No big loss for RIL on D6 order, says govt

Written by Gireesh Chandra Prasad | Gireesh Chandra Prasad | New Delhi | Updated: May 7 2012, 08:17am hrs
The oil ministrys move to disallow Reliance Industries (RIL) recovery of $1 billion cost at its KG D6 block until gas production improves, is unlikely to hurt the company significantly. For the government, the move at this juncture would mean an immediate revenue flow of $100 million as its share of profits from the venture.

The government wants RIL not to recover the $1 billion cost in the two years when gas production fell below target (2010-11 and 2011-12) and add the disallowed cost to the profits of those years. Under the production sharing contract (PSC), profits are required to be shared with the government according to a formula.

So, even after disallowing the cost, Reliance would still get 90% of such incremental profit ($900 million) as its share of profit petroleum without any delay. The remaining $100 million would, of course, go to the government cumulatively for the two years, said a government official, quoting the PSCs terms.

If the government had not attempted to restrict cost recovery, it would not have got even this $100 million right now. For the company, the difference is only of $100 million over the above two years. So, the dis-allowance would have only a marginal, temporary impact on both the government and the company.

In its notice issues last week to restrict RILs cost recovery proportionate to the use of infrastructure built, the ministry said the company under-utilised the facilities. RIL considers this wrongful denial of cost recovery which is unwarranted and violative of the PSC.

Production, which exceeded the targeted 27.6 million metric standard cubic metres (mmscmd) in 2009-10, faltered subsequently and has now dropped to 27 units against the targeted 80 units, for which the government blames RILs unfulfilled drilling commitment. RIL thinks drilling more wells goes against well economics that is, economically unviable unless the geological challenges affecting production are fixed.

As per the contract, RIL is entitled to recover cost from 90% of the revenue in the initial years of production, sharing the remaining 10% with the government a 9:1 ratio. If $1.005 billion is disallowed as recovery of costs, the same is added to the profits to be shared, most of which would go back to RIL. Once the costs are fully recovered, the investment multiple (how many times the earnings are compared to the investment) would turn in governments favour and as it touches 3.5, the state would get about 85% of profit petroleum, leaving the rest to the company, said another person privy to the contract terms. The proposed restriction on cost recovery in the initial years of production could only marginally boost the government's share of profits, while it could delay the change in profit-sharing ratio. The oil ministry on Friday clarified that its direction to the company only requires it to defer cost recovery till gas production is raised to the targets committed.

RIL stated on Friday that a contractor is entitled to recover all of its costs under the terms of the PSC and that there are no provisions that entitle the government to disallow recovery of any contract cost as defined in the PSC. The ministrys notice to RIL said the company has so far recovered $5.25 billion of the $5.69 billion spent on developing the field.

The oil ministrys move to restrict cost recovery follows the Comptroller and Auditor General of Indias observations last year on the management of the field. The statutory auditor had said the increase in the capital expenditure from $2.39 billion to $8.8 billion for the D1 and D3 discoveries in the K G basin casts doubts on the robustness of the data and assumptions underlying the development plan.

The CAG also said the auditor could not derive assurance regarding the reasonableness of the cost incurred with respect to the large procurement contracts made by RIL in 2006-07and 2007-08 due to lack of adequate competition and major revisions in their scope, quantities and specifications. Industry executives say there are very few reliable players in certain oil field services, whom exploration companies could depend on. If the few bids received from them are not accepted in time, the exploration firm might be delaying the operations and risking further cost escalation as the audited years were marked by the global commodity boom. RIL has reiterated that it remained committed to complying with the PSC provisions and procedures including adopting good international petroleum industry practices in its operations.