Given the high stakes involved and neither Cairn nor ONGC (partners in the Rajasthan block) ready to blink, the vexed issue of royalty is likely to head to arbitration. This has been a major bone of contention in the proposed Cairn Energy-Vedanta deal.
The Petroleum Ministry while endorsing ONGC's stand on the matter is categorical that royalty paid by ONGC for the Rajasthan fields output is ‘cost recoverable'. In other words, it should be set off against the gross revenue while reckoning the profit available for sharing between the Government, Cairn India and ONGC.
Such a position by the Government may well prove to be a deal-breaker, given that it will see Cairn India's bottomline and valuation take a sharp hit. Cairn Energy proposes to sell a maximum 51 per cent stake in Cairn India to Vedanta Resources for up to $8.48 billion. The matter has been referred to an inter-ministerial panel.
Currently, ONGC pays 16.67 per cent royalty on the price of crude oil produced from the Rajasthan fields. ONGC pays 100 per cent royalty, though its share in the field is 30 per cent. Cairn India which holds the remaining 70 per cent is the operator.
For FY 2011, ONGC is estimated to pay about Rs 1,228 crore as royalty for Cairn's 70 per cent share. Total royalty outgo during the year by ONGC (for both Cairn's and its share) is estimated at Rs 1,754 crore. The pre-NELP production sharing contract (PSC) under which ONGC was initially allotted the Rajasthan field stipulates that the ‘licensee' — in this case ONGC — of the field bear the entire royalty burden.
In the initial stages of the dispute after the deal announcement, ONGC said that it would bear only 30 per cent of the royalty. Since then, it has changed tack and claimed that though it would bear the entire royalty, the sum was cost-recoverable.
Cost-recoverable
By making it ‘cost recoverable', the royalty paid will be included in the project cost while calculating ‘profit-petroleum'. This will bring down the burden on ONGC over the life of the field, although for now, it must bear the burden of funding the payout.
ONGC says that its demand of making royalty cost recoverable is in line with Clause 3.1.9 of the PSC, which provides for the recoverability of certain expenses “incurred in connection with the contractor's activities under the contract and paid directly by the contractor”. However, Cairn says that royalty is to be borne by ONGC and is not cost-recoverable citing another clause (Clause 16.4 (a)) of the PSC.
Cairn India points out that the obligations and rights of contractors (persons engaged to extract oil from the field, essentially ONGC and Cairn) and licensee (ONGC) are separate and cannot be clubbed. So, it says, royalty paid by ONGC in the capacity of a licensee is not cost-recoverable.
ONGC estimates that under the current dispensation, it will have to incur as much as Rs 15,000 crore as royalties over the life of the field. It is to be noted that this amount was computed when crude oil was trading at more benign levels. With prices moving northwards since then, these numbers are likely to further firm up.
According to Cairn India's assessment, the total revenues from the Rajasthan fields through the life of the PSC (2020), on the basis of the present approved field development plan of 175,000 barrels a day is estimated at over $14.6 billion. And if royalty is made cost recoverable, it will bring down Government's revenue share by over $ 2 billion.