The government is about to offer oil and gas blocks for exploration licensing. As per the prevailing practice under the New Exploration Licensing Policy (NELP), the blocks are offered on the basis of profit-sharing. Firms first recover the cost of exploration and production and after that offer a proportion of their profit to the government. The firms bid for what share of profit they are offering the government. This requires that the government determine the costs of exploration and production. This is done by the Director General, Hydrocarbons, appointed by the Ministry of Petroleum and Natural Gas (MoPNG).
This has led to disputes about what the cost has been. Thus, the Rangarajan Committee has recommended that instead of profit, the government should consider a revenue-share. This would eliminate the need to determine the cost. Following this, recently, the Kelkar Committee has argued that there is no need to change the profit-sharing mechanism as it has been practised for some time and the disputes have been few.
While I do not know the specific arguments offered by the Kelkar Committee, I think the Rangarajan recommendation has some merit. Any self-respecting businessman, given an opportunity to gold-plate his investment, would do it and overstate it. Revenue-sharing will eliminate the need to assess the costs incurred. It is, however, argued that some auditing will be needed, even with revenue-sharing, to determine the strategy of exploration. Is the firm delaying production to benefit from higher prices in the future?
This can happen if the prices are government-controlled and there are indications that prices may increase in the future. For example, the natural gas price is $ 4.2/mmBtu and is expected to increase to $8.2/mmBtu by April 2014. In such a situation, it would make sense from the firm’s point of view to delay production. Such gaming should be expected. I don’t think this would have been a serious issue if the petroleum sector prices were free and market-determined, as predicting future prices would not have been easy with the firms preferring to get money as soon as they could. Revenue-sharing is more transparent and these days transparency will trump any other argument.
However, revenue-sharing increases the risk that the firm faces. It does not know what the cost would be and does not know if it would be able to recover it. Given this, the firm would offer a lower share of revenue to the