<div>The Union government's approval of the Marginal Fields Policy (MFP) for 69 oil and gas fields, proposing market linked prices and a revenue sharing mechanism, would shift the key risks to developers says India Ratings and Research (Ind-Ra). </div><div> </div><div>However, the policy is also likely to result in the simplification of the method to calculate the government's share. This presupposes prudence on the part of developers while bidding as the biddable parameter is likely to be the revenue share of the government. Developers will need to consider an overall exploration, development and production (EDP) cost along with volume and price estimates, as these would be the key variables for ensuring a reasonable internal rate of return on the projects.</div><div> </div><div>Ind-Ra expects the market linked prices for such gas to be closer to the lower of the spot or term liquefied natural gas landed prices, as these would be the alternatives available with key end-user industries. Thus, market-linked price from these marginal gas fields could be in the range of 1.5x-2.0x of the current domestic gas price of $4.66/mmbtu. Volume off-take at these prices should not pose a challenge and the gas is likely to see demand from consumers in the fertiliser, refinery and city gas sectors.</div><div> </div><div>In a significant move, the methodology for the calculation of the government's share from the hydrocarbons produced from these marginal fields has been shifted to the percentage share of gross revenue. This is in stark contrast to the earlier production sharing contracts (PSC) which comprised two main elements, cost recovery and sharing of profits based on pre-tax investment multiple. Thus, exploration and development (ED) costs (till the level bid for) were pass-through and first recoverable for developers. Furthermore, the investment multiple determined the government's share. Under PSC, the profit share of the government increased gradually till ED costs were recovered. Also, there were differences over gold plating of costs given that government's share of profit was calculated post the recovery of costs incurred by developers on ED.</div><div> </div><div>The prior methodology as outlined in PSC meant lower risks for developers as it allowed them to first recover the costs incurred followed by the sharing of profits with the government. However, profit maximisation strategies led to the allegations of gold plating of such costs. Additionally, this methodology led to disputes and delays in terms of costs acceptances due to the highly technical nature of cost details.</div><div> </div><div>The new methodology, though simplifies the basis of calculation of government's share, would place a greater risk on developers as they would need to estimate three key variables in advance before placing a bid a) EDP costs b) quantum of hydrocarbon extractable and c) market prices. Generally, revenue sharing contracts have been more amenable for businesses where upfront costs and output are fairly ascertainable. However, in case of hydrocarbon discovery both costs and output are not ascertainable completely and the success of the exploration activity itself is a low probability event. Thus, there might be situations where in developers could incur higher-than-expected EDP costs and thereafter the need to share a percent of the revenue with the government could lead to a longer payback or breakeven period, thus depressing project returns.</div><div> </div><div>Additionally, the nuances with respect to the percentage sharing methodology whether it would be a fixed percentage over the life of the block or would be a sliding scale dependent on gross revenue and cost incurred by the developer remain to be seen and would determine developers' interest in the same.</div><div> </div><div>In the PSC regime, the license to a particular developer was restricted to a single hydrocarbon, whether it be oil or gas and a separate license was required if any other hydrocarbon was discovered. However, the current policy would be applicable on all hydrocarbons discovered and exploited in the field which would ease the process for developers.</div><div> </div><div>MFP is applicable for the development of hydrocarbon discoveries made by national oil companies i.e. Oil & Natural Gas Corporation Limited and Oil India Limited. These discoveries could not be monetised earlier due to reasons such as isolated locations, small size of reserves, high development costs, technological constraints, fiscal regime among others. Under MFP, exploration companies would submit their bids for exploiting these oil fields under competitive bidding.</div>
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