FE Editorial : Cairn gets going

Written by The Financial Express | Updated: Feb 19 2013, 06:37am hrs
Youd think a country as oil-starved as India, where more than 80% of needs are met through imports, would be keen to encourage firms to spend more time and money on exploration, but not quite. The current production-sharing contract that governs how the oil/gas blocks are to be run, for instance, allows a firm to explore for oil in only the first 7 years, the next 13 are to be used only for developing the wells. It is obviously important for the government to be able to get oil/gas, but which company would go on exploring for more oil instead of producing it if the prospects didnt look good It was for this reason that, nearly 7 years ago, Cairn wrote to the oil ministry asking for permission to do more explorationits 7-year window had expired for the Rajasthan blockbut the ministry refused, never mind Cairns argument that continuous exploration is something allowed in most countries since, it is only as operators get more data from the fields that they can take decisions on whether to explore more or not. Ostensibly, the reason for why the government did not allow continuous exploration was that, in the case of Cairns $1 billion exploration programme, the government stood to lose $500 millionat the peak, Cairns profit-sharing was 50%if the company didnt find anything. But surely that was a risk worth taking given the data Cairn was showing it on how much oil there was to be explored And surely a country that is oil-starved needs to take some riskssimilar risks taken by PSUs havent always paid off either, but theyve been taken, including for overseas ventures.

An in-principle solution, though a flawed one, was found some months ago when the oil ministry allowed operators to do continuous exploration, but only on the condition that firms could not expense this unless they actually found some oilso, in case Cairn finds oil, the government will allow it to recover the $1 billion it will have spent on exploration from the oil that it produces; in case no new oil is found, Cairn will not be allowed any expensing from the old discoveries. It is based on this in-principle decision that, last week, the managing committee of Cairns Rajasthan blockthis has representatives of the government as well as the Directorate General of Hydrocarbonsapproved the companys fresh exploration plans. If all goes to plan, Cairn will end up giving the governmentCentre, Rajasthan as well as ONGCa total of $15 billion on an NPV basis once the oil is found.

While Cairn is going ahead since it is confident of finding oil, linking expensing to finding oil looks like a short-sighted decision, more so since expensing is allowed in the first 7 years regardless of whether oil is found. The obvious solution, if the government doesnt want to take any risk at all, is to move to pure revenue-share-based exploration instead of the current investment-multiple-based expensing model. Both have their advantagespure revenue shares dont allow expensing and so keep the government out of the operators day-to-day operationsand a final decision on which India will use is yet to be taken. But a combination of the twoas is now being used in the case of firms like RIL and Cairnserves no purpose as it doesnt encourage exploration except where its a dead certainty.