Petronet LNG: Licensed to kill?

On April 27, 2015, the petroleum and natural gas minister informed Parliament that Petronet LNG was being investigated for alleged irregularities in gas purchase contracts. Importantly, he noted that the findings of a government committee constituted for this enquiry “are under examination in consultation with Central Vigilance Commission” (CVC).

The minister’s written statement is important because Petronet LNG was knowingly and by design structured to operate as a private company outside the purview of the CVC and the Comptroller and Auditor General (CAG). This was achieved by limiting the combined stake of Petronet’s four public sector owners, namely GAIL, ONGC, IOC and BPCL, to 50 per cent, distributed equally among the four.

In reality though, Petronet operates with even less autonomy than its dominant public sector owners because the incumbent secretary to the petroleum and natural gas ministry not only sits as Petronet’s chairman, but also controls the dominant shareholder group. Nothing of any commercial importance happens in Petronet without the involvement of the ministry of petroleum and natural gas and the direct nod of its incumbent secretary.

Either because of the designed shareholding pattern or despite it, and I suspect the former, Petronet has indulged in massive irregularities since inception. These irregularities have cost the nation tens of billions of dollars.

The three widely reported irregularities in gas purchase contracts are briefly detailed below. Ras Gas of Qatar and Petronas of Malaysia competed in an open tender for supply of LNG to Petronet over a 25-year period. Ras Gas won with a firm bid that would have translated to a floor or minimum price of $3 and a cap or maximum price of $4 per MMBTU for re-gasified LNG at Petronet’s Dahej terminal for 25 years. The offer followed the standard industry practice of crude oil-linked LNG prices with a firm floor and a firm cap.

This price bid was re-negotiated in July 1999 exclusively with Ras Gas without approaching the competing bidder. A formulation, hitherto unknown in the world for long-term LNG contracts, was coined. Under this unique formulation Petronet agreed to buy LNG, on take-or-pay basis, at a fixed price at the mid-point of the quoted floor and the cap for the first five years; followed by an annual increase equal to 33 per cent of the originally bid cap, for each of the next five years. For the balance 15 years, LNG price was linked directly to the average price of crude in the immediately preceding five years without any floor or cap.

Even a rudimentary analysis would have demonstrated that at a discount rate of 10 per cent the net present value of payments in the first 10 years, under the negotiated formulation, would be at least19 per cent higher than that under the Ras Gas bid. And, for the net present value under the negotiated formulation to be equal to that under the Ras Gas bid, over the 25-year life of the contract, average crude oil prices would need to remain under $13/barrel for every five-year period starting year 6 through year 25! The rest, as they say, is history.

India lost and continues to lose billions of dollars in payments for Petronet’s LNG imports and reluctant end-users are currently being forced to lift re-gasified LNG at over $12/MMBTU, at the Dahej terminal, under the threat of the take-or-pay commitment.

The second major irregularity also relates to the same Ras Gas contract. The original contract covered the supply of 7.5 million ton per annum (MTPA) of ‘rich’ LNG “without extracting higher hydrocarbons”. These high value higher hydrocarbons comprising ethane, propane and butane were to be extracted and sold as feedstock to downstream petrochemical producers. To date, the first 5 MTPA of LNG has been delivered as contracted.

However, in August 2006, a separate contract was signed that allowed the additional 2.5 MTPA to be supplied as ‘lean’ LNG containing only half the quantity of higher hydrocarbons.

The direct losses to Petronet resulting from lower quantities of saleable ethane, propane and butane and the indirect losses to the downstream petrochemical plants set up by ONGC and GAIL in anticipation of receiving this feedstock also run into billions of dollars.

The third major irregularity covers Petronet’s hurried 2009 agreement to purchase 1.44 MTPA of LNG from Gorgon, Australia, for its Kochi plant at 14.5 per cent of prevailing crude oil prices per barrel. Deliveries are expected to start only in early 2015-16.

In July 2013, with crude oil prices hovering around $100/barrel, GAIL asked Petronet to renegotiate this contract since at that crude oil price the re-gasified Gorgon LNG would cost around $18 per MMBTU at the Kochi terminal. GAIL could not find a single buyer at this price. Even at current depressed crude oil prices, re-gasified Gorgon LNG would cost $10to $11 per MMBTU at the Kochi terminal. Once again, there is no floor or cap.

A number of other controversies relating to appointment of the first CEO & MD, purchase of land at Gangavaram port in Andhra Pradesh, payment of commission on profits to a secretary to Government of India in his capacity as chairman, not exercising the right to buy a 5 per cent stake offered in the Qatari LNG supplier’s facility, and allowing ADB to sell its 5.2 per cent stake in Petronet to Ras Gas (though ADB rightly chose to sell its stake through the market) have also been reported from time to time.

Involving the CVC in the ongoing probe of Petronet’s gas purchase contracts is a welcome step. The government should also ensure that Petronet is subjected to a full financial and performance audit by the CAG. Petronet is not a private company by a long shot. Even if a mere technicality makes Petronet a private company, it does not give Petronet license to inflict such massive losses on a gas- and energy-starved India. The loss to the nation from the reported irregularities must be established and accountability must be fixed, including fiduciary accountability of Petronet’s “independent” directors.

Petronet’s dubious contracts are the work of vested interests that benefit from keeping Indian LNG import prices high. Establishing mala fides would provide Government of India the legal basis for renegotiating these contracts.

The writer was Principal Adviser, Power & Energy, Government of India

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