM). The procurement price may be so fixed as to give a reasonable margin of profit to the contractor.

Further, one single generation cannot be allowed to consume all the non-renewable energy resources, as the future generations too are stakeholders. A government can be only a trustee of the national resources and has the duty to safeguard the national interest by utilising its authority to correct any error made in the past, instead of taking the plea --- a la A Raja --- that it is only following an existing policy.

Indeed the country needs a specific policy for each of the non-renewable natural resources like iron ore, bauxite, manganese ore, chromium ore etc, and we must immediately stop all mineral exports when it is clear that the available resources cannot meet our internal requirement for the next hundred years in view of the growth of our own economy. It is only logical that explorations must be carried out with the highest priority so that the country’s economic development can be planned properly. But at the same time there should be no hurry to exploit and utilise these non-renewable resources as many product sharing contracts compel us to do. It appears that kickback expectations from contractors are forcing us to go in for fast utilisation of existing resources. The real need of the hour is to cancel all product sharing contracts which are violative of the directive principles of the constitution. The members of parliament too have a duty to stop this daylight robbery.

TABLE A

TABLE B

TABLE C