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Why ONGC says Vedanta Cairn’t PDF Print E-mail
Wednesday, 06 April 2011 00:00
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 Much of the confusion over the Cairn-ONGC dispute, to be decided by the Cabinet today, results from the two seemingly parallel strands to the issue. The first begins in the mid-90s, when the government invited oil firms like Cairn, gave them a 60-70% stake in JVs with PSU oil firms ONGC/OIL, who were to pay the royalty on oil produced. When ONGC protested, a Group of Ministers (GoM) was formed and, in 1997, it said the government must make good on the losses ONGC/OIL suffered—a year later, a Committee of Secretaries said much the same thing, but no decision has been taken so far!

 

Two, there’s a commercial dispute between ONGC and Cairn, for a year now, on whether the royalties paid by ONGC can be treated as expenses or not. Both cite the same production sharing contract between them to say the exact opposite!

Let’s assume Cairn-ONGC produce R100 worth of oil and incurs R30 of expenses while doing so; that they give 30% of profits to the government, and 30% of what’s left goes to ONGC, the rest to Cairn. That’s Part A of the graphic. So, of the R100 of sales, R70 is the profit; R49 stays with Cairn-ONGC and R21 goes to the government. Since Cairn-ONGC share the profits 70:30, R34.3 goes to Cairn and R14.7 goes to ONGC—this is called profit-oil.

Now, both firms must get what they spent on exploration (only Cairn did this), on production (Cairn spent 70% and ONGC 30%) and on the cess paid to the central government (again, in a 70:30 ratio, though Cairn is in arbitration on this, saying it should pay nothing)—this is called cost-oil.

Now let’s bring in the royalty that’s paid to the Rajasthan government on the oil produced, at a rate of 16.6% of the value of the oil. Move to Part B of the graphic, and assume, to keep it simple, the royalty is R20 (it’s actually R16.6). In the example, the expenses will rise to R50 and profits will fall to R50. Cairn-ONGC will then get to keep R35 of the profit and the government will get R15. Cairn, in turn, gets R24.5 of this and ONGC R10.5 in terms of profit-oil.

Now add in cost-oil. As in the past, Cairn will get what it spent on exploration, both will get paid for what they spent on production and cesses, and ONGC will get paid the R20 it spent on royalties. So, in addition to exploration/production/cess payments, Cairn gets R24.5. And in addition to the production/cess payments, ONGC gets R30.5.

In the case where royalties are added in, the government gets R6 less (R21 minus R15); Cairn gets R9.8 less (R34.3 minus R24.5); and ONGC gets R15.8 more (R30.5 minus R14.7). ONGC’s still making less than it was in Part A since it is spending R20 more on royalties but earning R15.8 more (this difference is what the GoM said the government would make good).

According to ONGC, it will have to make royalty payments (it paid R828 crore on behalf of Cairn in the first nine months of 2010-11) that could add up to around R15,000 crore over the life of the Rajasthan field (on a net present value basis), depending on what oil prices are and the production from the Rajasthan field. Normally, such a dispute should have been in the arbitration courts by now, but it isn’t. The government plans to resolve this for the sake of keeping foreign investors happy. One proposal is that ONGC be told to allow the deal to go through since it would have to incur this cost anyway even if Cairn didn’t sell out to Vedanta—to the extent ONGC will go in for arbitration with Cairn, it can do this with Vedanta.

ONGC opposes this as it feels it won’t have the same leverage over Vedanta that it has over Cairn. The point then is whether the Cabinet should decide on something that is the preserve of the arbitration court. Two, if ONGC loses in the arbitration court, will the government make good its loss? Or will it argue that the GoM was not an ‘empowered’ one and so its decision wasn’t binding on the government? Either way, ONGC’s shareholders are a worried lot.

 

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