Some relief: Move to cap oilcos’ cost recovery dropped

By: | Published: April 26, 2018 5:45 AM

In what would give a modicum of relief to the high-tax-paying hydrocarbon exploration companies including Reliance Industries and Cairn, the government has withdrawn a decision to virtually deny these firms their contractual right to recover full costs, before sharing profits with it.

The move was patently contrary to the terms of production-sharing contracts (PSC), which allow full cost recovery by the oil explorer-producers.The move was patently contrary to the terms of production-sharing contracts (PSC), which allow full cost recovery by the oil explorer-producers.

In what would give a modicum of relief to the high-tax-paying hydrocarbon exploration companies including Reliance Industries and Cairn, the government has withdrawn a decision to virtually deny these firms their contractual right to recover full costs, before sharing profits with it. The Directorate General of Hydrocarbons (DGH) had, while approving the oil companies’ budget and work programmes for the current financial year, introduced a clause that the “investment multiple at the end of the year 2018-19 shall not be reduced…”

What this meant was that the government’s share of ‘profit petroleum’ would be intact, even if the companies stepped up capex during the year. The move was patently contrary to the terms of production-sharing contracts (PSC), which allow full cost recovery by the oil explorer-producers.

These terms continue to be part of the earlier PSCs while a simpler revenue-sharing formula that allows minimal scope for uncertainties will be built into new contracts under the Hydrocarbon Exploration Licensing Policy (HELP).

Put simply, profit petroleum is the profit retained after all investments are recovered by the contractor; a part of such profit is required to be shared with the government, the determinant being the investment multiple or the ratio of total net income to total investment. So the more the investment, the lower the multiple and the government’s share of profits. Had the DGH’s fiat been implemented, oil companies would have been forced to scale back their investments.

That would have been an undesirable outcome for the government, which has embraced the tough task of reducing the country’s ever-rising import dependency for oil and gas.

A person close to the latest DGH move confirmed to FE that the clause has been dropped and an order to this effect will be sent to the oil companies soon. “The government has clarified that enhanced production and not the government’s share of profits should be the overriding concern in this case. It needs to be ensured that companies keep investing in the fields,” added the person.

Debasish Mishra, partner at Deloitte Touche Tohmatsu India, said: “The new revenue-sharing regime (as opposed to profit sharing) under HELP is potentially free from such regulatory interventions and uncertainties, which had been a deterrent to domestic oil and gas exploration and production. These (profit petroleum) are baggages of the past.”

The DGH move came at a time when Reliance Industries announced fresh investments of `40,000 crore in its fields in the Krishna-Godavari Basin, off the Andhra Pradesh coast. Cairn, owned by Vedanta, has lined up investments to the tune of `37,000 crore over the next few years to ramp up production at its prolific Rajasthan (Barmer) fields. Under the PSC for the Barmer fields, the government’s share of profit petroleum is now 40% and DGH’s clause would have kept this share unchanged, regardless of the work programme submitted by the company. With the latest decision to drop the clause, the government’s share in profit petroleum will come down to around 30%.

The DGH’s move to protect government revenue followed criticism by the Comptroller and Auditor General of India (CAG) in various reports that the cost recovery clause in PSCs encouraged contractors to inflate their investments in order reduce payout to the government.

In fact, over the last three years, the government has taken several steps that has crippled investors in the oil and gas sector, which anyway shell out huge amounts as direct and indirect taxes. While profit petroleum for Cairn’s Barmer fields was hiked by a whopping 10 percentage points three years ago, a year later, the cess on oil was hiked by 47%. Last year, the government compounded the industry’s problems by issuing service tax notices on ‘cost petroleum’ (the share of oil/gas the companies get to compensate for their costs), cash calls (the amount a consortium leader asks others to pay for production costs) and royalty paid to the government. While industry outrage resulted in this getting partially fixed, the industry is still required to pay an 18% goods and services tax on the royalty it pays the government.

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