Reforms will hold the key for oil and gas sector.

Mumbai: India’s oil and gas sector will serve as an important barometer of investors’ sentiment as the United Progressive Alliance (UPA) government prepares to auction oil and gas blocks for exploration ahead of the national elections that are due by May.

The government is scheduled to launch the 10th round of bidding for oil and gas assets under the National Exploration Licensing Policy (NELP-X) in January. Oil secretary Vivek Rae had said at an investor roadshow in Mumbai in November that the government expects to attract investments worth $4-5 billion through NELP-X. The response to oil and gas block auctions in the last few years has been tepid.

Keeping this in mind, petroleum minister M. Veerappa Moily has undertaken a slew of measures in 2013 to alter the negative perception regarding the ease of doing business in India’s oil and gas sector, and making policies more attractive.

This is in stark contrast to 2012, when under then minister S. Jaipal Reddy, the oil ministry and Reliance Industries Ltd (RIL) sparred on a plethora of issues, setting an ugly precedent for other companies invested or waiting to invest in the sector.

Market-linked pricing

The highlight of the year in terms of policy decisions was the acceptance that natural gas prices in India will have to rise to make it more attractive for companies to invest. Consequently, a new market-linked formula for gas price, recommended by a committee under the stewardship of C. Rangarajan, chairman of the Prime Minister’s Economic Advisory Council, was accepted, though it is yet to be officially notified by the government.

The gas price under the new formula, to come into effect on 1 April, will be approximately double of what it is at present ($4.2 per million British thermal unit) to begin with and will gradually move in tandem with international market prices.

Vandana Hari, Asia Editorial Director at Platts, an energy research firm, said freeing the price of domestic gas from the “antiquated and unsustainable government-dictated pricing mechanism”, which was hindering growth in the sector, is a bold move.

Hari also said that higher gas prices were likely to attract investments into the upstream oil and gas sector “but foreign players might decide to wait and watch how the implementation of the new gas formula plays out, before jumping in”.

Sudhir Vasudeva, chairman of state-run Oil and Natural Gas Corp. Ltd (ONGC), said higher gas prices would be good for the sector as a whole. Even if the new formula led to the prices of domestic gas to double, it was better than paying around five times the existing price of gas in India for imported gas, he added.

The other key sectoral reform that has taken place in 2013 is a gradual move towards decontrolling diesel prices through successive, small hikes in its retail prices, along with that of petrol, through the year. In 2013, diesel prices in Delhi rose 14.06% to Rs.53.78 per litre, while the price of petrol (that was deregulated in 2010) rose 6.37% to Rs.71.52 per litre.

Though the government hasn’t been able to fully decontrol the price of diesel yet, Moily said that he would like to achieve this in six months. The increase in the prices of diesel and petrol are largely a reflection of depreciation of the rupee against the dollar over the last 12 months, which has made imported crude more expensive in dollar terms.

“The biggest achievement of the year undoubtedly, was that the government finally took steps to decontrol diesel prices and to target LPG (liquefied petroleum gas) subsidies,” said Deepak Mahurkar, oil and gas practice leader at audit and consulting firm PricewaterhouseCoopers India (PwC). “The pressure built from an unexpected corner of weakening rupee and unbearable trade balance.”

Vasudeva of ONGC said that it was heartening to note the reforms process initiated by the government, especially the realization that the subsidy burden (on account of selling petroleum products below cost price) was not viable. However, he observed that had the government “bitten the bitter bullet” of raising prices by a greater margin early on in the year, the existing under-recovery on the sale of diesel could have been avoided. Despite frequent price hikes through the year, oil marketing companies are still losing Rs.9 per litre of diesel sold.

Learning from the past

Many of the policy reforms appear to be inspired by the government’s widely publicized tussles with Mukesh Ambani-led Reliance Industries over the last couple of years.

RIL, which operates the D6 block off India’s eastern coast, has reported a sharp decline in gas output since 2010. The conglomerate and its partner BP Plc have cited geological complexities for the fall in output, but the oil regulator has contended that the companies had failed to drill enough wells. Falling gas supply prompted the government to disallow proportionate cost recovery to RIL, leading to arbitration proceedings over the issue.

One of the agencies that had a big role to play in this episode is the Comptroller and Auditor General of India (CAG). Its reports first indicted RIL of allegedly gold-plating costs to deny the government a fair share of profits it was entitled to. This was vehemently denied by the company and the two have been at loggerheads ever since.

However, the issue seems to have been resolved now as Rae had explained that CAG had the constitutional responsibility of doing a performance audit of the Directorate General of Hydrocarbons—the nodal agency of the oil ministry for upstream oil and gas exploration and production—under which, production sharing contracts (PSCs) are administered. But CAG is not meant to do a performance audit of individual companies unless the government specifically appoints it as an auditor for this purpose. The government’s auditor has accepted this as a legitimate way to move forward and from now on all CAG audits will be within the scope of the PSC.

For RIL, it can now charge a higher price for the gas it produces in exchange for a bank guarantee it has furnished, which can be invoked if legal proceedings eventually find that the decline in gas output from D6 was due to its own fault. Analysts have hailed this settlement between the company and the government as a positive development.

Also, to avoid similar complications in the future, the government has decided to accept the proposal of the Rangarajan Committee to move towards a revenue-sharing model with companies. Earlier, a company had the first charge on revenues from the sale of oil and gas to recover the costs incurred in such activities and a portion of the remaining profit was shared with the government. Under the new model, the operator will have to share a percentage of such sales with the government from the very beginning.

Another example of the government learning from its past mistakes is the fact that for the first time it is trying to secure all the necessary clearances needed for the development of a block (including approvals from the defence and environment ministries) before auctioning them out to companies under NELP-X.

Exploration and production work at many such blocks awarded earlier had been stalled due to want of such clearances, till the Cabinet Committee on Investments moved towards giving them the necessary approvals earlier this year.

Outbounds M&A’s

Even as the oil ministry is working towards removing the bottlenecks that prevent investments in the oil and gas sector, the desire to secure India’s energy needs through acquisitions saw the oil and gas space dominate the outbound mergers and acquisition deal activity in calendar year 2013.

According to audit and consulting firm EY, the total deal value for outbound transactions in the year-to-date was $9.3 billion, out of which ONGC’s three acquisitions—one in Brazil and two in Mozambique—were worth $5.6 billion.

Hari of Platts said 2013 was “pivotal” in terms of the steps taken in the sector and Mahurkar of PwC said the sector “moved miles ahead” in the year. Both agree that the fate of the oil and gas sector in 2014 will be decided by the on-ground implementation of the reforms process that has been set in motion this year.

Source : livemint.com