Revenue-share for new finds is a welcome move
Though the government has been trying, of late, to streamline clearances in the oil sector, the impact of this has been limited for a variety of reasons. While oil firms were liberated from the tyranny of being allowed to explore for fresh oil/gas in just the first 7 years of the contract—they are to develop wells in the balance 18 years of a production sharing contract (PSC)—earlier this year, a host of other clearances are still needed. Cairn India, for instance, has a $3billion investment plan that is contingent upon getting clearances early—given the government earns $85 on each barrel of oil versus the $15 it gets, Cairn’s owner Anil Agarwal recently pointed out that the government should be chasing him to produce more instead of the other way around.
The decision to allow firms to do ‘continuous exploration’ was followed up with a long overdue decision to partially free up prices of natural gas, critical if the sector is to attract future investments—in the oil sector, this has already been done. This decision should have enthused Reliance Industries Limited (RIL), the biggest private sector gas producer in the country, to invest more, but it didn’t. Apart from the fact that RIL finds the gas pricing still unattractive and wants it to be fully free-market determined, the government is embroiled in the issue of whether this partially free-market price should be allowed to RIL or whether it should make good its alleged short-supply of gas at the current lower price—while the government argues RIL had committed to supply this gas at the current $4.2 per mmBtu price, RIL says it has made no such commitment and it can’t be blamed if the gas field had less gas than it first envisaged.
This is what the government is now planning to fix with its decision to allot future oil/gas blocks on a revenue-share basis instead of the current practice where, once firms discover oil/gas, the government first allows them to recover their capital costs. Some have argued revenue share will discourage firms from exploration as their exploration costs will no longer be expensed. The fear is misplaced. If a firm spends $100 mn on exploration and finds no oil, even under the present contract, it cannot get the money back from the government. If, however, it does find oil, it can. The difference then is that it will get the money back faster in the current form of contracts as compared to the proposed pure revenue-share contract. So in order to make up for getting the money later, all the firm needs to do is to bid a lower revenue-share for the government than it would offer under the current expensing model. The good thing is that, with the government and the CAG no longer worried about ‘goldplating’ of costs—this matters only when expensing of costs is allowed—they need not poke their noses in the day-to-day business of the oil company. Just drill.