FE Editorial : Painless extraction

Written by The Financial Express | Updated: Jan 3 2013, 06:14am hrs
Gas formula as well as new PSCs are a good idea

Apart from the fact that crude production has been falling for all of the last yearand gas for almost two yearstwo issues have dogged the countrys oil exploration sector. The constant interference by the government in what should logically be the domain of the oil firms and, two, the government deciding on what prices of gas should be. Both have, to a large extent, been resolved by PMEAC chief C Rangarajans reportwhether the government accepts the report, especially on gas pricing, will depend upon what other ministries say since both electricity and fertiliser subsidies will be affected in a big way.

After explaining why a CAG audit and government permission is critical when it comes to firms doing explorationsince firms get to recover their costs first, any padding in costs affects government revenuesRangarajan recognises that this is keeping investors away. The number of exploration blocks awarded is down from around 50 in NELP 6 to roughly a fifth in NELP 9within this, the share of private operators is down equally sharply, from 70% in NELP 5 to 45% in NELP 9. So, Rangarajan has recommended the government move to a revenue-share arrangement with an upside for higher oil prices or unexpected production surprisespresumably this also applies to the downside. This happens in the existing arrangement as well, the only difference being firms get to recover all their costs firstso the contracts are for profit-shares. Theoretically, this will turn away investors since, in a non-oil-rich country like India, this could mean a greater risk for them. In reality, however, this is missing the woods for the trees. If there is no oil found, even under a cost-recovery model, a firm will not be able to recover the money it has invested in exploration. So, all that is needed in the new Rangarajan formula is to do some more discounting for the time it will take to get the oil/gas out. As to moving from the profit share to revenue-share mechanisms, thats pure mathsif profits shares are 30% and profits are 10% of revenue, the revenue-share bid will be for 3%.

On gas pricing, as from RILs KG Basin, the argument is a simple one: unless market pricing is allowed, few will want to invest. But how do you get market pricing in an economy where there is no real market as supplies are woefully short of demand. In the event, Rangarajan provides a two-step model. First, look at an average price of exports from countries where India imports LNG from. Two, look at prices at various global commodity exchanges. Since both prices are competitive in nature, average them and come to a representative price. Both recommendations, if accepted, will stimulate production with the caveat that a $4 in gas pricesRangarajans formulae will roughly double prices for Reliances gas to $8 per mmBtunecessitates a R1.6 hike in electricity tariffs and a hike of around R35,000-40,000 crore in fertiliser costs. That means either a huge increase in subsidies or a huge hike in losses, making this a devil and deep sea option.