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In an earlier blog on this site (5 August 2011), I had cautioned against what might be termed a short-term revenue based approach to infrastructure investments, arguing that this would seriously harm investor sentiment. A year and more down the road, I note with considerable anguish that my earlier apprehensions are coming true with a vengeance. While my earlier blog focused only on the upstream petroleum sector, we now see that the virus of short-term policy making expediency has spread like a cancer to various parts of the Indian ‘body economic’ which, if not halted at the earliest, can seriously affect investor sentiment. While my earlier focus was on the petroleum (specifically the upstream exploration and production) sector, I would now touch on events in other sectors which point to a spreading malaise. There are, as I see it, four primary factors for this state of affairs:

a)       Bumbling regulation:  My last blog (7 December 2012) highlighted major shortcomings in the regulatory framework in the upstream petroleum sector. In that blog, I had refrained from questioning the competence of the Directorate General of Hydrocarbons (DGH) to regulate and supervise the petroleum operations of companies with which the Government of India had signed production sharing contracts (PSC). Now, a friend who read that blog has brought to my notice that in the Ravva field (Krishna-Godavari basin) PSC, the DGH insisted that the contractor should drill more wells even though the contractor had achieved the agreed production levels by drilling a lesser number of wells (and no production gain would have resulted by drilling more wells). This must be the first case of its kind where a regulator sought to enhance the capital cost of a project, apparently unmindful of its adverse implications for the profit petroleum share that would accrue to the government. [My blogs of 30 November and 7 December 2012 have explained in detail the economics of upstream petroleum operations under a PSC]. While I am not aware of the final outcome in this case, it reflects a very poor understanding of both the technical and financial aspects of petroleum operations. Add to this the other episodes listed in my blog of 7 December 2012 and you would understand why there is increasingly lukewarm investor response to the offer of exploration blocks in successive bidding rounds under the New Exploration Licensing Policy.

b)      Contractual sanctity and pussyfooted policy: Considering that all major decisions in government (especially the Government of India) are taken after voluminous file notings and consultations with all concerned Ministries, the flip-flops in government policy in the past few years have been truly astounding. I will again take up examples from the petroleum sector (with which I am familiar). As far back as 1986, the Petroleum Ministry took a considered decision, with approval at the highest levels, to exempt investors in oil and gas exploration ventures from the payment of royalty. This was to encourage private foreign investment in exploration at a time when international prices were in the region of US$ 12 a barrel and any upfront deduction from revenue (as in the case of royalty) would have kept away investors. This policy was continued in the bidding rounds held after 1991; it was only with the advent of the New Exploration Licensing Policy in 1998 that royalty payment was incorporated in the fiscal package. This did not, however, deter the Government of India from departing from the contract provisions in the PSC with Cairn India for the Barmer block in Rajasthan and demanding, as a condition for approving the sale of interest in Cairn India to Vedanta, the payment of royalty. In my blog of 5 August 2011, I had pointed out how this move represented a breach of contract by the Government of India and why the payment of royalty would, in the final analysis, make little difference to the share of oilfield revenues accruing to the government. That Vedanta agreed to the condition in their anxiety to obtain government permission is beside the point; the government chose to alter the PSC when there was no logic in doing so and no interests of government or the country had been compromised. A second and more recent case is the gas price finalisation for gas produced from the D-6 gas field in the offshore Krishna-Godavari basin operated by Reliance Industries and its partners. The bid conditions when the block was offered clearly stipulated that the contractor was free to market the gas. The 2006 report of a Committee of officials of the Petroleum Ministry which prepared the guidelines for government approval for gas pricing under PSCs categorically stated that where gas prices had been arrived at on the basis of open competitive bidding (OCB), there was no need for government to interfere with the same. And yet, when the National Thermal Power Corporation was able to secure a deal for gas supply from Reliance at US$ 2.34 per million BTU, the Petroleum Ministry did not accept this bid. There was talk (fuelled by uninformed press reports) that the government stood to lose revenues from the field on account of the low gas prices. This was in spite of the fact that it was a government corporation that was benefiting from the lower gas price and the end-consumer would have been the ultimate beneficiary. And yet, when the same Reliance asked for gas prices higher than US$ 4.20 per million BTU, the Government of India was reluctant to look at a reasonable price for gas in the region. A higher gas price would have also given government a greater share of profit petroleum consequent on increased revenues from the gas field. In this Dr. Jekyll and Hyde situation, it will be very difficult for any private company to do business with the government, given that no one can predict flip-flops by future governments.

c)       Mistrust and bureaucratic inertia:  At the best of times, the private sector has found the Indian bureaucracy to be slow and obstructive, with petty harassment at various levels. Now, the prevailing atmosphere of suspicion of any major government decision has brought the bureaucracy at the higher levels to an almost complete stop. This paranoia seems to have affected the ministers as well: every decision goes to the Cabinet and/or to an Empowered Group of Ministers. Decision making has obviously been a casualty in such an environment. Matters are not helped by ill-informed and widespread media (especially electronic media) reporting that targets specific Ministers and bureaucrats. The slow, tortuous legal process in India is a matter of dread for any honest government functionary: once he is enmeshed in some enquiry, it can take anywhere from ten to twenty years to clear his name, with both his reputation and his career in tatters. At the same time, the failure to quickly bring to a closure corruption cases already under way only deepens the public suspicion that the powerful are above the law.

d)      Political posturing and doublespeak: Partisan politics has in the last couple of years played havoc with economic decision making. Take the case of foreign direct investment (FDI) in retail. The main opposition party had espoused this cause when it was in power – now, it suddenly discovers many evils in the policy. Other parties are no better – their response is dictated more by political exigencies and less by the merits of the policy. Opening up the insurance and pension sectors has run into the same roadblocks. Even the debate on the FDI retail issue has had its share of factual inaccuracies. The Bharatiya Janata Party (BJP) claimed that foreign fast food chains were importing potatoes for making French fries. The companies promptly issued rejoinders to the effect that the potatoes were wholly sourced from within India – in what is probably the greatest irony, the potatoes were sourced from farmers in Gujarat state, ruled for fifteen years now by the BJP. While the position of the Left is understandable, given their antipathy to foreign investment in any form (even when such investment makes sound economic sense), the position of other parties, especially those hoping to come to power at Delhi or in different states, seems to be dictated by political expediency. It is almost as if they are afraid to give any credit for successful policies to the political party currently in power and will back these policies once the levers of power are in their hands. Since this is likely to be a zero-sum game, given that no party looks like cobbling together a respectable majority to push through economic reforms, the result could well be legislative paralysis over an extended period of time.

2.                Opinion and decision makers in government, political parties, the media and academia need to clarify their positions on economic reforms, foreign investment and the overall role of the private sector in the growth process. Open thinking on these issues is all the more imperative since India is competing with a host of other nations to secure investment opportunities. Newer and newer countries are emerging as attractive investment destinations, ranging from the old Indo-China region to Africa and Latin America. India (and Indians) must shed their schizophrenic attitude to private investment. If India as a country wants to export its manpower and capital to other countries to earn foreign exchange and grab a greater share of the economic pie, it must equally welcome such investment. In fact, a situation is developing where, confronting the difficulty of doing business in India, even private Indian companies are looking for investment opportunities in other countries, thereby reducing the scope for job and income-creating opportunities within India. Let us pray that we do not reach a situation where private companies, Indian and foreign, take too literally the words of Mohammad Rafi’s immortal lines from the song from the film Pyaasa in beating a retreat from Indian shores:

Mere saamne se hata lo ye duniya

Tumhari hai tum hi sambhalo yeh duniya

Yeh duniya agar mil bhi jaaye to kya hai  

My last blog (30 November) detailed the fiscal regime in the upstream petroleum (exploration and production) sector. The intention was to show why the Government of India went in for a progressive resource rent taxation regime related to the profitability of a specific oil/gas field in the New Exploration Licensing Policy (NELP) bidding rounds. It would, however, be necessary to also point out the dangers inherent in any profit-based taxation scheme and the need for effective regulatory mechanisms to monitor pricing, production and costs in an oil/gas production venture to ensure that governments are not deprived of their rightful shares of revenue.
Let us start with the concept of ‘gold plating’ of costs. As the name suggests, this is nothing more than companies attempting to inflate costs of projects to show reduced profits, thereby reducing the tax they pay the government. In production sharing contract (PSC) systems, which (in the Indian context) should be more rightly termed ‘profit-sharing contract’ systems, since it is the profits from the project that are split between the government and the contractor, the contractor has (if not properly regulated) the incentive to show inflated estimates of the costs incurred by it on exploration, development and production operations. Since, under the NELP, cost recovery is the first charge (after royalty payment) on field revenues, higher costs translate into a lower volume of revenues available for profit sharing; as the previous blog shows, this also leads to the project showing a lower level of profitability (in terms of the pre-tax Investment Multiple {IM}) and placing the government-contractor sharing in the lower tranches of the IM. Government is then placed in a situation where it gets a lesser percentage of an already depleted profit petroleum.
Companies could conceivably attempt to restrict the share of profit petroleum flowing to the government by bidding absurdly high shares of profit petroleum for the government at relatively low IM tranches. Since lower tranches are reached relatively early in the life of field production, this distorts the net present value of the project at the time of bid evaluation in favour of such a bidder and ensures that it is successful in its bid. Subsequently, during the operation of the PSC, as long as the project does not enter the tranche where government draws a high share of the profits (or where low absolute profit petroleum gives only a meagre share of the overall field revenue to government), the contractor stands to garner a lion’s share of the field revenues. This situation can be brought about by the contractor in one or more of three ways:
(i) The contractor can enter into arrangements with sub-contractors to charge exorbitant prices for services rendered or goods provided in exploration, development and/or production operations. Of course, the contractor itself benefits financially from such an arrangement only if the sub-contractor is an affiliate or works out some system with the contractor to share the economic rent derived from overcharging for services. The contractor may also enhance production (or operational) costs by charging high overheads;
(ii) Cutting back on annual production enables the contractor to reduce the annual flow of revenue and thereby curtail profitability for a given level of cost recovery. This will push the profit-sharing numbers into a lower tranche, with a lesser percentage accruing to the government apart from also reducing the absolute amount of profit petroleum available in a particular year for division between the government and the contractor. There is also then a possibility that lower levels of annual production can be sustained over a greater number of years at lower levels of profitability, cutting into the government take;
(iii) Pricing of the final product – oil and/or gas – can influence the overall profitability of the venture. Sale of the oil/gas to a subsidiary or affiliate of the contractor or to a company with which the contractor has some undisclosed arrangement at prices lower than what would have obtained in a free market transaction will diminish the gross revenue as well as the profit petroleum.
It is in this context that strong and effective regulatory systems need to be in place to ensure that the contractor is carrying out petroleum operations in accordance with best industry practices. The experience of the Indian upstream petroleum sector in this regard has been discouraging, to say the least. Either the upstream regulator, the Directorate General of Hydrocarbons (DGH), has not performed the role assigned to it or the government has not empowered it in a manner enabling it to carry out its responsibilities effectively. So what are the attributes that make for a good regulator and how has the DGH fared in that regard? On two important criteria for a strong, effective regulator, the DGH comes out with a less than satisfactory report card:
(i) Autonomy: The selection of the person to head the regulatory body must be through an impartial, rigorous process. Right from 1993, the Government of India has kept the powers to appoint the DGH. Not only that, the DGH and the staff under him are drawn from the two national oil companies, Oil and Natural Gas Corporation and Oil India Ltd. In such a setting, with their future careers dependent on their respective government-owned corporations, there is every likelihood that any decision of the DGH would be seen as being weighted in favour of the government and the national oil companies, even if such is actually not the case. The temporary nature of their sojourn in the DGH also tends to make the DGH operatives naturally conservative and risk-averse – add to that the general tendency in the Indian system to view every decision with suspicion and you have a perfect recipe for a “pass the buck” syndrome to develop in the DGH. Not surprisingly, decision-making on PSC issues is almost totally Ministry-based, leading to interminable delays. As a party to the PSC, the Petroleum Ministry should not be the adjudicator in PSC issues where government and company interests and interpretations could (and often do) diverge. Recent history has thrown up instances where the Government of India has intervened in matters which ought to have been determined by the provisions of the PSC. The approval of the interest transfer in Cairn India to Vedanta only after the latter agreed to payment of royalty in the Rajasthan discovery (in contravention of the agreed PSC provisions) and the continuing imbroglio over the price payable for gas produced from the D-6 field in the Krishna-Godavari basin are but two instances where a straightforward interpretation of the PSC provisions has not been adhered to by the Government of India. Recently, we read of Cabinet approval being required for Cairn India undertaking exploration activity in its discovered field in the Barmer basin with the aim of augmenting oil reserves, when the matter related to essentially a technical decision that should have fallen within the jurisdiction of the DGH.
(ii) Competence: It is not my intention (nor within my abilities) to comment on the technical capabilities of the DGH personnel. Suffice it to say that deputing personnel for a certain tenure to the DGH is certainly not the best way to develop PSC and oil/gas field management competencies in the DGH. Three recent examples show how the DGH has not played the role that would have been expected of a strong regulator. Curiously, all three cases relate to the D-6 block where the Reliance-BP-Niko consortium is producing gas from an early NELP contract award. The first concerns the excessive expenditure allegedly incurred by the contractor in developing and producing gas from the field. An effective regulator would have analysed the expenditures in relation to the oil/gas production and taken a view on whether to allow the costs for cost recovery purposes. If the regulator was confident of its assessment, it would have been ready to face the challenge of determining the appropriateness of the costs incurred by the contractor through an arbitration process. In the D-6 case, at least from the newspaper articles, one only understands that approval to the development plan was withheld and subsequently granted. When challenged by the contractor to go in for arbitration, the government appears to have backtracked on its earlier stand. Such a knee-jerk approach shows neither the Petroleum Ministry nor the DGH in a favourable light. A second issue relates to the falling gas production from the field, far below the estimates originally projected by the contractor. While there have been all sorts of wild speculation on the reasons for the same, there has been no indication (or any clarification from the side of the DGH) as to why the production has fallen off so sharply. If the DGH was of the view that the contractor had wilfully reduced production, it should have taken necessary steps to compel the contractor to increase production by invoking the relevant provisions of the PSC. By failing to do so, the DGH created doubt in the public mind about the reasons for the fall in production, putting the government’s credibility at stake. Thirdly, there has been unseemly controversy over the pricing of the gas sold from the D-6 field. The PSC provides for the basis for valuation of the gas sold: it is not clear why there has been so much debate on what is essentially a commercial decision and why no effort has been made by the DGH (or the government, for that matter) to clarify the policy in this regard.
It is pointless blaming the DGH for the current state of affairs. The DGH is a creation of the government and it was (and is) the duty of the Government of India to create a strong and effective DGH which can safeguard the interests of the country while also providing a conducive environment for efficient oil and gas field operations. Unless the Government of India takes steps to strengthen the DGH and provide it with autonomy as well as managerial and technical competence, there is every likelihood that the interests of government (and of the country) will be compromised. Not only that, the trend of reduced investor interest in exploration ventures in India will be intensified, with long-term implications for the country’s energy security.

My earlier blog on India’s oil exploration policy (16 November 2012) has elicited responses from some old friends. Their comments have drawn my attention to two issues that are engaging the upstream petroleum (exploration and production) sector. The first relates to the ‘gold plating’ of exploration and production costs and its impact on government take from the producing field; the second concerns effective regulation of the upstream sector. Before taking up these two topics in my next blog, I feel it is necessary to acquaint my readers with the fiscal arrangements in place in the upstream petroleum sector. This blog will, therefore, explain the fiscal regime with some mathematical examples and highlight the rationale of its operation.

The New Exploration Licensing Policy (NELP) fiscal regime is modelled on the fiscal regime adopted for bidding rounds in the 1980s and 1990s, with some modifications. The contractor is entitled to recover in full the aggregate costs incurred on exploration, development and production operations as well as royalty payments (these are collectively referred to as cost petroleum). The contractor can opt to allocate 100% revenues from production to recover costs as long as aggregate costs yet to be recovered are greater than the revenue realised in any financial year or can opt for a percentage less than 100%: this is a biddable item. A notable feature of the NELP production sharing contract fiscal regime is that all costs (whether exploration, development, production or royalty payments) which are not recoverable from petroleum revenues in a particular year can be carried forward to subsequent years and recovered from revenue realised in those years. The pre-tax investment multiple (IM) for calculating the sharing of revenue net of cost petroleum between the contractor and the government in any year is worked out by the following formula:

IM_n+1 = (E_n+D_n+P_n+R_n) +PP_n – (P_n+R_n)/E*+D*

Where

IM_n+1 = Investment multiple in year n+1

E_n         = Cumulative exploration costs recovered for all years upto and including year n

D_n         = Cumulative development costs recovered for all years upto and including year n

P_n          = Cumulative production costs recovered for all years upto and including year n

R_n         = Cumulative royalty payments recovered for all years upto and including year n

PP_n      = Cumulative profit petroleum entitlement (including incidental income from petroleum operations) of the contractor for all years upto and including year n

E*     = Cumulative exploration costs upto and including year n

D*     = Cumulative development costs upto and including year n

Cost petroleum recovered by the contractor together with profit petroleum to which it is entitled (both computed over the contract period) constitute the gross revenue of the contractor. The IM being computed on net income, production costs (P) and royalty payments (R) are deducted from cost petroleum in its computation. Since exploration and development costs are incurred largely in the initial years of a PSC and taper off in later years (unless fresh discoveries warrant further expenditure on exploration and development), E_n+D_n will over time coincide with E*+D*. Essentially, it is PP, the profit petroleum share accruing to the contractor over the contract period, which will determine how high the IM rises. This value of the IM has great significance for the share of profit petroleum taken by the government on a year to year basis, as will be evident in the succeeding paragraph.

The main component of the bid evaluation process in the NELP is the percentages of profit petroleum offered to government by bidding companies in the first (less than 1.500) and last (greater than 3.500) tranches of the IM, since royalty payment is mandatory. Based on these two percentages, the percentage values for tranches between 1.500 and 3.500 would be interpolated based on a linear scale. An example would help clarify the picture:

As is clear from the above table, the share of government in net revenue rises progressively as the IM moves to higher tranches of profitability.

A view has been voiced in public discourse that the pre-tax IM method of determining government share is fraught with the danger that the producing company would be tempted to inflate (gold plate) costs to reduce the profitability of the venture and thereby confine government share to the lowest one or two tranches as well as reduce the quantum of profit petroleum available for division between the contractor and the government. It has, therefore, been suggested that a flat share of gross revenue (based on production) be taken by the government so that the ‘evils’ of gold plating do not lead to a reduction in government share. There are at least three problems with such an approach:

(a) royalty on oil and gas at between 10% and 12.50% of gross value is already levied on companies. A further flat rate levy implies an extension of the royalty approach. It also makes a risky, cost-intensive venture unviable at the outset by taking a large chunk of the pie away from the contractor, postponing the payback on its investment;

(b) the flat rate approach is insensitive to the fluctuations in economic rent arising from windfall gains. This could arise on account of rise in oil/gas prices, as has been witnessed over the past decade. Oil prices have climbed over fourfold since the turn of the century. A flat rate revenue sharing approach entered into in, say, 1998 (when oil prices were under US$ 20) would have greatly reduced the revenue share of government today (when oil prices stand at over US$ 80). There is also another possible scenario: a dramatic drop in exploration and development costs after contract execution because of advances in technology would also confer huge benefits to the contractor, with the government not sharing in the windfall gains.

(c) a flat rate regime could also adversely affect the exploration and development of marginally profitable discoveries. A ‘one-size fit all’ flat tax regime does not account for the varying geological prospectivity and the differing costs of exploration and exploitation of discoveries in different petroleum basins (both onshore and offshore) of the country. Varying the flat tax rate across different regions would invite the accusation of arbitrariness in rate fixation.

This is not to discount the need for vigilant monitoring of the contractor’s operations to ensure that government is not deprived of its legitimate share of profit petroleum. However, merely because, as a society and government, we lack confidence in our regulatory institutions is no reason to look for simplistic fiscal solutions that deny government its rightful share of economic rent from petroleum operations. This is a topic we will turn to in the next blog.

Coal, that black diamond, is currently generating more heat than light… at least that is the conclusion one reaches on reading and viewing the current debates on what is popularly referred to as “Coalgate”. At the heart of the controversy is the (apparent) failure of the government to allot coal blocks to private parties through a bidding process rather than by direct allotment, as has been done over the past decade. Unfortunately, the focus is largely on the allocations to apparently undeserving parties rather than on the issue of what is the most cost-efficient method of mining coal to meet the energy requirements of the country. Once again, we are in the uncomfortable situation of a public sector versus private sector debate rather than an assessment of how best to meet the country’s fuel requirements.
The first bogey that needs to be laid to rest is the contention that coal mining and extraction should vest entirely with the public sector. A public sector monopoly with its cumbersome processes can hardly be expected to meet the rising demand for coal. It would be interesting (and instructive) to analyse why the coal sector was not opened up to private investment at around the same time (1974) as the petroleum sector. After the first oil shock of 1973, surely India’s energy planners should have been giving serious thought to augmenting supplies of alternative fuels for the power sector, given India’s large coal reserves in relation to its petroleum reserves. There could be two possible reasons for this (in hindsight) costly oversight. The first (rather charitable) explanation could be that it was felt that the public sector could meet the coal requirements of the power sector. This explanation could probably have had credibility till 1991, when the Indian economy underwent a U-turn. By 1991, the capability of the public sector to meet crucial infrastructure needs was being seriously questioned. International agencies like the World Bank, IMF & ADB leant on the Indian government to fully open up the petroleum sector (from exploration for oil and gas to refining and marketing of petroleum products) to private (Indian and foreign) investment, when approving loans to bail out the Indian economy in a crisis situation. However, they exerted no similar pressure as far as the coal sector was concerned. It could be surmised that the clout of international oil and gas companies being significantly more than that of global coal mining companies, the pressures from the former influenced the views of international lenders to a far greater extent. But why did the Indian government not proactively go in for opening up the coal sector as well to private investment in 1991? After all, the critical balance of payments situation in 1990-91 should have awakened policy planners to the dangers of an energy crunch, which required concerted action in respect of all fuels, not just petroleum. The explanation for this policy failure will necessarily have to be not so charitable to the Indian government: it reflects the vested economic and political interests that were against giving up control over the lucrative coal sector. The major success in petroleum discovery and production post-1974 was in the offshore Bombay High field; since offshore allocation of petroleum exploration licenses lay squarely within the competence of the Indian government, it was relatively easy for the central government to offer offshore exploration blocks in successive exploration rounds between 1980 and 1995; even the offer of onshore blocks got little attention, because the production in onshore areas was located largely in the states of Assam and Gujarat and had not led to the development of powerful pressure groups as in the coal sector. In contrast all coal blocks were onland, in states like the then undivided Bihar and Madhya Pradesh, Odisha, Goa and Andhra Pradesh. Equally important was the coalition of interests that had developed in the coal sector (unlike in the limited onshore petroleum mining sector). Politicians, mining sub-contractors, transporters and labour contractors, among others, stood to gain from the many contracts that could be garnered from the operations of the public sector entity. With such an array of pressure groups opposed to any change in the existing system, it comes as no surprise that the coal sector remained a public sector monopoly.
What steps could, if taken over the past twenty years, have helped in avoiding the present brouhaha in the coal sector? This requires an examination of the possible policy framework that would not only have ensured a transparent system for entry of private players in the coal sector, but would also have enabled greater cost efficiency while also giving government a greater share in revenues generated from increased production (and value addition). The experience of a bidding process in the petroleum sector over three decades could well serve as a guide to the development of a robust allocation and management system in the coal sector.
First and foremost, there is need to shed ideological blinkers regarding private investment in the coal mining sector. It is not good economics to have an inefficient public sector that extracts lesser quantities of a mineral at costs which are higher (for given geological conditions) than the international norm. This was the logic behind the New Exploration Licensing Policy (NELP), introduced in the petroleum exploration sector since 1999, which required Indian public sector oil and gas companies to compete for oil and gas exploration blocks with domestic and international players in bidding rounds. Competition in the coal sector will improve economic efficiency by exposing all companies to best international mining practices and encourage cost reduction efforts to improve profit margins. There is, of course, the issue of how to permit companies with no previous expertise in coal mining to bid for blocks. Here, the path followed in the petroleum sector can be adopted. Indian private or public sector companies newly entering into coal mining activities could be considered if they bid jointly with Indian or foreign companies with previous experience in this sector. This was how companies like Reliance Industries, Gujarat State Petroleum Corporation and Videocon Industries were able to enter the petroleum exploration and production sector.
More importantly, there is need to lay out a specific contractual framework within which all companies (private and public sector) must carry out operations. Petroleum exploration and production activities have been carried out under the ambit of production sharing contracts. Developing similar contractual arrangements for the coal sector would not only streamline operations relating to prospecting for and extraction of coal but also enable putting in place a fiscal regime that allows companies to earn a reasonable rate of return on the capital invested by them while also giving government a share in the profits realised from the sale of coal produced. The important features that will need to be a part of such contracts are detailed in the succeeding paragraphs.
The first requirement is the specification of the duration for which the coal block will be allotted to the successful bidder and the manner in which coal resources in the block will be assessed and exploited. In case there is need for a company to carry out a geological assessment of the block, the period for such assessment should be specified, with the proviso that production plans must be prepared and approved in a specific time period. Any unreasonable delay on the part of the contracting company in commencing production should invite sanctions ranging upto termination of the contract. The specification of a contract period for the block (with provisions for extension by mutual agreement between the company and government) enables the computation of the likely revenues from the block (under different assumptions regarding future coal prices) and is crucial for determining the proportions in which revenues (net of costs) will be shared between the company and government.
The second aspect relates to the sharing of the “economic rent” from the sale of coal (and possibly coal gas) produced from the coal field. As in the petroleum sector, the company could first be required to pay a flat-rate royalty linked to the value of gross production. It would then be permitted to recover its costs of prospecting, capital investment and operation from the gross revenues less royalty. Revenue (net of royalty and cost recovery) would then be shared between the company and government based on a resource rent tax, which could, as in the petroleum sector, be based on the post-income tax return on investments in the project by the company. The company would also be liable for corporate income tax on its profits after payment of all government levies, including royalty and resource rent tax.
Profit determination is crucially linked to the pricing of coal and other by-products. Where coal is permitted to be sold in the open market, a fair third-party arm’s length sale price would have to be determined to ensure that government gets its due share of revenues. In the absence of a free market for sale of coal, prices may need to be set by an independent regulator to meet the needs of different sectors of the economy. Here, the pricing policy will have to be such as to meet the profit concerns of the private investor as well as the requirements of the economy.
Transparency and fairness in allotment of coal mining leases can be ensured through a single-stage bidding process. Once technically qualified bidders have been shortlisted, the financial packages offered by these bidders would be evaluated in terms of the net present value (NPV) of revenue streams accruing to the government over the life of the contract in the form of royalty, resource rent tax and income tax, discounted at an appropriate interest rate. The successful bidder would be the one offering the highest NPV to the government (based on assumptions regarding production over the contract period, coal price and the discount rate, applied to all the bids). This has been the approach adopted by the Indian government for award of petroleum exploration blocks in successive bidding rounds down to the present day and seems perfectly adaptable for use in the coal sector.
The introduction of such a system in the coal sector would go a long way in ensuring a transparent, rule-bound method for award of coal blocks. Of course, after the award of the blocks, a rigorous regulatory framework would be necessary to monitor production, set the price for sale of coal (and coal gas and other by-products, where produced) and approve costs incurred in extraction of coal. There is also the issue of coordination between the central and state governments, since many clearances for coal production would need to come from the state government. More significantly, there is the question of how the revenues which are to accrue to the government will be shared between the central and state governments. While royalty and a large portion of the corporate income tax will flow to the state governments in accordance with laid down financial devolution norms, a formula for sharing the resource rent tax between the central and state governments will need to be evolved, possibly through the recommendations of future Finance Commissions, by widening their terms of reference to include non-tax revenues.
What is evident is that there can be a well-defined path for allocation of a natural resource like coal, which meets the requirements of fairness and transparency while also addressing the differing concerns of the principal stakeholders – the operating companies, the state governments, the central government and local communities. Such an approach will reduce the likelihood of future controversies and will promote investment in a crucial natural resource sector, contributing crucially to the raw material requirements of a growing economy.

“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.

Dear Prime Minister,

I went through your speech on the occasion of Civil Services Day on April 21 this year. The recent rash of arrests of senior civil servants in states like Maharashtra, Andhra Pradesh and Uttar Pradesh has certainly caused disquiet in the civil services. The merits of the charges against them in cases ranging from Adarsh to Emaar and the NRHM will be decided in the appropriate judicial forum. What causes greater concern is the failure to address the root causes of what I can only term as a growing tragedy. Tragedy not because of what it portends for individual civil servants but because of its implications for the health of the administrative system and the country as a whole.

There were three issues you touched on in your speech: neutrality, system and process change and bold decision-making (with no witch hunting for bona fide mistakes). Let me start with neutrality. Successive political leaderships at both the central and state levels have, over the past thirty years, diluted this concept almost to the point of no return. While proximity of the bureaucracy to the powers that be has always, to some extent, promoted individual advancement, the wholesale dominance of the political element in postings has sent a very strong message to the bureaucracy. Can we deny that postings even in the Government of India are very largely dependent on the fancies of individual Ministers? Gone are the days when a powerful Establishment Officer would send a panel of names to the Ministry, which could only accept one name or reject all of them and send them for reconsideration. Today, it is no secret that a word from the Minister decides the posting in a Ministry at the centre. The less said about the state governments, the better. The concept of a “committed bureaucracy” (first touted in the 1970s) is the norm in all states, give or take some honourable exceptions. If we really want neutrality, we should seriously implement the concept of Civil Service Boards in both the centre and states (with representation from outside the bureaucracy as well) so that postings are made on merit and suitability and not on political proximity.

System and process change is another area where there has been more talk and superficial action rather than any desire for deep-rooted reform. We still have extremely centralised (hence, discretionary) systems of procurement for items from supplementary nutrition under ICDS to arms purchases for the defence forces. Apart from some tinkering with e-tendering and the like, there has been no attempt to delegate procurement to different levels to check the temptation of centralised corruption. Moving to computerised systems, especially in areas of public interface, has been halting and disjointed, dependent more on flashes of individual brilliance and dedication. To give an example, the Bhoomi initiative in Karnataka is yet to be replicated on a national scale. Vested interests in different departments work against the implementation of such system-transforming changes. Our penchant for ascribing deeper motives to any effort is being manifested once again in the UID, where expert views are being trotted out to defend privacy and raise security concerns. We are in danger of letting the “best become the enemy of the good!” Thank God we were able to withstand the criticism of EVMs, which (as anyone who has participated in the election process will affirm) has, along with electoral ID cards (another system reform), greatly reduced the scope for booth capturing and bogus voting.

Of greatest concern is the pattern of politician and bureaucrat-chasing that we are seeing over the past two years. A PIL or a CAG report is used to conduct a trial by media, where guilt is proclaimed even before all facts and the legal position have been examined and before judicial or political processes have worked themselves out. A period of pre-trial incarceration in jail seems to have become the norm, even where the accused is unlikely to evade investigation or tamper with witnesses. The tortuous course of police (or CBI) investigations and subsequent judicial processes guarantee at least a decade or two of court attendance for a bureaucrat implicated in any such case. It would be in the interests of both the system and honest bureaucrats if all such cases were brought to a closure within a time frame of two to three years. The system would benefit by cleansing the Aegean stables of corrupt elements and the honest bureaucrat would be reassured that even if s (he) is charged in any case, s (he) would get justice fairly quickly. In the Adarsh case, the charge sheet has been filed well over a year after investigation started. The Kerala palmolein case has dragged on for over eighteen years with no hint of closure. In the 2G case, even a decision taken ten years ago has been made a ground for launching investigation against a former Telecom Secretary. Contrast this with the speed of the investigation and judicial process in the insider trading scandal in the USA! In such a scenario, no bureaucrat will go in for any decision (leave alone a bold decision).

In some ways, the situation is reminiscent of the period of Jacobin Terror in France after the French Revolution, with the bureaucrat in the place of the French nobility. A lynch mob mentality (with pre-judged guilt) seems to have become the social norm in recent times. It is not the corrupt bureaucrat who will suffer in such a situation. The honest bureaucrat, who lives only on his reputation, and does not have the resources to fight a protracted legal battle, will be the victim. The consequences are obvious: decision making will slow down at a time when the challenges confronting the country are growing at an alarming pace. Mr. Prime Minister, unless we address the basic causes of the current malaise, we are condemning ourselves to a period of continued ineffectual governance. The real sufferers will not be the bureaucrats: as in the case of post-Revolution France, it will be the people (in this case) of India.

Dear Finance Minister,

Actually, I would like to address this letter to you and the Chief Ministers of the various states of India. But since the policy pronouncement in the Budget speech has come from you, it is probably more apt to send this letter to you, with the fervent hope that Chief Ministers (and their Ministers dealing with the subject of Land Registration and Stamp Duty) also take note of what I have to say.

Your budget speech detailed measures to tackle the malaise of black money and spoke of efforts to unearth such funds stashed in offshore accounts. I am at this point, however, more concerned with the generation of black money and its circulation within the country. One such measure in the budget which is likely to give a fillip to the generation of black money is the decision to levy TDS of 1% on the sales value of urban properties above Rs. 50 lakhs and rural properties above Rs. 20 lakhs.

It is a corollary of Gresham’s Law that any attempt to extract advance tax from a revenue source will drive that source underground. In any case, the evader of today is unlikely to be deterred by this measure; it is only the honest tax-payer who will pay in advance and then chase the tax refund that will take its own time to reach him. So the measure will only impose more burdens on the honest tax-payer while having no impact on the conscious evader. What is likely is that the net of evaders will broaden: it would not be surprising if a large percentage of property valuations from the next financial year are just a little below Rs. 50 lakhs (say, a Bata price of Rs. 49.99 lakhs). Potential buyers will then seek to ensure that “white” payments through the banking system are below the threshold limit of Rs. 50 (or 20) lakhs, with the rest of the payment fuelling the black economy.

The problems with “under the table” property sales have as much or more to do with the evasion of stamp duty and registration charges as with the evasion of income and wealth tax. An examination of the “ready reckoner” rates for land and property valuation fixed by state governments show these to be at least 40% lower than the actual market value. Consequently, buyers have an incentive to declare only the “ready reckoner” value as the property value and pay stamp duty only on that amount. To evade stamp duty payment, buyers are ready to offer anywhere from 50% to 70% of the market value in cash. Apart from the loss to the state government exchequer through the undervaluation of property values, those with undeclared incomes also find an easy investment conduit, which is less cumbersome than hoarding, say, gold or currency notes.

What is to be done then? For one, state governments should base “ready reckoner” rates closer to market values through a more scientific, market-based analysis of property values. This would reduce the incentive to under-declare property values and ensure that a fair share of the value accrues to the government. Secondly, it should be mandatory for all such transactions to be undertaken through the banking system. Thirdly, the integration of the land registry data bases with the income tax data base and the use of up to date market intelligence would enable the income tax department to conduct random assessments of transactions that are significantly below market value. Strict penal provisions for evasion combining recovery of multiples of stamp duty and income tax evaded with prosecution for offences under the Indian Penal Code would have a significant deterrent effect on a large body of those undertaking such transactions.

Mr. Finance Minister, your desire to curb the menace of black money is definitely laudable. But trying to enforce compliance through advance payment of tax is likely to create more problems than it solves. Technology and information-based measures that reduce the scope for discretion of the assessing authorities and the incentive for the tax-payer to cheat the exchequer are far better long-term solutions to the problem.

Yours sincerely,

A concerned citizen