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Friday, 19 October 2012 00:00
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Oil regulator suggests moving to revenue-sharing

While the dispute between the government and Reliance Industries Limited (RIL) has deepened with the government threatening to hold back approvals for RIL’s KG Basin development plans if the latter didn’t agree to an audit by the CAG, the oil regulator has come up with some good solutions on ensuring we don’t have a repeat of this in future oil contracts. Since, in the RIL case, the original dispute is over the allegations that RIL has gold-plated its costs (and this lowers the profit-share of the government), the Directorate General of Hydrocarbon’s chief has suggested that the government move to revenue-share contracts in future as opposed to the current ones where operators like RIL are first allowed to recover their costs and then share the profits with the government. If the sharing is based on easy-to-monitor topline revenues, this means the government (or the CAG for that matter) won’t be worried about what an RIL spends on capex or opex—in other words, firms will be free to run their business without undue interference from the government. It’s not clear if the government will accept the DGH solution, but the Prime Minister’s Economic Advisory Council is also studying the matter and its report is expected in the next few weeks. Changing from the current model to a revenue-share one is simple maths. If a firm offers to share 30% of profits with the government while bidding and the firm has a 10% profit margin, under the new model, it will bid a 3% revenue-share. Critics argue firms will not bid since the profit-share model de-risks their investments as they get to recover costs first. This is only partly true since, in the event a firm doesn’t find oil, it loses all its investments and it is irrelevant whether it is on a profit-recovery or a plain revenue-share.

How important fixing the current system is, is best seen from the fact that the number of blocks being awarded is down quite dramatically, from around 50 in NELP 6 to roughly a fifth in NELP 9—within this, the share being given to private operators is down equally sharply, from 70% in NELP 5 to 45% in NELP 9. Not all of this, it is true, is due to just the problems of profit-share production contracts and problems of the sort that RIL is facing in its KG Basin wells. In the case of Cairn, where there is no dispute on capex costs, the company had to shut operations in 4 blocks when it found it couldn’t access them due to requisite permissions not forthcoming from the army or the navy. It took ONGC, a state-owned company, almost 3 years to get permission to drill fresh exploratory wells. Similarly, while each oil block is controlled by a management committee (this has government officials as members), the shortage of staff means MCs meet just 1-2 times a year as opposed to the minimum 4 meetings a year. While all of this needs to be fixed for investors to want to come back, the DGH solution will go a long way in bringing back confidence.


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