Proposed shift in contractual regime may raise period of cost recovery

Association of Oil & Gas Operators (AOGO) was formed on August 1, 2006 on the initiative of Sastry Karra to network, exchange information on operating issues in upstream segment, find common solutions and if necessary approach the authorities to facilitate the changes which shall encourage exploration in India. It represents 99 percent of upstream operations in India.

Ashu Sagar, Founding member & Secretary General of AOGO, in response to queries raised by Raja Iyer, Research Analyst at Asapp Media, opined that the proposed shift from cost-recovery contracts to production-linked payment regime for exploration projects may increase the period of cost recovery, and decreases the reward function, particularly in challenging geology.

"Domestic energy policies need their place in sun, vis-a-vis other policies, if the country has to make any significant progress. The sanctity of contract, stability of fiscal regime, separation of upstream regulator, and only value added state interventions are necessary for the growth of this sector."

Following is the excerpt of his response..

Can we have your comments on the pricing formula proposed by the Rangarajan Committee for natural gas? He proposed the weighted average of the price prevailing in Henry Hub, JCC, NBP and the import price.
There are three disagreements with Rangarajan. First, he accepts that PSC (production sharing contract) provides for arms length price discovery, and government is so contractually bound. He also accepts that allocation or fixed price vitiates it, yet he recommends it. Any base index price must contain a variable component with no government allocation, to fulfill the letter and spirit of contract.

Second, the index gives heavy weights to markets that are almost in balance, and not markets that are supply deficit. Thus, it falls way short of approximating Indian market situation, and is not representative. It is also too complex to update regularly.

Third, the netback is used with reference to Gas that is usually wet and rich & comes from easy Geology. Indian Geology is challenging and gas is dry and lean. Its product mix is not comparable and such netback is fallacious.

Industry players feel that the proposed shift to production-linked payment from the current cost-recovery contracts exposes the exploration companies to risk. Can we have your comments on that?
This changeover increases the period of cost recovery, and decreases the reward function, particularly in challenging geology. It makes marginal prospects even less attractive. It is a wrong choice for Indian upstream. It shall dissuade companies from making serious bids for ultra deep waters, frontier blocks, logistically difficult blocks, marginal plays or challenging areas.

Oil and gas industry complains that it shares huge tax burden. The government depends on the sector for a considerable portion of its indirect tax receipts. Is there case for government to reduce tax incidence on the sector?
Government has to be sensitive to any increase in exploration cost. As it is, poor services availability, long administrative delays, challenging Geology, increase this cost. Now the Service tax has tilted the field further. GST is currently not designed to provide a relief either. I certainly hope that there shall soon be an effort to converge the fiscal and energy policies.

What are the problems facing city gas distribution sector? Given that the earlier auction for CGD licenses (in late 2011) was a failure, what are the things the government must keep in mind while auctioning such licenses in future?
No Comments

The government is about to release shale gas policy. What is your expectation from the policy?
I believe a lot of work still needs to be done to reconcile the requirements of upstream, with policies in other areas. Government has still not reverted back to industry with any cohesive draft. If these challenges are resolved, government may not need a separate policy.

India depends on imports for 80 percent of its oil needs. What is your suggestion for increasing energy security in the country?
Domestic energy policies need their place in sun, vis-a-vis other policies, if the country has to make any significant progress. The sanctity of contract, stability of fiscal regime, separation of upstream regulator, and only value added state interventions are necessary for the growth of this sector.

In the context of the shale gas revolution in USA, is there scope for fall in the crude oil and natural gas price in the years ahead?
There could be some reduction, but demand from emerging and developing economies is likely to compensate much of the increase, and prevent deep reductions in price, unless similar large finds or alternate resources become available in many more domains. New technologies for new sources usually demand high prices to bloom.

The government allowed OMCs to raise diesel prices by 45 paise a month. Besides, bulk buyers would be charged market price. Assuming that these measures are implemented properly, by when do you expect diesel under-recovery to decline to zero?
No comments

List out some of the reforms that need to be implemented in the oil and gas sector (both downstream and upstream).
Appoint an upstream regulator, separate PSC (production sharing contract) administration from Policy Making and Regulation, List out the responsibilities and targets for the PSC administrator, free prices, stop allocation, give upstream an infrastructure status , maintain sanctity of contract and speed up decisions.

LNG regassification terminal projects are proposed at Andhra Pradesh, Chennai and in some other parts of the country. Do you think these projects would increase import of natural gas into the country and hence meet energy deficit?
Yes.

Besides change in the contractual agreement (from cost-recovery to revenue sharing contracts), do you expect any other change in the policy framework in the 10th round of Nelp?
This needs an entirely new contract. We have seen issues in CBM (coal bed methane) contracts also, so it can’t be used as is. We hope, the Government seriously reviews whether it can afford the revenue sharing model as it is, or it needs to design other fiscal measures to make the NELP attractive once more.