Putting revenue before resources is wrong

The Centre is moving towards a revenue-sharing system for oil exploration contracts from the time-tested policy of production sharing. It released a draft model Revenue Sharing Contract (RSC) recently seeking public comment. The Production Sharing Contract (PSC) regime was the basis of the nine NELP (New Exploration Licensing Policy) bid rounds over the last two decades. These rounds resulted in over 250 PSCs, attracted investments worth over $20 billion and led to 130 discoveries with three of them being categorised as major.

Over a period, the PSC system attracted controversy becoming a challenge to both contractors and the Government. Purposeless procedures took precedence and the primary purpose of finding and producing oil and gas was lost. It is unfortunate that faulty contract management has now led to changing a sound policy.

PSC versus RSC

The key difference between the PSC and RSC is that the PSC model would encourage investors to take higher exploration risks, and in the event of success, the costs could be recovered. Since only one-third of our sedimentary basins have been fully explored, a contract model that encourages intensified exploration activities should have been preferred.

India remains one of the least explored countries and could hold large potential resources. For example, 15 basins out of a total 26 sedimentary basins in India spread over on-land, offshore and deepwater, are estimated to hold prognosticated hydrocarbon resources of over 200 billion barrels of oil equivalent. Out of these, hydrocarbon-in-place volume of 80 billion barrels has been established through exploration activities by the public sector and private oil and gas companies. There is still a significant ‘yet to find’ hydrocarbon resources of over 120 billion barrels. Therefore, significant increase in exploration efforts is critical and this requires the urgent attention of the new government.

Interestingly, two very eminent economists — C. Rangarajan and Kelkar — leading two different panels, had different ideas of contract models. Dr. Rangarajan preferred the revenue sharing model as “it would overcome the difficulties in managing the existing model based on the pre-tax investment multiple (PTIM) methodology and the cost-recovery mechanism.”

And Dr. Kelkar was of the view that “The Indian PSC is designed to encourage E&P [exploration and production] activity in the interest of enhancing national energy security. The committee analysis shows that under PSC, the interests of the government are aligned with the interests of the contractors. Under the PSC, as the investor returns improve, the government take also increases as it is designed to allow the government to retain a fair share of the upside.”

Faults of the RSC

Now that a final decision seems to have been taken by the government in favour of the revenue sharing model, one expected a simple, easy to manage contract structure. However, the draft model revenue sharing contract disappoints.

It introduces the concept of escrow account in a contract which is meant to attract risk capital to first find resources before the revenue could be shared. An escrow account, by definition, is a temporary pass-through account.

Revenue in oil exploration comes post-development of a commercial discovery and these are not temporary transactions. Typical contract terms are for over 25 years. Such contracts are essentially endeavours in partnership. While the resources belong to the government, it needs oil and gas companies with technical capabilities and balance-sheet strength to make risk investments.

The draft contract expects investing companies to receive all revenues only under an escrow account so that the government could protect its share of revenue, and in certain circumstances, restrict the contractors’ access to the account. The spirit of partnership and trust is completely missing.

The other striking feature is that there is a wrong assumption of certainty about discovery-to-delivery periods and more importantly, about oil and gas production profiles. Under the draft provisions in the model contract, the contractor is expected to commit to a production profile and is liable to pay penalties if the actual production varies from the forecast by 25 per cent.

Nothing in oil and gas business is certain. The data from seismic surveys using the best of technology cannot tell with certainty whether the fluid seen is oil or water. One needs to drill a well to find out. And drilling a well could cost over Rs.20 crore if it’s a simple, shallow, onshore well to over Rs.500 crore if it’s a complex deep water well.

Finding oil and or gas is not certain to make it commercial as it has to be in right quantity and at the right price. In India, strangely very simple procedural deviations can make a discovery an illegitimate one! How much oil and gas one will end up producing is again uncertain as it is dependent upon multiple technical factors. One knows the precise answer only when the last barrel is produced from a field. To put such penal provisions is a sure way to put off serious investors who have multiple investment options across the globe.

Considering that only one-third of our sedimentary basins are fully explored, only 15 per cent of basins have been covered by 3D seismic surveys and only 15,000 wells have been drilled over 60 years (there are one million wells in production in the U.S.) what we need is a contract structure that will attract risk investment and help to step up exploration activities significantly.

This is the only way we can catch up on the lost decades.

To my mind the priority steps are:

(1) Build the National Geo Data Repository and launch Open Acreage Licence Policy — This allows prospective bidders to look at the data any time and offer a bid to explore in the most transparent manner;

(2) provide market-determined oil price to ONGC and Oil India to bring marginal oil fields into production and to implement enhanced oil recovery techniques to recover more from matured oil fields;

(3) resolve the current uncertainty over gas price promptly;

(4) remove the artificial distinction between oil and gas for the purpose of tax holidays — both these are commodities of hydrocarbon molecules and can easily substitute each other and exploration risks and efforts required to find them are same, and

(5) announce the PSC extension policy to remove uncertainty over the production sharing contracts of few producing fields coming up for extension.

Launching NELP X with a revenue sharing contract model without clarity on the above five areas will be akin to putting the cart before the horse. The current draft model of revenue sharing contract needs to be revised to bring the focus back on finding resources first and the government share of the revenues needs to be collected in the same way that it collects income tax and duties.

India depends on imports to meet 75 per cent of its crude oil requirements spending close to Rs.3,000 crore everyday. If the domestic oil exploration activities are not stepped up, over the next 10 years, we would end up transferring $1.5 trillion of our wealth (that’s the current size of our economy) to oil exporting countries.

On the contrary, the countries which were able to attract investment and technology ended up finding more oil and gas resources. The most recent and fascinating examples are the discovery of super giant field in Mozambique and in Phoenix South prospect in Australia, where oil has been discovered in a place close to an initial discovery made 34 years earlier. What it tells you is that exploration is a never-ending game where perseverance and passion surely pays and the ever-advancing discovery and recovery technologies aid immensely. All that the government needs to do is to put in place enabling policies that encourage exploration endeavours for ever.

( The author is former CEO, Cairn India)

(This article first appeared in The Hindu dated September 22, 2014)

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