Cost hikes overrun energy sector

Written by Siddhartha P Saikia | New Delhi | Updated: May 12 2014, 18:08pm hrs
KGThe exploration and production company is not the only state-run firm struggling with spiralling expenses.
Reliance Industries (RIL) is mired in arbitration and subjected to adverse commentary for revising the KG-D6 development expenditure from $2.47 billion initially to $8.84 billion, but the public-sector hydrocarbon explorer ONGC too reworked its capital spending plan several times since it got its KG block (KG-DWN-98/2) in 2000, at the same time that RIL received its block (KG-DWN-98/3). Whats curious is, ONGC has already incurred $1 billion for exploration alone in the block where commercial production is not expected before 2017. While ONGC hasnt even readied a field development plan (FDP) for its 9,800-sq km block, the latest estimate is that development of the first-to-be taken-up northern segment of the block would itself cost $5 billion and that of the full block almost double that amount.

The exploration and production company is not the only state-run firm struggling with spiralling expenses.

NTPC, another major energy PSU, can hardly claim to have been economical with costs either (its fixed costs have risen 83% between FY09 and the first quarter of FY14, the latest period for which figures are available), although the cost-plus regime (for fixing tariffs) has long come to its rescue.

Private players in the power sector enjoy no such immunity as their tariffs get predetermined through auction. Then there is Coal India, which saw its cost of production jump over 20% over two years.

In the case of ONGC, not a single molecule of hydrocarbon has been produced by ONGC from its KG-D6 block while RIL has been producing gas from its block since April 2009. Its another matter the private company could not match the committed production schedules for geological reasons. The northern part of ONGCs KG-DWN98/2 is seen to hold 2 trillion cubic feet (tcf) of gas and 117 million tonnes of oil, while RILs KG-D6 field was initially seen to hold 5.45 tcf of gas (this estimate was lowered substantially later).

ONGC produces about 15 million tonnes of crude oil every year from Mumbai High where it continues to invest billions of dollars to sustain the output (the third phase of redevelopment is about to begin and is estimated to cost Rs 21,546 crore). At its peak in 1989-90, the field yielded a little over 20 million tonnes of crude.

Whether by design (as is alleged in the case of RIL) or inefficiency (as with the ONGC), avoidable cost increases would eventually burden the consuming industries, hit the economy hard and stoke inflation.

RIL had in 2004 claimed a development cost of $2.47 billion for its KG-D6 block, which subsequently was increased to $5.20 billion (for phase 1) until FY09 and another $3.64 billion spending was reported by the company for phase 2. The total cost thus escalated to $8.84 billion, something which caused the Comptroller and Auditor of General (CAG) to frown on the company and pull up the petroleum ministry for alleged lack of due diligence. (The government later decided to disallow $1.84 billion in costs to RIL and an arbitration process is now under way, with the company challenging the move.)

Of course, RILs KG-D6 production that started in April 2009 peaked at 69.43 million metric standard cubic metres per day (mmscmd) in March 2010 but since dropped sharply and now is pegged at just 12.75 mmscmd. The peak production of 80 mmscmd was supposed to be achieved by 2012.

While big cost overruns are not alien to ONGC (Mumbai High, its mainstay is no exception), other energy PSUs like NTPC and Coal India have long enjoyed immunity from the adverse effect of their skyrocketing costs. Power generator NTPC has seen its costs balloon over the last few years but the increase has been sharper in the case of fixed costs that are protected under the cost-plus regime, rather than the variable (mostly fuel) costs. The PSUs variable cost had gone up only 29% between FY09 and Q1FY14 as it sourced fuel mostly from the domestic market at largely regulated prices.

NTPC sources say a spike in metal prices in the last few years that increased the cost of power equipment and surging land costs jacked up fixed costs. But the company really does not have a reason to complain as all its power stations continue to operate under the protective cost-plus regime, unlike private firms that face commercial risks for their projects won through tariff-based competitive bidding. NTPC is entitled to a 15.5-16% return on equity, but there is no assured return on projects awarded through the bidding route to private players.

As NTPCs power tariffs move almost in tandem with its costs, its average tariff for last fiscal stood close to Rs 3.06 per kWh, a rise of 44% from Rs 2.12 per unit in 2008-09. In contrast, non-automatic pass-through of fuel costs (which have risen in the case of most private plants) and a weak payment security mechanism have hit private players.

Moreover, the state-owned power generator would continue to be somewhat insulated from commercial risks from for some more years because not only its existing capacity of 42,500 MW and 20,000 MW under-construction projects but another 40,000 MW for which the company has signed MoUs with distribution companies a massive 1 lakh MW capacity in total would remain out of the tariff-based bidding mechanism.

While fixed costs are protected, NTPC is better-placed compared with private players including ultra mega power projects on the variable cost side also, as it sources coal largely from the domestic market (local coal is 50-60% cheaper than imported coal). The Central Electricity Regulatory Commission (CERC) had to come to the rescue of the Mundra power projects of Tata Power and Adani by allowing compensatory tariffs after an unanticipated spike in prices of imported coal upset their calculations.

Coal India too saw a 23% increase in its average coal production costs between 2011 and 2013 on the back of higher manpower and input expenses. Production cost at the monolith, which extracts around 90% of its coal from opencast mines, averaged Rs 910 a tonne in 2010-11, but increased to Rs 1,121 a tonne in 2012-13. Its costs would have gone up even further had it implemented the government-recommended performance-linked pay (entailing an outgo of Rs 250-30 crore annually). CIL is increasingly outsourcing mining work to private contractors to improve its operational efficiency.

While ONGCs output is stagnating (partly because of the subsidy load on it that constrains capital expenditure), RIL, with no prior experience in deepwater exploration, made 19 discoveries in the KG block between 2002 and 2008. Of this, 18 were gas discoveries and one an oil discovery. Of the gas discoveries, D1 and D3 were declared commercially viable in April 2003 and March 2004, respectively.

RS Sharma, who was chairman and managing director of ONGC from May 2006 to January 2011, tried to expediently monetise the KG Basin block held by the company, but volatile crude came in the way. Sharma said that between 2003 and 2008, the price of crude oil shot up (it reached $147/barrel in 2008), pushing prices of all field services northwards and causing scarcity of rigs. Incidentally, RIL monetised its KG-D6 block in 2009. He said that ONGC would have to spend more in its KG-D6 block than RIL spent in its. A relief for the public sector explorer is that it would not have to build an on-land processing facility, as it proposed to utilise the plant set up by RIL at Kakinada in Andhra Pradesh.

The higher the crude oil price, more is the price for field services. For example, the cost of hiring jack-up rigs has increased from about $70,000 per day two years ago to $120,000-$150,000 a day now. ONGC has deployed a rig, Platinum Explorer, in KG Basin that costs $585,000 a day, said an ONGC official. We cannot proceed for redevelopment of Mumbai High unless we get a crude price realisation of $75/barrel for the South fields and $65/barrel for the North fields. Last fiscal, our average crude price realisation was just $46-47/barrel, he said.

ONGC has yet to complete its KG Basin FDP, which is the backbone for a project as it decides the total number of wells to be drilled, production envisaged and cost to be incurred. ONGC has appointed Norwegian oil and gas industry service provider Aker Solutions to chart out the FDP for the block.

(With inputs from Noor Mohammad)