Narendra Modi continues with OID cess despite calls to drop it; now oil import reduction under threat

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Updated: October 27, 2017 4:20:34 AM

Despite many calls—by the industry, the oil ministry and even Parliamentary committees—to withdraw the OID cess, the govt has continued with it

Narendra Modi,  OID cess, oil import, MoPNG, Discovered Small Fields, HELP, OID Act of 1974, oil industry, finance ministry, Discovered Small Fields, Oil Industry Development Board The ministry of petroleum and natural gas (MoPNG) asserted that the overarching objective shall be to maximise exploration, recovery and production; revenue will be only a secondary consideration in decision-making. (Reuters)

On October 9, 2017, the prime minister invited the chief executives of major oil companies and energy experts to discuss how best to encourage higher exploration and production (E&P) in India to meet the target of reducing oil imports by 10%. The ministry of petroleum and natural gas (MoPNG) asserted that the overarching objective shall be to maximise exploration, recovery and production; revenue will be only a secondary consideration in decision-making. One wonders whether the finance ministry was listening, and if adequate attention is being paid to the fiscal measures that are out of sync with the government’s professed objectives and plan of action. Are various ministries marching in harmony to achieve the PM’s target?

The fiscal measures that are out of sync with the GoI’s objectives are disproportionate levy rates—cess @20% and royalty @10%—and the extension policy for mature/producing fields. Higher levy rates (cess and royalty) reduce the rate of return for oilcos, which in turn mean less risk-capital investment by the latter. Less risk-capital translates to lower recovery of hydrocarbons.
Access to oil and gas are crucial drivers for the growth and ambitions of a country. As is known, the economic philosophy of Fabian socialism and nationalisation took a complete about-turn in 1991. ‘Free market’ has been our mantra for the last 25 years. Oil-gas E&P, along with telecom, has been in the forefront of a massive and successful induction of private capital for our growth. In petroleum, the new policies of Discovered Small Fields (DSF), Open Acreage Licensing Policy (OALP), Hydrocarbon Exploring and Licensing Policy (HELP) and the envisioned natural gas marketing hub show that this government is determined to do what it takes to bring an energy revolution in India. The prime minister’s call to reduce oil and gas imports by 10% by 2022 has the industry hungry and seeking new acreages under the new policies. In this scenario, however, there remain a few policies that are antithetical to this goal—the Oil Industry Development cess is one.

The OID Act of 1974 was adopted simultaneously with the nationalisation of oil industry. At that time, huge funds were required to keep up with the developments in the industry. An Oil Industry Development Board was formed and the cess was imposed to provide funds to develop the Indian oil & gas. Until 2016, the cess was based on a fixed rate per metric ton. The government modified the cess rates from time to time, but maintained it in a ‘7-10 % of prevailing prices’ band.

The changes of 1990s brought private capital into upstream through production sharing contracts (PSCs). This reduced the pressure on government funds for oil development, the original trigger for the cess. Interestingly, in the PSC regime, there were both kinds of companies—cess-paying as well as cess-exempt. It was observed that cess-paying companies were reluctant to undertake and tried to delay new exploration even when cess-exempt companies for the same acreage were pushing for additional exploration or development. Thus, the actual experience showed that cess was reducing the exploration appetite of E&P companies. The government took the positive step of removing the cess for auctions under the New Exploration and Licensing Policy (NELP) regime in 1999. This exemption is being continued for all new regimes as well. However, the government has stopped just short of withdrawing, and it continues for the earlier (pre-NELP) blocks, which account for most of the current production in the country. The maximum gains in productivity and exploration could have been achieved had the cess been withdrawn.

By early 2015, oil prices had fallen dramatically, to levels not seen for over 15 years. As the cess was at a fixed value per metric ton, its effective rate galloped to as much as 20% of the sale price. As a percentage of the margin, the impact was even more disastrous. The industry sought that the cess be removed or, if the cess must be continued, it should be made ad-valorem and not be more than 7-8% of sale price in keeping with historical rates. It will automatically shoot up when there is an upsurge in prices, giving the government a share of price-increase benefit. At the same time, it shall not cripple the industry in low-price regimes.
The finance ministry used this request as an opportunity for a permanent increase of revenue. It made the cess ad-valorem but used a debilitating cess rate of 20%, thus making the 2015 crisis permanent! The accompanying graphic shows the huge increase of revenue from cess thus achieved. Even as production has remained flat, the cess accrual has increased manifold. Effectively, it is sucking away what could be left on the table for new acreages, reducing the appetite of companies currently committed to producing and already producing in India.

In the next year or two, most of the pre-NELP contracts shall move into extension. The increased component of profit on oil and the cess shall make most of the fields/additional exploration uneconomical/marginally economical. The result shall be that a lot of oil and gas may be left underground as it shall be commercially unviable to produce it—a luxury that an energy-deficient country like India can ill afford. It shall also undermine the efforts to meet the import-reduction targets.

Time and again, the industry, MoPNG and the Standing Committee of Petroleum and Natural Gas have all called for a removal/reduction of the cess to incentivise exploration, development and production. In 2006, for instance, the 10th Standing Committee of Petroleum and Natural Gas noted the non-use of cess funds for the original objective and recommended its removal from all the blocks, and establishment of a “price stabilisation fund” instead. However, the finance ministry did not want to let the cess go, and it continues to date—adversely impacting Indian E&P. It seems the increase of exploration or production of oil & gas is not on the finance ministry’s radar at present. So, going forward, this is where we are:

Oil & gas is a critical source of energy for India in the foreseeable future. The domestic production of oil & gas is a strategic necessity—economically, politically and militarily. Domestic production meets only around 18% of consumption needs and is declining. India’s energy demand is growing at one of the fastest rates on a global basis. Oil & gas is the country’s single-largest import, and affects our current account deficit significantly. This, in turn, negatively affects major macro-economic factors. According to a 2015 report by the Boston Consulting Group, the Indian government’s take from domestic oil production is amongst highest in the world. This is despite India being an oil- importing country. E&P of hydrocarbons is a high-risk/risk-capital-intensive business, and the new investment is extremely sensitive to the government take. Considering India’s challenging geology, steep revenue-seeking fiscal policies already in place undermine the attractiveness of new schemes proposed by the ministry of petroleum and natural gas. The impact on maturing fields seeking extension may even be fatal. Everyone knows what needs to be done. Team India must play in unison and succeed.

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