Legacy problems in oil and gas

Private participants are unhappy with key changes in contract terms for fields where ONGC and OIL are partners

As India enters the next phase of oil and gas exploration policy through the recently launched open acreage licensing policy (OPAL), the curtains have fallen on the policy regimes of the 1990s that opened up the business to the private sector. The earlier regimes are, however, beset with legacy problems from the production sharing contracts (PSCs) signed between the government and contractors.

For 28 oil and gas blocks that were given out to companies in the first round of privatisation, the immediate issue is the renewing of their contracts. InMarch 2016, an extension policy for these blocks was notified but that has added not just to the uncertainty for contractors, but has become another instance of how changing policy regimes can be problematic for companies.

The March 2016 policy made two important fiscal changes over the terms of the original PSCs: One, a flat 10 per cent increase in the government’s share in profit petroleum (that is, the value of petroleum produced and shared in a contract area minus costs); two, contractors were told they would have to pay cess and royalty in proportion to their participating interest in a block. Companies need to accept these changes in order to get an extension.

Private players say this is an instance of government going back on its contractual commitments. The government that time wanted companies to invest in exploration of oil and gas with associated risks. The government exercised its “back in right” after a commercial discovery, without paying for exploration expenditure. This right was largely in the form of a 30 per cent equity for the government nominee — Oil and Natural Gas Corporation or Oil India, which were also the original lease holders of these blocks. The government would allow recovery of cost from production, take a share of profit petroleum and the rest was to be proportionately shared among the partners.

To attract investors, companies were exempt from all taxes including royalty, cess and import duties, other than income tax. While PSCs, like that of Ravva, capped royalty at ~481 a tonne and cess at ~900 to be shared by all the parties, for most others ONGC and OIL paid the full levies, including the share of private companies.

Over the years even though the government increased cess and royalty, it issued a separate notification maintaining the cap for PSCs where the levies were specified. The objective was to provide an attractive fiscal regime under which companies paid only income tax.

For the two state-owned companies, which got a share in production without the associated risks, the levies became a pain point. Returns from some of these aging fields started to become negative after the payment of royalty and cess. They could not justify approving the development plans of these fields to their boards since higher production meant higher levies. The changes put in place by the extension policy were driven by these considerations.

ONGC officials argue the change in fiscal terms does not amount to the government reneging on contracts. “Under PSCs, the contracts can be extended after renegotiation of terms. If the private companies do not agree by that, they can choose not to extend it,” said an official. This argument, however, can be used both ways. If the original terms are unsuitable for ONGC and OIL, they can quit, too.

A senior executive in one of the private companies involved in these joint venture PSCs says the state-owned companies have a share as a government nominee so they should not look at only commercial considerations but promote production from these fields. “The government made ONGC and OIL the nominee inmost of the blocks for their rights. However, in reality this nominee could be any party. Given that the nominee was acquiring a stake in a successful discovery without incurring any expenditure, they were made to bear royalty and cess on entire production,” he says.

The oil and gas space has moved on since the early 1990s, and private companies have full stake in blocks without any government nominee. Over $5 billion have been invested in these fields, which has helped the country reduce its import dependence. Production from these blocks constitute roughly 25 per cent of India’s oil production but since these are aging fields, the economics of operation and development are changing for both the state-owned companies and the private operators.

Cairn Vedanta, for instance, could see a 33 per cent hit on their revenues with two of their blocks—Cambay and Ravva—coming under the revised terms laid down by the extension policy. PSCs for these blocks are due for extension in 2023 and 2019. The company had to earlier accept the changed terms in favour of ONGC for its flagship asset at Barmer when the government insisted on it as a condition for approval of the Vedanta takeover of Cairn India. Hindustan Oil and Exploration Company (HOEC), Tata Petrodyne and Assam Company are among those that are impacted by the new policy. According to one estimate, the new regime will effectively transfer over 35 per cent of revenue from private players to the government companies.

“Our government has made significant progress through HELP [Hydrocarbon Exploration and Licensing Policy] and OPAL which will have a positive impact in the medium to long term. However, with the recent recovery in oil prices, India’s import bill is increasing and the government will need to balance the trade and fiscal deficits. Creating incentives for existing domestic production, maintaining sanctity of contract and reforming the approval processes will have a more immediate effect. This will also be crucial to attract further investment,” says Sudhir Mathur, CEO, Vedanta Cairn Oil & Gas.

One way out of this Catch 22 situation is to reimburse the levies to the state-owned companies which in any case will not find operating most of these fields viable if private companies quit. P Elango, managing director, HOEC, says, “PSUs have a valid commercial argument but in order to maintain the contract sanctity and same fiscal terms, the government should create a mechanism for reimbursing them the levies they pay. A kitty could be set aside from the government’s oil sector revenues for this purpose.”

Since the 1990s, government policies have largelymoved away from state-controlled dominance with the New Exploration and Licensing Policy and now OPAL allowing full control to private companies. A fair approach to the extension for the 28 PSCs will require changes that are more attuned to the liberal policy regime that now prevails.