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Nuggets on MGR at Brooklyn Hospital Unorganised. Residual. Indeed! A doctor WHO dreamS AND DREAMS Ten minute Mahabharata Fall of a titan The forgotten czar A great effort What caused the financial meltdown Narasimha Rao denied his rightful place in history A walk down memoryís lane Salacious gossip, terrific quotes and surprising typos Super... The dramatic decade Ė A drab dramaÖ The original sin of no pricing policy... Policy changes that would have worked... Randor Guy spins a yarn Creating an innovative society 2014: the election that changed India How adroitly GR walked with giants! Will Ďprintí survive online onslaught? What the CEO really wants from you Technologise banking, disbursement... Itís all GAS The political economy of TN A taut novel on the audit profession One life is not enough... The Media Moghul The uncivil non-civil servant... MIT-a phoenix that rose again and again Turbulent years: a letdown How to run an office Impressive Coffee Table Book From the battle zones... To the brink and back Pure and simple theft of national money Chronicling change through six generations....
 
Itís all GAS
The book, Gas Wars: Crony Capitalism and the Ambanis, did not get the critical look it demands. The book shows that despite having eminent economists and petroleum experts, India is acting like a banana republic unable to adapt needed policy to ensure Indiaís energy security.

A reader unfamiliar with the oil industry may conclude that the goal of the authors, Paranjoy Guha Thakurta, Subir Ghosh and Jyotirmoy Chaudhuri, was to throw light on the unhealthy relation between Reliance Industries and the government in shaping  gas sector policy. Threats of filing defamation cases by RIL against the authors and book distributors reinforced the impression that the authors were trying to expose cronyism. Abrupt changes of petroleum ministers have given rise to speculation that these were done to favour some one company or another. Mani Shankar Iyer was replaced by the Ambani family friend Murli Deora, then by Jaipal Reddy and then by one referred to in the book as “oily Moily” supposedly to help RIL.

However, the main thesis of the book dealing with gas pricing does not support such a conclusion. Actually doubling the gas price would help the country in the long run. Incidentally it will help the public sector giant ONGC more than RIL.

Those not familiar with the oil industry or understanding economic laws are likely to accept the cronyism argument of the authors. They have based their arguments mostly on the PILs, letters written to various government bodies by activists like E A S Sarma (former Power Secretary), Common Cause, retired bureaucrats like T S R Subramanian (former Union Cabinet Secretary) and Surya Sethi (former Planning Commission advisor), opposition leaders like Gurudas Dasgupta (CPI MP) and Arvind Kejrival (AAP leader), reports of Parliamentary committees, Directorate General of Hydrocarbons and audits of CAG.

 

Huge costs of oil exploration, production...

I have worked in international oil industry in different countries for over 45 years. I hold that these experts have failed to appreciate the underlying philosophy of production-sharing agreement and also the huge risks involved in oil and gas exploration. No consumer likes higher oil and gas prices. However, when it is imposed on us either directly (in the case of oil where our dependency is more than 75 per cent) and indirectly (in the case of gas where our dependency is slowly increasing from the current level of 40 per cent), keeping prices low will hurt us in the long run. It is precisely because of India’s policy of keeping domestic prices below international prices that India has failed to develop its gas sector all these years.

Ironically, there is plenty of material in the appendix of the book (unusually large with 154 out of 570 pages) to show possible cronyism: selling IPCL to Reliance by the NDA which resulted in Reliance controlling 70 to 90 per cent of petrochemical products; selling oil and gas fields of ONGC and OIL (Panna-Mukta and Tapti) to Reliance-Enron consortium in the name of privatisation promoted by the World Bank; special income tax provision in the Union budget 2009-10 which alle

gedly benefited Reliance to the tune of Rs 20,000 crore from their gas pipeline investment, etc. Though the main body of the book quotes various experts who are critical of the gas price increase, one need not conclude from all their arguments that such a policy is due to cronyism.

 

Low oil prices can’t  tame inflation...

True, higher gas prices affect power and fertiliser sectors. But its impact on inflation is limited mostly to these sectors. So can the government absorb higher oil prices to reduce inflation? An attempt made by subsidising diesel has worsened budget deficits. Such attempts will cause even higher inflation and affect the poor more than the rich.


....but impact severely growth

What is the long-term impact of lower gas prices? Inadequate investments in exploration and production in the country, larger imports and further huge increase in import bill – all will impact heavily on economy. Strangely, this has been pooh-poohed by several experts quoted in the book. The greatest paradox is that the experts do not seem to be bothered by India importing LNG paying over $14 per 1000 BTU, whereas doubling of gas prices to $8 is made to look like cronyism! And with no concern for keeping large capacities for power and fertilisers idle.

There is an impression held by most critics of RIL that gas production has been intentionally held back to put pressure on the government to increase gas prices. Not many are prepared to accept the technical explanation given by RIL that it was the unexpected geological complexity that has resulted in lower production. This is what happens when a company has an ethical deficit.

It is not easy to reduce gas production rate once it starts. Also every company has every incentive to produce to the maximum because of the time value of money, given the uncertainty of future price volatility. Especially after British Petroleum (BP) took interest in the field, any such ‘game’ of withholding production would create a great ethical and credibility deficit to the reputation of this international giant.


No benchmark for pricing gas

I do agree with comments critical of the pricing model suggested by Rangarajan committee, which has recommended doubling the price. It is not based on sound logic. It may be because the committee could not get expert advice on gas sector and also on PSCs. Just because there is no international benchmark for gas prices, unlike in the case of oil prices (Brent and WTI), basing it on some averages does not make sense. What relevance has Henry Hub in the US or National Balancing Point in the UK or LNG price based on Cocktail of oil pricing in Japan to the Indian gas market?

Why didn’t it recommend free market to determine  gas price? The argument given by the committee is that there are not many gas sellers, that RIL may have a monopoly, that India did not have well-developed infrastructure; and so it may not be possible to discover price through the free market. This is not a sound argument. If buyers cannot justify the prices they have to pay, they always have other alternatives. Bureaucrats need not figure out what those alternatives are. The market will figure them out.

 

Net easy to estimate cost...

One of the concepts suggested by experts is to base gas price using cost of production.  A fundamental problem, that looks like a sensible suggestion, is the problem involved in assessing cost of production. Despite the availability of modern tools, it is not possible to estimate the cost of exploration to assess cost of gas production. One might have drilled many dry wells before hitting a gusher. The US had to wait for many years to learn this lesson. Even in the free market-oriented economy like the US till mid 1980s, gas price was regulated and based on cost of production for inter-state gas trading. This resulted in gas shortage in the US; once gas prices were liberalised there was a gas surplus and gas prices fell. It is because of gas price liberalisation, shale gas became a game changer in the US. Should we not learn from the US experience?

India has a huge potential for shale gas though not as large as that of the US or China. But with the government continuing to control gas prices, not only there is no incentive to explore for shale gas; even conventional gas exploration has stagnated. New Exploration and Licensing Policy is supposed to have given the freedom to contractors to sell gas at arms length. But the government continues to control gas prices because of political compulsion and little possibility for gold plating. Expert committees are also hesitant to recommend market-based prices. RIL and BP are likely to get huge compensation from international arbitration because of this clause in the production sharing contract.

 

Gold-plating difficult...

One of the factors highlighted in the book is the possibility of ‘gold plating’ the investment. It is true that when investors are guaranteed some minimum rate of return, say like in the case of a power plant, pipeline project or fertilizer production, there is every prospect for gold-plating. However, in the case of investment in gas exploration and production, chances of such gold plating are often minimal. There is no guaranteed return in oil exploration. Yes, there could be a possibility of charging higher overheads since PSCs allow for recovery of costs. It is for this reason that all the costs have to be approved by the management committee where government experts are represented. Here is every chance of crony capitalism. But the authors have not been able to come up with any data to show that there is gold plating.

The authors argue that investment multiples concept in PSCs, which allows higher percentage of profit to the government, encourages gold plating. I cannot understand the rationale behind such an argument. If a contractor invests more than required and fails to find and develop gas reserves, how would he able to recover all those costs? RIL initially thought that it had 50 trillion cubic feet (tcf) of gas, which was later reduced to 10 tcf which was further reduced to 3 tcf. Back of the envelope computation shows that if reserves are only 3 tcf, and the government allows even doubling of gas prices, then the rate of return for KG basin will be just about 12 per cent. Is this an attractive return for a high-risk project?

 

ONGC and GSPC costs are higher…

In the KG basin, besides RIL led consortium, there are other investors led by ONGC and Gujarat State Petroleum Corporation. GSPC has announced development plans to invest about $2 billion to produce a field containing 1.8 tcf reserves to reach maximum production of 5.6 million metric standard cubic metres per day (mmscmd). ONGC is planning to develop its oil and gas in northern area fields in KG basin investing about $9 billion to produce 2.5-3 million tonnes of oil and 9 -10 mmscmd of gas. When these investment numbers are compared with those of RIL which has spent about $8 to $9 billion (by some estimates, about $6 billion) to reach a maximum gas output of 62 mmscmd, it does not look like they have ‘gold plated’ their investment.

What no expert has pointed out is the possible sweetheart deal RIL might have got in their PSC terms. First the government need not wait to get some profit till the contractor recovers all his cost. Some producing governments are successful in getting some percentage of the profit from the first year of production itself. Also a good negotiator will be able to get higher share of the profit once the contractor is able to recover his costs and also a reasonable rate of return. Since the government profit share gets higher once the contractor reaches some level of profitability, higher gas prices will work to the advantage of the government.

 

Government can tax windfall profits

There is always pressure on the government to impose windfall profit taxes when oil or gas prices are high. A well-structured PSC obviates such a tax and helps the government with a higher share of the profit. It was this reason, which drove Indonesia to develop the concept of PSCs. Unfortunately most experts critical of RIL are asking for lower prices which actually robs the government from getting higher share of the profit gas. No one,  not even Arvind Kejriwal has raised these issues of the PSC terms. All are questioning the doubling of prices. This is a good example of missing the forest looking for trees.

 

Credibility deficit hurts

Unfortunately, because of the old historical baggage of Ambani family’s doubtful ethical practices of managing the political leaders of both NDA and UPA, there is a credibility deficit. If not for brothers’ dispute, Ambanis would have been able to take India for a ride by selling KG basin gas for just $2.34 per unit for 17 years. Even when having higher gas prices, allowing market to discover gas is the right thing (after all private companies sell oil at market prices) in the national interest to promote energy security. And it has not been easy for UPA to do that. When a gas or oil field lies in two adjacent blocks, any possible dispute is regularly resolved through unitisation agreement without taking recourse to litigation. Unfortunately for RIL, there is an impression created that they have been ‘stealing’ from ONGC who owns the adjacent blocks.

Let us see how the NDA government under Modi will deal with gas pricing. It was his pet project GSPC which demanded prices based on LNG import (higher than $14 per unit) for its gas production which was disallowed by the UPA. Let us hope that Modi will start a new era in gas exploration by liberalising gas market rather than implementing Rangarajan committee’s irrational pricing model.

Author was former board member of Georgian National Oil Company where he exposed PSC related corruption and retired as Manager of Conoco, a leading US oil company.

 

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