London-listed Vedanta Resources faces tough decision after a panel of ministers set stringent conditions for approving Cairn India deal even though after accepting the stipulations the nation’s largest private sector oil producer will still remain a hugely profitable venture.

Vedanta will have to decide if it should continue to pay Rs 405 per share or $6.65 billion for buying 40 per cent stake in Cairn India from its Edinburgh-based parent Cairn Energy plc or a lower amount in view of Group of Minister’s condition that royalty on all important Rajasthan oilfield will be cost recoverable.

Cairn India doesn’t pay royalty on its 70 per cent share of 175,000 barrels per day of oil output, but will now have to agree to deducting the royalties paid by state-owned ONGC from revenues earned from oil sale, lowering its profitability.

Sources in the know of the development said cost recovery of the royalty will lower Cairn India’s profit, in net present value (NPV) terms, by Rs 6,272 crore over the approved life of the field till 2020.

This is less than the net profit that Cairn India earned in 2010-11 fiscal (Rs 6,334.40 crore) and half of the Rs 12,600 crore liability it would have to incur if it were to pay state government royalty at the rate of 20 per cent of $70 per barrel oil price on its share.

Sources said when Vedanta in August agreed to buy Cairn India, the Indian basket of crude oil was at around $75 per barrel. In May it has averaged, $110 per barrel, a huge upside for Vedanta. Cairn India got $94.2 per barrel for oil in January-March quarter.

Vedanta, they said, will weigh if the cost recovery liability is more than the upside it has already got in crude oil price. Also, Cairn India’s peak output is now estimated at 240,000 bpd as against 175,000 bpd.

Oil and Natural Gas Corp (ONGC) had made claim for cost recovery of royalty as per provisions of the contract for Rajasthan field in June 2010, much before the Cairn-Vedanta deal was announced.

Cairn India had in fact in July that year acknowledged ONGC’s letter that asked for approval of oil regulator DGH to be produced for beginning cost recovery process.

While oil ministry as well as Solicitor General of India backed ONGC’s interpretation of contract, Cairn India went back on its word and started opposing cost recovery the moment the deal with Vedanta was announced.

ONGC has to pay Rs 18,000 crore in royalty on the entire output over the life of the field. In the absence of cost recovery, this liability together with its obligation to pay for 30 per cent of capital and operating expenditure in the field, made the Rajasthan project a losing proposition for it.

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