The Hindu Business Line : Abolish cess to increase crude oil production

Approximately 30 million tonnes a year of oil production in India is subject to cess, resulting in about $1.6 billion revenue to the Government. This amount, put into field development, can generate a huge volume of new oil reserves, the royalties, profit oil and corporate taxes from which would more than make up for the lost revenue to the Government, argues SASTRY KARRA.

India stands distinctly disadvantaged when it comes to oil and gas resources, having less than 4 per cent of the sedimentary basins of the world, about 2 per cent of reserves, and one per cent of oil production. Oil and gas consumption, however, is increasing at 8 per cent per year and is expected to grow at this rate for many years. Bold policy changes have drawn the attention of many new domestic and international players to the exploration and production sector (upstream or E&P) over the last 15 years.

The numerous advantages of increasing domestic production versus oil imports — for instance, saving foreign exchange, ensuring security of supplies, and multiplying effect of domestic investments — are but a few. The current popularity of exploration awards under the New Exploration Licensing Programme (NELP) is the result of:

Increased data availability;

New discoveries, some of which are world-class;

Requirement for national oil companies (NOCs; ONGC and OIL) to bid if they wish to participate, and the elimination of carried interests for the NOCs;

Streamlining of the royalty system, with cess being eliminated in the process;

Continuing seven-year tax holiday for new field development;

Very high degree of transparency in the award process, and

Timely awards and signing of production-sharing contracts (PSCs).

It is time to take one more bold step to increase domestic oil and gas production — abolishing cess. There are four forms of government take in the Indian PSCs: Royalty, cess, profit-sharing, and corporate tax. In addition, there may be State levies. No other industry shares its profit with the government.

Benefits of scrapping cess

Cess is also a form of royalty, and the more punitive of the two. It is only applicable to pre-NELP blocks or acreage given to NOCs on a nomination basis in which the licensee may be one of the NOCs. The blocks that pay cess on oil are: nomination blocks held 100 per cent by NOCs (for example, Mumbai High), joint venture blocks that were awarded as field development contracts (such as Mukta, Panna, Ravva), and exploration blocks that went on to production (such as PY-3, CB-OS/2).

While contracts considered fair by all parties were signed for these blocks, the first field development approval and subsequent incremental investments may not appear to be attractive to the NOCs because of the disproportionate levy of royalty and cess in the exploration blocks that went on to produce.

Field development awards, such as those for Ravva, Panna, Mukta and Tapti, are different from exploration contracts, in that the share of royalty and cess is paid, pro-rata, to the company's working interest.

By eliminating the cess, producers appear to benefit instantly. The biggest beneficiaries will be the NOCs, followed by other producers such as British Gas, Cairn, Niko, Canoro, Geo-Enpro, and Reliance. However, the cess not paid is partially captured by profit oil/gas (amount of production, after deducting cost of oil production allocated to costs and expenses, that will be divided between the participating parties and the host government under the production sharing contract) and corporate tax. About half the cess not paid would be immediately captured from increased profit oil and corporate taxes. The magic of eliminating cess will allow these producers to further invest rapidly into these mature fields and increase reserves and production.With cess done away with, the increased investment in brownfields or marginal fields will generate enough additional production to make the government revenue grow beyond what it is in the present system.

Reserves Accretion

The phenomenon of reserves accretion in discovered fields must be explained to the financial authorities. Nine out of 10 oil and gas fields worldwide show significant reserves accretion as they traverse from first development to final abandonment. There are myriad case studies that convincingly demonstrate this fact.

There are instances where certain fields produce more than their original STOIIP (Stock Tank Oil Initially In Place). The STOIIP, determined at the early stages of development, is not a sacrosanct, unalterable figure. An upward revision in reserves can be brought about by (a) technological advancements such as, say, 3-D seismic, EOR/IOR methods (b) economic parameters, for example, oil price and change of fiscal regime, and (c) re-interpretation of old data, among other factors. Not only can the so-called "possible" and "probable" reserves easily turn into proven reserves over time but additional previously unknown reserves can be added as well.

According to a paper published in the journal of the Society of Petroleum Engineers (SPE#94680): "Review of field reserves from different parts of the world reveals that reliability of reserves estimates is rather poor. Many fields show wide fluctuations in reserves estimates through time, both at pre- and post-production stage, with a tendency toward underestimation.

"Accompanying this trend, uncertainty attached to the "best" reserve estimate does not shrink with additional data, defying intuition. Reasons for such phenomena are varied, but one fundamental reason is the approach the industry generally takes toward reserves estimation. Reserves variations, whether in upward or downward direction, adversely affect project economics. Factors that affect reserves evaluation include reservoir aspects, development scheme, operations and technology, economic and regulatory aspects, and "intangibles" that relate directly to human input and conduct. In the last-named category, proclivity to ignore statistical rules leads to distortion in reserves and associated uncertainty estimates.

"The vision toward improving reserves reliability involves a multi-pronged approach that tackles all these root causes."

Production from brownfields

As per another article in SPE#94075: "Brownfields have been defined as mature fields in a state of declining production or reaching the end of their productive lives; such fields contain resources that are needed worldwide by the countries they belong to and the world economy. These brownfields are generally more than 30 years old and account for 67-72 per cent of world's production. When compared with other fields — deepwater and greenfield — brownfields represent the most significant capacity to provide future production. "Many mature fields are being operated using technology put in place when the field was originally developed. Technologies routinely applied in new field developments are being ignored in brownfields, and many of these fields are performing below their real capacity and require engineering and operational attention. While increasing asset value through improved reservoir performance in such fields has been desired for decades, productivity and recovery results have been difficult and even impossible to attain because critical tools and technologies were either not made available or inadequate."

Disincentives

Investment disincentives such as cess will delay incremental investment or eliminate it, resulting in a tangible and permanent loss of reserves. Approximately 30 million tonnes a year of oil production in India is subject to cess, resulting in about $1.6 billion revenue to the Government. If this investment is put into operational fields or discovered field development, an additional 160-320 MSTB (Millions of Stock Tank Barrels) of new oil reserves could be added. The revenue generated from royalties, profit oil and corporate taxes from these additional reserves will more than make up for the lost cess revenue to the Government.

One useful and commonly quoted indicator of a nation's reserves is the R/P ratio — that is, a ratio of recognised reserves and annual production, in number of years. In India the number often quoted is 18, which implies that we can produce at current levels for 18 more years, with the reserves already found and developed. However, the dynamics of this ratio is not well understood outside the oil industry. As the production rate `P' is increased by new investments, `R' also goes up due to increased recovery efficiency, thereby keeping the ratio constant or even increasing it. The success of the NELP must be followed by giving incentives to marginal field and brownfield development. This can be best accomplished by eliminating the cess. If this amount is channelled into the producing blocks for infill drilling, upgrading facilities, finding oil in deeper horizons and new marginal field development, the temporary loss of cess will be paid back many times over to the Government.

(The author is President and CEO of Hardy Exploration & Production India Inc.)