In recent months media has been full of stories on how Ambani brothers are fighting over the huge gas reserves found in 2002 in block KG-D6 of Krishna Godavari basin. One optimistic estimate puts the reserve as high as 40 trillion cubic feet. By any standard, it is a giant gas field. Instead of concentrating on the important item of how the wealth from these gas reserves should be shared between investors and the country, media has been diverting public attention to sensational topics of family disputes, balance of corporate power, the role to be played by the brothers' mother, positions of respective famous lawyers like Harish Salve and Ram Jethmalani, possible partisanship by the ruling and opposition parties, etc. Sadly, national interest has been given lower priority. This article discusses how a spirited adherence to the production-sharing contract terms will safeguard national interest.

Lack of knowledge on PSC

All the controversy and confusion comes from a lack of knowledge of underlying production sharing contract (PSC) signed by Mukesh Ambani's Reliance Industries Ltd (RIL) with Indian government. It is the PSC which provides the legal framework for exploration, development and production of gas reserves. PSC was used for the first time by Indonesia. It is a legal framework used by several countries today for oil and gas exploration. If properly administered, PSCs are most suited for profit sharing when crude oil prices can swing widely. When prices go high, as it happened in 2008, it can force the government to take recourse to windfall profit taxes. PSCs will avoid such problems. While it gives a stable tax regime for investors, the government gets a bigger share of the profits when the investment generates 'windfall' profits if PSC terms are structured properly. However, it needs considerable expertise on the part of the government to implement a PSC.

Possible ‘sweet heart’ deal

PSC also gives considerable scope for 'rent seeking' officers and ministers since it is not easy for outsiders to detect possible sweetheart deals. It is for these reasons some countries adapt simple 'concession' type of contracts.

Well-negotiated PSCs provide protection against oil companies' gold-plating the investment. It can also prevent excessive operating costs. PSC provides for a coordination committee, consisting of the representatives from the government and investors, to approve all the major decisions. It also provides checks against selling oil and gas below the 'market prices.'

Once the investments are recovered and when the return exceeds some benchmarks, the government gets a bigger share of the so called 'profit oil and gas.' The most important factors to be monitored for ensuring proper sharing of the profits generated in any PSC are the prices for oil and gas. Since there are no well-defined benchmarks for assessing the market prices for oil and gas, there is a lot of judgment involved to assess the correct prices requiring considerable experience in international oil and gas trade. This is precisely where the Ambani brothers' dispute can result in huge losses to the nation if the government does not act diligently.

Never sell gas at fixed prices…

Despite recommendations by several high powered committees, the government has not liberalized the Indian gas market. Gas prices are fixed on an arbitrary basis by the bureaucrats in petroleum ministry without allowing the market to decide. Even when India was paying international price to import LNG as high as $12/ million British thermal unit (mmbtu) in 2008, the government-owned gas production was sold at a throw way price of less than $2/mmbtu. Two important lessons that have been learnt by oil companies are never sell gas at fixed prices on a long term basis and also that gas prices move in sympathy with oil prices. Looks like these lessons seem to have been forgotten or ignored both by Ambani brothers and the government officials. Is it deliberate? Or is it out of ignorance?

A few billion dollars, take it or give it...

Depending upon what the crude oil prices would be in the next 20 years and also the relationship between crude oil and gas (it could get a premium or be discounted as much as 30 per cent with respect to crude oil equivalent price), total profits generated over a period of 20 years could be between $ 156 billion and $ 48 billion. Usually the government share of these profits is about 70 per cent and thus it can vary between $109 billion and $34 billion from KG reserves. For example, if average crude oil price were to be about $100 per barrel, then crude oil equivalent gas price would be $16.7 per mmbtu. On the other hand if oil prices were to be $50/b, and gas prices are discounted as much as 30 per cent in relation to oil prices, then the gas prices could be $5.83. When the gas prices can vary over such a wide range (perhaps even more), it is not prudent to sign a fixed price contract.

If the government were 'forced' to accept a lower price that Anil Ambani's Reliance Natural Resources Ltd (RNRL) is demanding, then profits would be just $13 billion. Thus what is at stake are billions of dollars depending upon how PSC terms are implemented. I am presuming that Reliance PSC is negotiated for the government by experts in accordance with the international best practices without hiding any sweetheart deals. This is a big assumption. Since PSCs have commercially sensitive terms public do not have access to them even under RTI.

In total contravention of PSC norms

When the partition of assets took place between brothers in 2005, Mukesh Ambani's RIL agreed to sell 6.1 tcf (20 million cubic metres per day for 17 years as per recent High Court decision) to Anil Ambani's RNRL at a fixed price of $2.34/mmbtu. This is in total contravention to PSC and the government need not accept it. In any PSC, there are terms that force any investor to sell gas at arms length market price and a negotiated price between two brothers does not meet that criterion. Let us assume that the brothers were on good terms and they had negotiated say a price of $1/mmbtu or their mother suggested even a lower price, should the government accept it? It is possible that as per the mutual partition contract between the brothers, RIL may have to pay any price difference between what RNRL may have to pay to buy the contracted quantity of gas and $2.34 mmbtu. But this need not concern Indian government.

Indian government should consider taking RIL to court for violating the basic terms of PSC ( not trying to get the arms length market price) and try to null and void the original contract itself to safeguard the national interest if PSC allows it. Even otherwise, the government is likely to have legal rights to refuse a lower gas price allegedly negotiated between the brothers based on the PSC. If brothers were on good terms, no one would have found out about this sweet heart deal. Thus as far as the government is concerned the main dispute is between them and RIL.

Of course it does not mean that it can remain indifferent to the case of Ambani brothers' dispute that is now in the Supreme Court. Just like the High Court might have ruled without taking into consideration the PSC terms and ruled in favour of RNRL and forced the price of $2.34 on gas sales, the Supreme Court may do the same if the government does not present its case. In fact the government should have acted soon after it came to know the partition terms between the brothers and asked RIL for clarification. This dispute, which on surface looks like a private affair between two brothers, can even develop into a scam of the century since billions of assets are involved.