<div>Is auctioning of energy resources the best way to increase production? The experience of India’s hydrocarbon sector would certainly prove to the contrary. After 15 years and 9 rounds of auctions under the New Exploration and Licensing Policy (NELP), the country has managed to award 260 hydrocarbon blocks to the private sector. However, only three of the discoveries have actually started commercial production.<br /><br />This is the reason why India imports 75 per cent of its fuel requirements accounting for one third of India’s import bill at $168 billion (Rs 102,480 lakh crore) in 2013-14. Out of the three blocks under production, one is under arbitration where the contractor is accused of misrepresenting the investment figures with the government levying a penalty of over $2 billion on the contractor for not producing the projected quantity of gas.<br /><br />The newly elected NDA government, like in other sectors, has decided to overhaul the hydrocarbon policy in the country, even though the recommendations were prepared by a committee appointed during the Congress-led UPA government.<br /><br />The government has prepared a draft Model Revenue Sharing Contract (MRSC), which seeks to fill up the loopholes of the previous hydrocarbon policy and create a more conducive and competitive environment to attract foreign companies to invest money in India’s hydrocarbon basins.<br /><br /><strong>The Fine Print<br /></strong>The government has prepared an uniform policy for the hydrocarbon sector this time. The NELP policy was only for the Oil and gas. Other hydrocarbon resources like CBM and shale gas were governed by separate policies. Merger of all policies into one was being demanded by the industry for many years.<br /><br />The new policy proposes a model that does not allow cost recovery of investments. Rather the company will have to indicate the quantity of oil and gas it will share with the government at different stages of production as well as at different rates. Under the newly proposed model, the government’s share of revenue will be determined through production price matrix.<br /><br />"The government's revenue share of crude oil and/or natural gas shall be determined on the basis of a two dimensional production-price matrix, where the government's revenue sharing with the contractor(s) shall be linked to the average daily production in a month and average oil and gas prices in a month," reads the draft MRSC.<br /><br />Besides quoting the amount the companies will share with the government at different levels of production, the companies would also be required to quote the quantum at different price levels. For example, at less than $100 per barrel, at $100-125, $125-150 and at more than $150 per barrel for crude oil. In case of gas, the draft MSRC proposed 4 price bands starting from less than $6 per million British thermal unit rate (mmbtu), $6-10, $10-14 and more than $14 per mmBtu.<br /><br />The production levels for onland, shallow offshore and deepwater have been proposed at different tranches.<br /><br />Companies will have to bid the amount they will share with the government at different levels of production as well as different rates for oil and gas.<br /><br />Under the cost recovery model, the companies used to bid for maximum work programme, (the amount of capital to be invested). In that model, the government would get its revenue only after the company recovered its investments. This model was criticised by the Comptroller & Auditor General which said it encouraged companies to keep raising cost so as to postpone higher share of profits to the government.<br /><br /><strong>Is Revenue Sharing Better Than Cost Recovery?<br /><br /><img align="middle" width="644" vspace="2" hspace="2" height="290" src="/image/image_gallery?uuid=4e1dd90f-2943-4100-ae0a-9f12a9662fbf&groupId=36166&t=1415700972537" alt="" /><br /></strong><br />Analysts feel that the in the developed countries, it is the cost recovery method that is successful because of the trust between the government and the companies. However in India, there is always a suspicion over the investment figures produced by a company. This is why, the revenue sharing model is better. “It is about the cultural difference. In India, the private sector has not won the trust of the government. Therefore cost recovery method created a lot of problem,” said an analyst with an international consultancy.<br /><br />The fact that there is lack of trust between the government and the investors is substantiated by the introduction of the escrow account in the draft MRSC.<br /><br />According to the guidelines issued in the draft MRSC, the contractor will be required to put all the revenue generated through the sale of Oil and gas in an escrow account. And any withdrawal from the account will have to be decided by the Government.<br /><br />P Elango, former CEO of Cairn India Ltd, questions the logic of escrow account in the proposed policy. “It is for short term transactions. In the Oil and gas sector, contract terms are for over 25 years. Investors would be very disappointed if they do not have direct access to revenue.” said Elango.<br /><br />“By making escrow account mandatory, the government has killed the spirit of trust that should be there between the two parties to work together for such a long duration,” added Elango.<br /><br />RS Sharma, Former Chairman, ONGC also criticised the clause on Escrow account and said the government should withdraw this part of the draft immediately.<br /><br />The draft policy differentiates between the levels of challenges that geography of the block poses for the explorer. Based on this, the government has proposed different timelines for the submission of appraisal programme based on different categories like Ultra deep water, high temperature and tight reservoirs etc.<br /><br />For onland and shallow water blocks, the time has been increased from 34 months 10 days to 60 months 7 days. Similarly, for deep water blocks, the appraisal timelines has been increased from 46 months 10 days to 66 months and 7 days.<br /><br />The government has also tried to make companies accountable for the production projections that they make. It has introduced penalties through a clause in case an operator does not produce the Oil or gas promised under the annual programme quantity.<br /><br />Reliance Industries, operator of the KGD6 basin, had projected that it will produce 80 million metric standard cubic meters of gas per day from 2012. However, the company missed its target by miles and has been producing between 8-15 mmscmd of gas for the past 2 years.<br /><br />“In case, the contractor fails to achieve the approved programme quantity in any year and falls short by more than 25 per cent of the Programme quantity, liquidated damages of 10 per cent of the value of the shortfall will be imposed on the Contractor,” reads the proposed policy.<br /><br />The government while preparing this draft MRSC, has tried to walk a tight rope. On one hand it has tried to repair the loopholes that were exploited by the contractor in the KGD6 basin, on the other it has tried to be flexible with the timelines for bringing discoveries into production.<br /><br />Former secretary to the government of India, EAS Sarma compared the existing production sharing contract with the proposed RSC: “If the existing production sharing contracts (PSCs) incentivise gold-plating of investments and over-invoicing the costs, that permits money laundering, the proposed revenue sharing contracts (RSCs) avoid these possibilities but, on the other hand, provide scope for under-stating potential production schedules to escape penalties and under-invoicing revenue accruals to profiteer at the expense of the government.”<br /><br />The final policy will have some changes as per the suggestions of the stakeholders, but whether it helps India ramp up its hydrocarbon production will be known only in the course of next 4-5 years.<br /><br />neeraj@businessworld.in<br />neeraj.epiphany@gmail.com<br /><br /> </div>
