Reason from the depths

Published: Wed, 11/06/2013 - 06:56 Updated: Sun, 02/02/2014 - 20:34

The government should not allow old prejudices and corporate rivalries to cloud its judgement on crucial national issues. It has to increase indigenous petroleum and natural gas production and reduce import dependency

Mohan Guruswamy Delhi 

Anything to do with Reliance automatically becomes problematic. Its baggage of perceived wrongdoing, corporate skullduggery and the much-celebrated regime insensitive influence in the halls of government often precludes an objective analysis of any policy issue that concerns it. Reliance Industries Limited (RIL) has been India’s most spectacular corporate rise. From a single-man yarn broker it grew into India’s largest single corporation, all in the lifetime of its founder. The stories of its use and misuse of the levers of power and the sheer bravado with which it is believed to have pulled off caper after caper is the stuff of legends, books and a movie or two.

But, companies too, like individuals, grow up and change. We don’t judge, by what they did, the robber barons that built the great corporate empires of America and made hundreds, if not thousands of others, similarly think big and make America the land of wealth, innovation and adventure. For that matter, we don’t judge Jamsetji Tata by the treatment meted out to the adivasis of Chotanagpur (now in Jharkhand) whose lands were taken, whose forests were slashed down, and whose hopes and memories were erased forever. We now judge it by the contribution the industrial powerhouse made to the nation by ushering in India’s long delayed industrial revolution, and the living legacy of the giant Tata Group with its Rs 600,000 crore or about $95 billion turnover — with 58 per cent of it from its foreign investments.

Today, RIL is India’s biggest exporter. In the year ended 2013 its exports totalled $44.1 billion, and it paid more than Rs 27,000 crore in taxes, amounting to about three per cent of the Government of India’s tax revenues. It has a turnover of Rs 370,000 crore. RIL has about three million retail shareholders holding up to 500 shares.

These figures suggest that RIL should now be treated as a national asset. Instead, it is often considered by many to be an enemy of the State. Clearly, Reliance continues dogged by its past.

Mukesh Ambani has tried to distance himself from the past. The New York Times wrote in June 2008 that “he said all such activities were overseen by his brother before they split, and had since been expunged from his tranche of the company”. “We de-merged all of that,” he is supposed to have said while breaking out in a belly laugh.

However, that past and the sibling present still beset RIL and every issue concerning it flares up into a bout of insinuation, recrimination and irrationality that makes a sensible discussion all but impossible. Take the issue on hand relating to the pricing of the gas production from D1 and D3 fields in block KG-D6, India’s first ever deep-water field.

It’s a complex issue. But, like many such issues, it does not defy reduction into simpler terms. Quite simply, it is thus: RIL was given the contract to extract gas from the D6 block from a depth of about 3.5 km in the high seas. The extractable reserves were initially estimated to be 11.3 trillion cubic feet (Tcf) of 2P reserves. In  oil terminology, 1P means proven reserves, 2P is for proven plus probable, and 3P is for proven, probable and even possible reserves. This was downscaled by the Director General of Hydrocarbons (DGH)
to 10.3 Tcf.

Earlier in October, RIL restated these reserves by 10-15 per cent, suggesting they could be 8.5-9 Tcf. The fact that they are 2P reserves clearly indicates an element of probability. Deep-depth drilling is a tricky business. No one knows for sure what surprises lie in wait down there. Historically, 2P reserves have a strike rate of 50 per cent. The 1P reserves in KG D1 and D3 are just 1.4 Tcf. RIL was expected to drill 50 development wells, but so far has drilled only 18. RIL indicates that it has hit a slew of unforeseen problems with water and sand ingress into the fields, making further drilling commercially unviable and technologically impossible.

RIL indicates that it has hit a slew of unforeseen problems with water and sand ingress into the fields, making further drilling commercially unviable and technologically impossible

Some bureaucrats in the ministry for petroleum and natural gas (PNG), with some undoubted priming by interests inimical to RIL — and why not, for RIL in its heydays too played this game — are now digging their heels in and insisting on 50 wells. RIL says if the 1P reserves are extremely limited and 2P is tending towards 3P, it would be pointless drilling more wells. It’s akin to drinking from a bottle of juice with more than one straw. And how many straws can you push into the same bottle? In other words, the extractable oil will remain the same despite more wells. Their argument is that if India needs more oil it should discover more fields. And India needs more oil, as of yesterday.

In 2007 the PNG ministry appointed Dr P Gopalakrishnan to look into the reasons for the rise of phase one capital expenditure from $2.47 billion to $5.2 billion. Dr Gopalakrishnan appears eminently qualified. He has over 30 years of experience in reservoir management and optimization for companies such as ONGC and KOC. He has a PhD from the Institut National Polytechnique, Toulouse, France, with a basic degree in petroleum engineering from the Indian School of Mines, Dhanbad.

However, Dr Gopalakrishnan, too, has a past baggage problem. He was responsible for a previous study for upgrading the reserves. That is, according to him, there are more 1P reserves. In his report to the PNG ministry he recommended that RIL be asked to drill more wells. Some of the PNG bureaucrats and others outside who are traditionally inimical to RIL are now citing this report as the gospel.

The conflict of interest should be apparent to anyone willing to open his or her eyes. The consultant is a person who in a previous avatar had said there were even more reserves. RIL has written to the prime minister and the PNG minister that he can hardly be expected to be fair now and say something that will conflict with his earlier stance. RIL has completely rejected the suggestion made in his report, ‘Addendum to the Field Development Plan’ (AFDP) and has communicated this to the government several times. It is essentially saying that the initial diagnosis is wrong; the biopsy proves it and so don’t expect us to follow his line of treatment, and at our cost.

RIL counters, saying, with the benefit of experience, it and others too have since revised the quantity and quality of reserves to lower than first estimated and drilling more wells is pointless. Oil majors BP and NIKO too have downgraded the reserves in D6 by as much as 70 per cent to a mere 2.9 Tcf from the original 10.03 Tcf. It is not exactly uncommon for a producer to downgrade its estimated reserves after drilling a few wells. ONGC/OIL have done it several times. But they are never held responsible for the so-called under-recovery.

 

Let us look at the macro-economic realities. India had a trade deficit of $191 billion in 2013. Of this, $109 billion was due to oil. India imports 82 per cent of its oil needs. In October, the price of the Indian basket of imported oil peaked to $114 a barrel when it was assumed that it would be $104. Every additional dollar adds $1 billion to the oil bill. India is the world’s fourth largest consumer of energy with an oil equivalent of 563.5 million tonnes of oil a year. Its oil demand is growing by 5.1 per cent every year. Clearly, there is an urgency to produce more oil and gas domestically.

In the past few months, India has experienced a terrifying run on the rupee due to the widening current account deficit (CAD), mainly due to the burgeoning trade deficit, the biggest contributor to which one oil imports. The road to our national salvation means closing this trade deficit, which means reducing
our energy import dependency quite significantly.

Some bureaucrats with undoubted priming by interests inimical to RIL — and why not, for RIL in its heydays too played this game — are insisting on 50 wells. RIL says if the 1P reserves are limited and 2P is tending towards 3P, it would be pointless drilling more wells

There are plenty of 2P and 3P reserves in and around India. We have to make those fields viable by higher producer prices. Last year, the government subsidized oil consumption (under-recoveries of petroleum-marketing PSUs) to the extent of Rs 190, 000 crore or close to $30 billion at today’s exchange rates. Fertilizer subsidies and electricity subsidies further ramp up the subsidy bill. The argument many make that higher indigenous PNG producer prices will mean higher government outflows towards subsidies is nonsensical. For a start, they are unmerited subsidies. Then the government needs to take a call between stimulating higher oil and gas production in India and the sundry desires of citizen consumers for lower prices.

Rival and downstream business interests also are at play. They suggest a pooling of prices. This means that LNG will be imported, say, at its mid- 2010 price of about $13.60/MMBTU, pooled together with the low-priced KG D6 available at $4.32/MMBTU, and made available to our steel, fertilizers, plastics, power and other industrial producers at subsidized prices. Now, if the government were to take D6 gas at $4.32/MMBTU and sell it at, say, $13.60/MMBTU, it would gain 85 per cent of the extra $9.28/MMBTU, which would mean a yearly gain of over Rs 50,000 crore. The question is, why should the government give this away to big industry when it would do well to use this money to help uplift tens of millions more each year out of their miserable below-poverty-line (BPL) existence? RIL has a point. Why should it be penalized to make other tycoons happy?

Robbing Peter to pay Paul is an old government habit. We pay more for electricity because the high prices some pay go to cross-subsidize others who pay little or nothing for it. We pay more for petrol and diesel because the price of LPG has to be kept low to keep the urban middle class happy. We import wheat at far higher prices than we pay for domestic procurement to keep consumer prices low. Sometimes we do the same with onions. At other times we prevent exports of commodities like cotton or sugar to keep domestic prices low or sometimes allow a flood of imports to beat the Indian producer down.

This makes for an unstable economic regime at the best of times, and distorts markets and prices. Above all, it impedes the growth and natural development of industries. The best system would be for the State not to constantly meddle with the market’s natural dynamics by supporting one producer against another or penalizing one consumer to benefit another.

It can be argued that in countries like India, with hundreds of millions still under the shadow of appalling poverty, some cross-subsidization is inevitable and even required. But, to extend this argument in favour of cross-subsidization to favour big business and their large industrial ventures is quite ridiculous and downright dishonest.

In the past we have had disastrous policies like the freight equalization policy covering the iron and steel industry. Under this policy, iron and steel were supposed to be available in all parts of the country at the same price. So, steel produced in Jamshedpur at a certain price received different levels of subsidy to make steel prices the same in Mumbai or Ranchi. The steel-based industry in eastern India consequently rusted, as unthinking central planners and a meddlesome government blunted the competitive advantage conferred by nature.

Another example that readily comes to mind is the fertilizer industry. This policy, ostensibly to make urea available nationwide at low prices, actually ended up subsidizing an inefficient industry and enriching the owners by guaranteeing a 12 per cent rate of return on investment. Today, the fertilizer industry is the biggest champion of the fertilizer subsidy that last year ballooned to over Rs 130,000 crore. The consequent distorted price of urea has led it to be preferred over other fertilizers and its overuse, diminishing the long-term productivity of the soil.

 

The insinuation by those opposed to RIL getting the new gas price of $8.4/MMBTU from April 2014, as suggested by the Rangarajan Committee, is that RIL deliberately under-extracted in anticipation of a higher price. As such it must be made to supply gas at the previous price of $4.20/MMBTU till the ‘shortfall’ due to lower extraction than what was estimated is met. RIL suggests that the higher the price, the greater the recoverable reserves, as it will make very advanced and costly drilling and extraction technologies viable. This is a paradox that seems to elude most lay members of Parliament and others.

RIL antagonists harp on the Production Sharing Contract (PSC). The PSC is a standard oil and gas industry contract and explicitly acknowledges that reserves and production figures are governed by probability and not certainty. An expectation is very different from a certainty. The KG D6 field was mostly about 8.5-9 Tcf of 2P reserves, of which 1P reserves are just 1.3 Tcf. Clearly, it is a business of chance. When an estimate is given it cannot be clung to as if it was a guarantee. Only the very naive will give or expect guarantees in the oil business.

Today, RIL is India’s biggest exporter. In the year ended 2013 its exports totalled $44.1 billion, and it paid Rs 27,000 crore as taxes, amounting to about three per cent of the government of India’s tax revenues. It has a turnover of Rs 370,000 crore

India must summon the will to forge a consensus to deal with our oil and natural gas situation. We need to make more reserves feasible by offering higher producer prices in keeping with international trends. Unfortunately the government has lost its way and has been swayed off course by ill-founded and
imaginary misgivings.

The Government of India is not without its credibility problems. It is now increasingly perceived to have become discriminatory and arbitrary. By its pricing policies it clearly discriminates between imported and domestic production. This discrimination has resulted in waning interest in India’s New Exploration Licensing Policy (NELP) over the last few years, with fewer and fewer substantial companies coming to bid for blocks. Oil majors, repeatedly seeing expediency overtake policy, have stayed away as they have become extremely sceptical of the sanctity of contracts signed with the government.

There is another discrimination the government is accused of. It is on the pricing of oil and gas. In energy equivalent terms, a crude price of $100 a barrel translates into $17 per MMBTU, whereas gas (as LNG) is available at far lower prices of $12 and below. We know that there are bigger gas reserves compared to oil below our deep seas. We also know that gas is far more difficult to extract and transport to the market. Regardless of the provisions of the PSCs and policy pronouncements made by successive governments since 1999, the practice today is to give import parity pricing for crude oil but deny the same to natural gas and let cartels of consumers dictate gas prices to the government. Income tax benefit under 80IB is provided for the production of crude oil but it is perversely denied for natural gas.

The only way out of this situation is to go the way of crude oil, and fix import parity prices that become the natural benchmark to decide what domestic gas reserves would be commercial to produce. Sectors which need to be subsidized can be transferred subsidy from the higher revenues which then accrue to the government as a result of higher profit from petroleum royalty and taxes.

The government needs to set its course and not allow old prejudices and corporate rivalries to cloud its judgement on crucial national issues. It has to sustain a policy to increase indigenous PNG production and reduce import dependency. But, first, it must extract reason from the depths it has been buried into.

The government should not allow old prejudices and corporate rivalries to cloud its judgement on crucial national issues. It has to increase indigenous petroleum and natural gas production and reduce import dependency
Mohan Guruswamy Delhi 

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