Oil exploration policy: missing the wood for the trees

“It is a bad workman who blames his tools.” The constitution of the Rangarajan Committee to review the production sharing contracts (PSC) for petroleum exploration and production seems to be a case where the problems of the Government of India with private oil explorers and producers are sought to be blamed on the PSC rather than on those charged with its implementation. Since the media discussion on the subject has raised issues which one thought had been answered in the first flush of liberalisation in 1991, a dispassionate look is required at what really the problem in this sector is and whether the wrong area is not being focused on.

Actually, there is nothing wrong with the PSC devised for the New Exploration Licensing Policy (NELP). The NELP was fashioned on the PSCs of the 1980s and 1990s, with the only real change being the introduction of a royalty payment on oil and gas production. Even the royalty payment as part of the fiscal regime has been palatable to NELP bidders only because of the high oil prices: it is unlikely that companies would have accepted this levy in the low oil price scenario of the 1980s and 1990s. However, what has probably been the greatest plus point of the PSCs has been the linking of government revenue share to the profitability of the oil/gas venture. The statement in a recent Mint article attributed to the Director General of Hydrocarbons (DGH) is fraught with adverse implications for government revenue share. If government share is linked to production rather than profitability, windfall profits accruing to an investor from rising oil/gas prices will not be shared with the government. In fact, this was one of the major factors which influenced adoption of this fiscal model by the Government of India, which has thereby been a major beneficiary of the dramatic oil price increases from the 18 dollar per barrel level of the mid-1990s to the 90 dollar levels of today.

Regulatory inadequacies are a major cause for the recent controversies. The PSC mandates a clear procedure for sanctioning field development expenditures by companies. Nothing stopped the DGH from refusing to approve expenditures on the grounds of inflated costs. If the DGH was sure it was on firm ground on the Reliance D-6 field cost issue, it (or the government) should not have been worried over reference of the issue for resolution to a sole expert or to arbitration. To keep the issue dragging for months and years while all sorts of wild public speculation were encouraged is hardly the way to inspire investor confidence. The same applies to the company claiming that the gas reserve estimates are less than earlier anticipated. A clear technical view needed to be taken on this issue rather than indulging in public debate on geological reserves.

At the heart of the DGH supervisory riddle is the Petroleum Ministry’s approach to PSC administration. If the intention is to have a strong, independent regulator, the Petroleum Ministry ought to ensure that the DGH is staffed by permanent professionals from the oil industry who do not have to look over their shoulders each time they take a decision. Instead, the DGH refers each and every matter to the Ministry for resolution. Matters are not helped by immediate (often uninformed) public scrutiny of each and every move by the Ministry. The result is what might be termed policy paralysis. Instead of going by the letter and spirit of the PSC, issues settled by government decisions in the past are revisited at the cost of contractual sanctity. Take the example of the transfer of interest in Cairn India to Vedanta. The Petroleum Ministry was insistent that the company must meet the condition of royalty payment, never mind that the Fourth Round (1991) bidding conditions specifically exempted companies from royalty payments. That Vedanta agreed to pay royalty was more a reflection of its keenness to get government approval for the transfer of interest in Cairn India rather than on the merits of the contractual position.

What is more worrying is the schizophrenic approach to private investment in this sector. Let one thing be clear: India is a country with only moderate prospectivity as regards oil and gas reserves. International oil companies will invest risky exploration dollars only if they are guaranteed a stable contractual regime and consistency in government policy. It is the entry of these players (with or without Indian partners) that has seen oil/gas production from new exploration blocks in the last decade in the Krishna-Godavari, Rajasthan and Cambay (Gujarat) areas, at a time when the national oil companies, ONGC and OIL, have no new discoveries of any significance to show. Yet, when a major discovery of reserves, as in Rajasthan, by a private player takes place, there is an immediate uproar over the profits that the private company will realise, without an understanding of the revenue (and, of course, the petroleum) benefits that the country stands to gain from the venture. Everyone, from the media to the government and elected representatives, feels the country is being short-changed in the bargain. Instead of creating an environment which encourages more investment in what is undoubtedly a risky sector, attention is focused on how to extract “more golden eggs from the goose”.

Let us as a country be clear on what we want. If we want to be insecure and mistrust every investor, we must accept that scarce exploration dollars will flow to those countries which have far more attractive prospects. However, if we are prepared to deal maturely with private investment, with fair, impartial regulatory mechanisms in place, we can have our cake and eat it too.

2 responses to this post.

  1. If contracts have no sanctity, and if enforcing contracts through the courts is difficult, no one would want to get involved. In addition, if the regulator is unable to deal with ‘gold plating’ of costs, wouldn’t a straight revenue share be easier to implement?


    • Glad you appreciate the importance of contractual sanctity at a time when large sections of public opinion, including the media, have given it short shrift. There is an issue with straight revenue share, which I will deal with in my blog of 30 November 2012. Thanks for your response.


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