Telecom has been hit by the government trying to maximise its revenue, and oil/gas now looks like it is going the same way
Most will agree the new policy on allocating oil/gas acreage is better than the earlier one where the government picked blocks that oilcos then bid for. In the Open Acreage Licensing Policy (OALP), an oilco identifies the areas it wants and these are then bid for. But, when the government moves one step forward, it often also moves several steps backwards. That is especially unfortunate when, as compared to the plan to reduce import dependence for oil/gas by 10% by 2022, this is actually rising. India imported 77.3% of its crude oil in FY14 and this rose to 82.8% in FY18; in the case of natural gas, this rose from 33.2% to 45.4% .
Instead of making oil/gas exploration attractive, last month, the government put in a profit cap that made it unattractive to increase investment. Right now, the share of oilco profits that the government gets depends on the “investment multiple” (IM), or the oil/gas revenue divided by the capex—the lower the IM, the lower the government share. In other words, more capex will lower the IM and, so, lower the government’s profit share. While the government telling oilcos that the IM must not be allowed to fall resulted in protecting its revenue share, it also meant that oilcos were being encouraged to not invest more even though this would eventually lead to more production.
Unnerved by the criticism that ensued, the government quickly rolled this back. But what followed was even more absurd since oilcos were told that cost-recovery would be on the basis of the Production Sharing Contract (PSC)—signed by the government and the oilcos — and “extant government policy”! That is, the government backed off this time, but reserved the right to change policy whenever it liked. This, by the way, is very similar to the retrospective tax that the BJP campaigned against so vociferously when it was in the Opposition. If, say, a Reliance invests $5 bn in its gas fields, this is based on the policy regime when it signed the PSC; any change in the PSC, then, is retrospective since it changes the rules after the investment has been made. That such a policy that builds in uncertainty under the guise of “extant policy” will hit investment does not seem to have occurred to anyone in the oil ministry.
Amazingly, the OALP perpetuates this obsession with government revenue. Unlike in the past where oilcos got to recover their costs, after which profits were shared with the government, the OALP is based on a revenue-share agreement, like in telecom. So, while the cost-recovery of the past resulted in the government taking a long time to clear the oilcos’ investment plans, this does not happen in the revenue-share model — artificially jacked up costs, as was alleged for Reliance’s KG Basin investments, after all, would lower the government’s profits in a cost-recovery model.
But, instead of going in for a single revenue-share number as happens in telecom, the OALP has a complicated bidding structure. In OALP, an oilco has to bid for how much revenue it will share at the Low Revenue Point (LRP) which is defined as revenues of $0.05 mn per day and at the High Revenue Point (HRP) which is $7 mn a day. Any production between this will pay a revenue-share somewhere in the middle—this is what causes the problem.
Take the case of an oilco (see graphic) where the expected production potential is 60,000 barrels of oil per day (bpd). At this level of production, assuming a cost of $12.5 per barrel to produce the oil and, say, a $50 per barrel price, the government gets 66% of the revenue and the oilco’s return on investment (RoI) is 68%. This RoI obviously depends upon the cost structure and also the level of production. If the costs are higher than $12.5 per barrel, the same 60,000 bpd output will fetch it a lower RoI.
The oilco, obviously, also has the option of shifting to a less- or a more-aggressive production schedule; the aggressive schedule is better for the country since more oil will be drilled faster, subject to the oil field not being damaged by excessive production. But, such is the tyranny of the sliding revenue-share scale, if the oilco produces 30,000 bpd instead of 60,000 bpd—it will then drill for twice the duration to take out the same amount of oil—the government take comes down to 48% and the oilco’s return on investment goes up to a whopping 194%!
Now assume the oilco wants to ramp up production to 70,000 bpd. This will have to be done by using more chemicals or more water injection and will result in higher costs, $13 per barrel in our example. The government share then goes up to 72% and the oilco’s RoI falls to just 33%; at 90,000 bpd, the oilco actually loses money. So, in order to maximise government revenue, we have a policy that encourages the oilco to maximise RoI even if this means the country gets less oil/gas.
Postscript: As reported earlier, when Cairn India found more oil and wanted its PSC to be extended some years ago, the government failed to respond. Cairn then went to court and, later, the government came up with a policy that made such extensions automatic provided the government share of profits went up by a whopping10 percentage points. While Cairn would have liked to pursue its case in court, the new policy says the government has the right to not extend the PSC if there is any pending court case/arbitration! So Cairn is back in court, this time asking whether the government has the right to force it to sign away its rights if it wants its PSC extended. And the government still expects India’s import dependence to come down despite such policies.