Reliance wins case govt should never have filed

By: | Published: August 1, 2018 1:15 PM

Gas ‘migration’ happens all over the world, but instead of resolving issue, Govt/ONGC accused Reliance of theft; award will have implications for cost-padding case also.

reliance, RIL, ril share price, ril news, ril share price bse, ril share price nse, reliance industries ltd share price, reliance industries, reliance industries share price, mukesh ambaniThough Tuesday’s arbitration ruling is not related, it will have important implications for the government’s larger case against RIL for artificially inflating its capital costs. (Reuters)

Given the way the issue played out in the media, it can be argued that the government had no option but to press ONGC to claim Reliance Industries Limited (RIL) had ‘stolen’ its gas and that it needed to pay $1.6bn in damages for this. But while the media can be accused of sensationalizing the matter, calmer heads should have prevailed in both the government and ONGC.

For one, even if it were true that part of the gas – 0.3 trillion cubic feet (tcf) – that RIL had extracted from its KG Basin fields actually belonged to ONGC’s 98/2 field that is adjacent to RIL’s, the cost of this gas and the losses to ONGC were always dramatically different.

After all, ONGC would have had to invest several billion dollars to take out in gas, so ONGC’s claim for damages would have to be restricted to the profits it could have made from this 0.3 tcf of gas after taking into account the capex and opex it would have had to make. Not surprising then, that the international arbitration panel that was examining the claim has not just refused to grant ONGC its claim, it has asked it to pay RIL for legal fees incurred. Chances are, the government/ONGC will challenge the award, but that is a bad idea.

Indeed, given the report on gas reserves by international consultant DeGolyer and MacNaughton (D&M) has dramatically lowered the reserves of gas in the fields, it would appear ONGC may have made big losses had it invested in the field – for the record, the government/ONGC have not contested the findings.

More important, however, this is not the first time in the history of global oil and gas exploration that reserves have migrated from one field to another due to the fact that the underlying reservoirs were connected. The way that such issues have been resolved, however, has been joint development of fields, not filing claims for damages. Had ONGC and RIL jointly developed the fields once the reservoirs were found to be connected, the PSU would have paid its share of the capex and opex, including the royalty paid to the government.

And while ONGC/government were quick to blame RIL and claim it knew the reservoirs were connected – that’s where the concept of theft/pilferage came from – the facts show ONGC and the regulator in a poor light as well since neither realized the reservoirs were interconnected though they had data on it for years before RIL started extracting gas. In retrospect, this is not surprising since RIL didn’t know either. Indeed, it upped its original estimates of gas in the field from 7 tcf to 12 tcf while D&M later estimated the reserves were just 2.9 tcf.

Though Tuesday’s arbitration ruling is not related, it will have important implications for the government’s larger case against RIL for artificially inflating its capital costs. While the CAG’s audit report had first talked of RIL’s capital costs being too high, when the government finalized its stance, it took a different tack.

Rather than getting into whether the capex was padded since this would have been difficult to prove, the government said RIL had promised a certain gas output for the capex and since it had not delivered on that, part of the capex would be disallowed – under the profit-petroleum rules, as the capex rises, the government gets less profits; so by disallowing part of the capex, the government said RIL had to pay it a higher profit-petroleum.

Till now, around $3.2bn of capex has been disallowed. In FY15, for instance, the oil ministry disallowed $2.8bn of such expenses, or 59% of the capex incurred by RIL as the gas produced was 59% less than what RIL had supposedly promised; in FY16, the disallowed expenses rose to $3.1bn or 65% of capex. This was a tenuous argument since the production sharing contract (PSC) doesn’t link capex with output, but it seemed reasonable since the argument was that RIL wasn’t producing the gas because it wanted to wait till prices rose – at that point, prices were $4.2 per mmBtu while RIL was lobbying for around doubling of that price.

But now that the D&M report has shown there is very little gas left in the RIL fields, the government can no longer argue RIL was hoarding gas; and if it can’t do that, it may not be possible to justify disallowing $3.2bn of capex.

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