India - The Search For Hydrocarbons – A Regulatory Conundrum.

16 September, 2016

The regulatory regime governing the exploration and production of hydrocarbons in India is a complex one that has undergone a plethora of change in recent times. This post examines the many developments as well as the past discourse that has set the context for change.

Brief Background of the Regulatory Regime Governing the Hydrocarbon Sector

In post-1991 India, regulatory reforms in the hydrocarbon sector were implemented through a royalty-cost recovery regime initially under a set of Production Sharing Contracts (PSCs) (Pre-NELP PSCs) and thereafter under the New Exploration Licensing Policy (NELP). Both regimes presented challenges for contractors as well as the Government. Cost recovery meant that the contractor would spend money upfront to explore and recover the same from the revenue generated from the block, then sharing any balance revenue, i.e. “profit”, with the Government.

Rangarajan Committee: Revenue Sharing Model

In this context, in 2012, the Government appointed a Committee headed by Dr.C.Rangarajan, then Chairman of Economic Advisory Council to the Prime Minister to examine this. This committee, popularly called the Rangarajan Committee (RC), consulted major exploration and production (E&P) operators and industry bodies such as FICCI and recommended discontinuing cost-recovery. Instead, RC suggested a revenue-sharing model which meant that after the contractor pays the royalty, the Government would immediately have a share in the revenue. [1] Under this model, the contractor would bear all costs till production without any recovery mechanism, thus incentivising the contractor to minimise cost. The Government would be indifferent to how much a contractor spends and would not be involved in cost-monitoring, so long as operations are safe and reservoir is intact.

RC recommended that the sovereign has to be a passive owner of resource rather than an active collaborator in operations. Simultaneously, it encouraged the contractor to adopt efficient technologies to expedite commercial production. Further, these recommendations came at a time wherein the calculations of Government NPV were done with a high case assumption of $140 / Bbl for oil and $12 / mmbtu for gas.[2] Global prices for both oil and gas have plummeted since the issuance of RC recommendations.

Kelkar Committee: Cost-Recovery Model

It was politically delicate to scrap the cost-recovery model in a hurry, especially since the Government was defending it in high-value domestic and international arbitrations. So another Committee, chaired by Dr.Vijay Kelkar, a noted economist and civil servant, was set up to give a “Roadmap for Reduction of Import Dependency in the Hydrocarbon Sector by 2030”.[3]

The Committee, popularly called the Kelkar Committee (KC), was of the view that the cost-recovery model would be best suited to India. KC noted that no major oil importing country followed the Revenue-Sharing Contract (RSC).

Contractors need to be incentivised to incur additional costs to develop India’s large number of maturing fields. The RSC model of minimising costs could prove to be counter-productive. KC further recommended two things in place of cost-monitoring:

Self-certification of costs by the contractor – this would eliminate the supervisory role of the Government while providing freedom to the contractor to incur additional costs. Royalty and profit oil calculations of contractors would be subject to assessment just like income tax.

Supernormal profits tax – till a contractor’s profits reach an extraordinary level, Government take will be limited to only royalty and corporate tax.

The Price Dimension

Juxtaposing the RC and KC recommendations on PSC with their pricing recommendations throws up interesting results.

RC bravely proposed adoption of the RSC. On pricing, it argued that India is not ready for complete deregulation. While crude prices under NELP are linked to import parity prices, gas price, including gas produced by private players, is regulated. Till India gets ready for gas-on-gas competition, RC recommended price regulation through a formula (RC Formula) which takes into account the average of three global benchmarks.

KC, while conservative on PSC, was braver on pricing by recommending the complete deregulation of gas pricing and proposed that producers should be allowed to sell gas at market-driven arms-length price. KC also recommended the inter-generational equity approach on pricing: =this generation is using up resources of the next one and therefore, must pay the highest possible price – i.e. market-driven arms-length price.

The Sovereign Quandary – The Stop-gap Arrangement

The PSC recommendations cannot be harmonised without the pricing recommendations. While RC gave respite as regards gas pricing, it advocated dismantling of the cost-recovery method. Further, if one discounts the timing of RC recommendations and its market-related justifications, the RC model is conceptually self-contradictory when it advocates spending freedom to contractor on one end, but allows the Government to decide the price on the other. KC reinforced the PSC regime, but that was coupled with complete price deregulation, again a sensitive issue.

In 2014, the new Government got the benefit of low crude prices, accompanied with the prospect of reviewing the contentious recommendations. Astutely, the Government decided to defer complete deregulation in the interim. An internal Committee modified the RC Formula in late 2014[4], which halved the gas price from US$ 8.4/mmbtu (as per RC Formula) to US$ 5.05/mmbtu[5] and thereafter to US$ 4.66[6] and US $3.82[7]. The price revisions of March 2016 have brought down the gas price to US $3.06[8], while the ceiling price for difficult fields is now US $6.61[9]. However, the industry has voiced concern over the effectiveness of this pricing formula[10]. As per ONGC Chairman D.K.Sarraf, the next revision due on October 1, 2016 is estimated to take the price down to somewhere around or even less than US$2.5/mmbtu[11].

The “New” Delhi – HELP and Other Initiatives

In October 2015[12], the Ministry of Petroleum & Natural Gas (MoPNG) floated a Consultation Paper on RSC, indicating a tilt towards RSC. Then on 10th March, 2016[13], the Union Cabinet cleared many proposals pertaining to the E&P industry, which also reveals a calibrated shift in approach.

NELP has been replaced with the Hydrocarbon Exploration Licensing Policy (HELP) with a uniform license for exploration and production of all forms of hydrocarbon, an open acreage policy, easy to administer revenue sharing model with marketing and pricing freedom for the crude oil and natural gas produced. HELP combines Uniform Licensing Policy (ULP) and open acreage licensing policy, which was advocated by KC, while it has adopted RSC as advocated by RC.

HELP proposes marketing and pricing freedom for both crude oil and natural gas with special treatment for High Pressure High Temperature (HPHT), Deepwater (DW) and Ultra Deep Water (UDW) discoveries. This “freedom” comes with certain fetters including a ceiling price to be calculated biannually based on a complex formula for HPHT, DW and UDW, and provisions for calculation of Government revenue for all other types of wells.

The Road Ahead

The Government has been treading the middle path as regards KC and RC. The latest policies, while in principle tilted towards KC, have kept RC legacy alive by incorporating two features, the RSC and a formula-based pricing mechanism. Fortunately, the formula is not prescriptive as in RC and provides some freedom to operators.

A selective reading of RC and KC recommendations may result in a conundrum if the base assumptions behind the recommendations are not properly examined. Therefore, a purposive reading of the RC-KC recommendations alongwith a roadmap for phasing out the ceiling price formula, details on the pricing policy under HELP and the new RSC will enhance the “ease of doing business” in this sector.

The time is ripe for India to optimise its position in the world of cheap oil.

[1] http://www.eac.gov.in/reports/rep_psc0201.pdf

[2] Para 6.2(iii) on Page 36 of report of the Rangarajan Committee.

[3] http://petroleum.nic.in/docs/kelkar.pdf; www.petroleum.nic.in/

docs/FinalReportKelkarCommittee2014.pdf

[4] www.petroleum.nic.in/…/committee_report_on_gas_pricing_2014.pdf

[5] http://ppac.org.in/content/4_1_NaturalGas.aspx – November 2014- March 2015

[6] http://ppac.org.in/content/4_1_NaturalGas.aspx – April 2015 – September 2015

[7] http://ppac.org.in/content/4_1_NaturalGas.aspx – October 2015 – March 2016

[8] http://ppac.org.in/ViewAllCircular_whtnew_Reports.aspx?ModuleID=26 – April 2016 – September 2016

[9] http://ppac.org.in/ViewAllCircular_whtnew_Reports.aspx?ModuleID=26 – April 2016 – September 2016

[10] http://www.bloombergquint.com/business/2016/09/08/ongc-calls-for-revision-of-gas-pricing-formula