Allow tax holiday for oil blocks

Despite the gloom around the global economy, most experts have been predicting a healthy growth outlook for India. The expectations largely ride on the resilience shown by the Indian economy, strong fundamentals and the huge opportunities that the sub-continent offers. However, the ambitious growth trajectory, coupled with industrialisation, brings along its share of challenges on the energy security front.

Although the per capita consumption of energy in India is significantly lower at 585 kg of oil equivalent (kgoe) as compared to China's per capita consumption at 1698 kgoe and US' 7034 kgoe — the energy requirements have been steadily on the rise.

Even with the meagre per capita consumption, India ranks among the top four consumers of energy globally. With the compounded annual growth of 6.5 per cent in the last five years, the country has witnessed unprecedented surge in energy consumption.

Traditionally, India has relied primarily on fossil fuels for its energy requirement with limited focus on alternative sources of energy. Oil and gas, being one of the most common form of fossil fuel, accounts for more than 42 per cent of India's overall energy basket.

Although India made its first oil discovery in 1889, the growth in domestic production has been pretty tardy over the years.

India now accounts for less than 1 per cent of global crude production. This huge gap in domestic production and consumption results in heavy reliance on imports to cater to domestic demand.

Tax holiday

Sensing the challenges on the supply side and the need for wider participation, the Government of India came up with the New Exploration Licensing Policy (NELP) in 1999. Apart from bringing in the private players on a level-playing field with the National Oil Companies, the NELP policy also ushered a seven-year tax holiday from the profits generated from production of crude. Exploration sector being capital intensive and marred with high risk and long gestation period, the tax holiday effectively incentivised the exploration companies.

These policy initiatives had a positive impact on the E&P sector with 269 exploration blocks being allotted under the NELP rounds with multi-fold increase in exploration coverage. The first eight rounds of NELP attracted investment in excess of $14.3 billion and witnessed 87 oil and gas discoveries in 26 blocks till date.

The pragmatic policies of the government and the tax holiday played a pivotal role in attracting some of the global oil companies as well as domestic corporate houses.

The tax holiday provides a 4-5 per cent cushion on the return on income to the exploration companies who undertake the risks and uncertainties associated with the business.

The enhanced activity due to favourable policy and tax holiday has resulted in more than 15 per cent growth in the domestic crude production between 1999 and 2010 — even though, some of the discoveries made under NELP blocks are still under appraisal/development and production is expected to commence shortly.

Demand-supply gap

With the steady increase in demand and limited large discoveries made in India, the demand-supply mismatch continues to be huge and India continues to rely on imports for more than 70 per cent of its crude requirement.

This huge reliance on imports reiterates the importance of continued investment in the domestic oil and gas sector to somewhat insulate against the associated risks.

Moreover, out of the 26 sedimentary basins in India, so far, only eight basins have been explored to some extent. This translates into about huge unexplored terrain within the subcontinent — and potentially reasonably huge domestic resources.

To tap the unexplored terrain and to fund the exploration activity within the country, there is a need for continued encouragement and private participation in the domestic oil and gas sector.

The tax holiday has played an anchor role in establishing the domestic oil exploration sector as an attractive proposition for investors as compared to other geographies with similar geology.

Keeping the requirements of our economy in mind and the past results, the government should consider continuation of the tax holiday for the oil and gas sector with regard to NELP blocks awarded after April 1, 2011.

(The author is Partner, Tax – KPMG in India.)

COMMENT NOW