Linking cost recovery to discovery is a big flaw though
The oil ministry’s decision to allow all companies to freely explore for oil and gas is a major step forward, designed to revive the flagging oil and gas sector where, over the years, private sector interest has been falling. The immediate beneficiary will be Cairn India which has been, for over a year, asking for permission to explore for more oil in its Rajasthan block—if all goes to plan and Cairn-ONGC find the oil their studies suggest is there in the block, the government stands to gain an additional $15 billion in net present value. That means $9.5 billion more for the central government, $4 billion for Rajasthan and $1.5 billion for ONGC as its share of the profits of the field it jointly operates with Cairn. Others, like RIL and even the state-owned ONGC, will also benefit in a big way since both have, in the past, been denied permission to explore once their initial exploration phase is over—under the production sharing contract (PSC), only the first 7 of the 25 year period can be used for exploration, the rest has to be used for production. The international practice, however, is to allow continuous exploration.
But there’s a catch here that can be quite serious and may stop companies from exploration. Under what’s been approved, companies cannot expense what they spend on the new exploration unless there is a new discovery—so if Cairn spends $1 billion on the new exploration and ends up finding nothing, it cannot deduct this from the revenues it earns from the oil produced in the rest of the field. This is in keeping with what the CAG has said, that fresh approvals for exploration can be given “beyond the existing PSC provisions—for the benefit of GoI or its parties”. While the government wants to be cautious in giving fresh permissions since companies can pad up costs, the better solution is to move to pure revenue-shares without cost recovery—the Rangarajan panel is looking at this. But in such revenue-share agreements which have no cost-recovery, the revenue-shares promised are much lower that those where companies get to recover their costs first. So, by telling firms they can’t expense their exploration costs, but must pay the government higher cost-recovery-based revenue shares, the oil ministry wants the best of both worlds. That’s unfair and will discourage further exploration, which is what the government is trying to promote.
The Rangarajan panel recommendation that gas prices be almost doubled—this will apply to RIL after 2014—is sure to energise exploration since gas prices need to bear some relation to other energy prices. The exact details of what formula has been proposed are not out, but it’s important to keep in mind a $4 mmBtu hike in gas prices will necessitate hiking electricity tariffs by around R1.6 per unit and a Rs 35,000-40,000 crore hike in annual fertiliser subsidies. That’s the next leg of this reform that needs chasing.