Government’s ‘help’ to oil and gas sector a big leap forward

A set of new policy measures will help unlock India’s hydrocarbon potential, but a lot will depend on crude prices rising (Image: Andrea De Silva / Reuters)

India’s hydrocarbon potential, compared to some of the more oil-rich regions of the world such as West Asia and Latin America, has always been limited. But whatever potential the country has in terms of oil and gas reserves, if fully developed, can play an important role in reducing the dependence on imported fuel.

Not only will this prevent the outflow of precious foreign exchange, thereby improving the fiscal deficit situation, tapping domestic hydrocarbon resources can also proportionately bring down the risk of any price and supply shock in India (which imports 75 percent of its crude at present) on account of geopolitical volatility in regions like Iran or Russia.

While demand for oil in the world’s biggest economies like China and Europe is weak because of macroeconomic headwinds, tailwinds in the Indian economy are expected to propel economic growth and demand for fuel in an energy-deficient country. It is for this reason that global giants in the field of exploration and production (E&P) of oil and gas, including BP Plc, BG Group Plc and Royal Dutch Shell Plc are attracted to India. Then there are the Indian E&P heavyweights like state-run Oil and Natural Gas Corporation (ONGC), Reliance Industries Ltd (RIL) and Cairn India, a part of Anil Agarwal’s Vedanta Group.

A common thread running between all the aforementioned Indian and international oil and gas companies was a desperate demand for sweeping reforms in policies governing the exploration of India’s hydrocarbon reserves.

A complicated set of rules had seen many oil and gas companies spar with government agencies such as the upstream regulator DGH (Directorate General of Hydrocarbons), downstream regulator PNGRB (Petroleum and Natural Gas Regulatory Board) and Management Committees (MC) that supervise the progress of work at individual hydrocarbon blocks. These MCs comprise representatives of the oil ministry and the company operating the block.

Consequently, several cases have ended up in litigation, either in courts or with arbitrators. The biggest casualty of this logjam has been the overall development of oil and gas production in the country.

But the regulatory environment for development of these reserves within the country is set to change soon, thanks to the reforms brought in by the National Democratic Alliance government at the centre; and if E&P activity doesn’t pick up in the near future, it is more likely due to depressed crude oil prices rather than a hostile regulatory regime.

On March 10, oil minister Dharmendra Pradhan announced a slew of policy changes that was music to the ears of CEOs at oil and gas firms that have an interest in India.

The National Exploration Licensing Policy (NELP) that existed hitherto was replaced by the Hydrocarbon Exploration Licensing Policy, interestingly abbreviated as HELP.

One of the major changes in the new policy was to “prospectively” (the government has clearly had enough of retrospective amendments it appears) replace the existing profit-sharing (also known as cost-recovery) arrangement with a revenue-sharing mechanism.

Earlier, when the government entered into contracts with companies that won hydrocarbon blocks through an auction, the operator was allowed to recover costs (approved by the government) incurred to develop the block from revenues generated through it. The government’s share of earnings would be calculated on the remaining sum.

This led to multiple arguments between regulators and companies over questions such as what overheads constitute valid cost items and the justified quantum of such costs.

The new revenue-sharing formula is simpler. It is a kind of ‘pay-as-you-go’ model where the operator will have to part with a percentage of gross revenues generated from the block. As revenues increase or decrease, so will the government’s share of earnings.

To be sure, the fine print of these new commercial terms and conditions remains to be assessed. “Thursday [March 10] was a golden day as far as the oil and gas industry is concerned. Certain dream decisions have been taken in response to some of the industry’s long-pending demands,” said Dinesh K Sarraf, chairman and managing director of ONGC. “It is now for the industry to respond and make investments.”

ONGC is walking the talk by chalking up plans to invest as much as $4-5 billion over the next three years to develop new oil and gas discoveries, especially in the Krishna-Godavari basin, off the eastern coast of India.

Sarraf said that the revenue-sharing model gave companies like ONGC a lot of “comfort and flexibility”. Under the profit-sharing model, an operator had to go to the government to get even the smallest of costs approved. This led to several delays in developing the block, and even after taking a decision to incur certain costs, disputes arose between the company and the government.

“The focus of E&P companies was being drawn away from operations and more towards dealing with the government or the court or an arbitrator to resolve disputes. Now the focus can return to our main objective of exploring hydrocarbon reserves,” Sarraf said.

One of the key concerns of oil and gas companies with the revenue-sharing model has been over whether it would compensate them sufficiently for the risks involved when drilling in complex geological areas like deep and ultra-deep water fields. But Sarraf stated that companies will tweak future bids for oil and gas blocks accordingly to ensure a certain level of profitability is maintained. Also, the government has sought to address this concern with a concessional royalty regime. Against a royalty rate of 5 percent earlier, deep and ultra-deep water fields will attract no royalty for the first seven years of production. Thereafter these fields will attract a royalty of 5 percent and 2 percent respectively.

The other major reform was to free the pricing of gas from new blocks and existing discoveries that were yet to commence production, especially in deepwater and complex geological areas where risks for the operator are higher. But while gas producers are free to price and market the fuel as they please, they have to adhere to a price ceiling. The cap, which has been put in place for the time being to prevent a price shock to users of natural gas in sensitive sectors like power and fertilizer, is linked to the opportunity cost of alternative, imported sources of energy including LNG (liquefied natural has), fuel oil and naphtha.

This cap, at current prices of the fuel sources that are a part of the equation, works out to around $6-7 per million British thermal units (mBtu) of gas, according to TK Sengupta, director (offshore) at ONGC. Sengupta described this as a “very good price” for producers in the current context. At these prices, gas producers stand to gain substantially more than $3.8 per mBtu, which is the current price of natural gas as fixed by the government using a dynamic pricing formula, which takes into account prices in gas-surplus countries like US, Canada and Russia.

HELP will also allow oil and gas firms to explore whatever source of fuel they can discover in the area contracted out to them–be it coal-bed methane, shale oil or gas or any other condensate–without seeking fresh permission from the administration for each kind of fuel.

The government has also decided to extend the lease for 28 small- and mid-sized hydrocarbon fields where the contractor’s licence period is coming to an end before full utilisation of production rights.

“Allowing access to all forms of hydrocarbons, marketing and pricing freedom for gas and moving towards an open acreage licensing system are a quantum change in the E&P sector governance in the country,” said Mayank Asher, managing director and chief executive of Cairn India. “We hope the government will also extend this to existing producing acreages where similar hydrocarbon potential can be tapped into. Existing operators are most-suited to develop both the unconventional and the conventional resources given their knowledge of the basins they are operating.”

A statement issued by BP Plc on March 10 had stated that the government’s decision to deregulate gas prices could unlock production from new developments in deep and ultra-deep water and high-pressure, high-temperature areas, and lead to the development of a competitive gas market in the country.

The oil minister’s own projection is that development of hydrocarbon reserves valued at $40 billion could be unlocked over the next 10 to 15 years on the back of these reforms.

An Edelweiss Securities Ltd report dated March 10 states that the new policy regime has the potential to spur investments to the tune of $24 billion in the oil and gas sector.

But there is one caveat. Globally, energy companies are finding it difficult to sustain high levels of E&P activity against the backdrop of subdued crude oil prices. A JP Morgan research report dated March 6 estimates global E&P spend to fall 23 percent year-on-year in 2016 to around $279 billion, compounding the 21 percent decline witnessed in 2015.

Over the last two years the brent price of crude has nosedived almost 63 percent to hover around $40 per barrel at present. This has thrown the plans of most major E&P companies in disarray as they don’t find the current prices of the commodity remunerative enough to justify the capex they’d have to incur to develop these resources. And there is no reason why India should be an exception to the trend.

But there is consensus that crude price will rise, to at least $50 per barrel to begin with. Sarraf contends that this isn’t a bad price for oil and gas operators to work with. And when that happens, the new set of rules laid down by the Indian government will surely provide a shot in the arm to development of hydrocarbon resources in the country, furthering the goal of ensuring the nation’s energy security.

Disclaimer: Reliance Industries Ltd is the owner of Network 18, publisher of Forbes India.

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