Reliance KG Basin Gas Pricing Controversy

Krishna Godavari (KG) Basin is spread across 50,000 sq km in the Krishna River and Godavari river basins near the coast of Andhra Pradesh.

The site Dhirubhai-6 (D6) is where Reliance Industries Limited(RIL)  discovered the biggest gas reserves in India. 

In government records, the 7,645 sq km block is known as KG-DWN-98/1.

The KG basin is considered to be the largest natural gas basin in India.

 

Government of India opened up hydrocarbon exploration and production (E&P) in the country to private and foreign players in 1991. 

Small and medium sized blocks were opened up in this round which was followed up by giving out bigger blocks in 1999 as per the New Exploration and Licensing Policy (NELP)

Through NELP, Reliance bagged the rights to explore the D6 block. 

 

All mining resources belong to the people of India, government monitors the exploration and production of these. In the case of oil and gas sector, government enters into contractual relationship with the private player through a Production Sharing Contract (PSC). The PSC lays out roles and responsibilities of all parties, specifies the detailed procedures to be followed at different stages of exploration, development and production. It also specifies the cost recovery and profit sharing in the contract. Directorate General of Hydrocarbon (DGH) monitors the PSC. A PSC was signed between the government of India (GOI) and undivided Reliance Industries and its minority partner Niko Resources (10 per cent stake) for exploration and production of oil and gas.

 

 

 

Before dwelling into Reliance KG Basin Issue, get some foundations clear

• New Exploration Licensing Policy(NELP)
• Conventional Mining & Royalty
• Production Sharing Contract (PSC)
• The Crux of Reliance KG Basin Controversy
• Timeline of Reliance KG Basin Controversy
• War of Words

An oil platform at Reliance Industries’ Krishna Godavari basin block.

 

 

New Exploration Licensing Policy (NELP)

Under this policy, government auctioned potential oil and gas field areas to private players such as Reliance, Cairn etc.
These companies would take all risk of discovering the oil/gas, drilling it out and sell to to make profit.

Conventional Mining and Royalty

• if you are involved in Iron-ore mining, the Indian Bureau of Mines ( IBM) will determine its present market value and you have to pay 10% royalty of that, to the Government.
• For example you digged 1 kilo (!) iron ore, its present market-value is Rs.100, you’ve to give Rs.10 as royalty
• It does not matter how much profit you make out of this, you’ve to pay 10% right from the day one of your mining activity.
• But for the gas-exploration, the system of royality is different, it is called:

Production Sharing Contract (PSC)

• But here in case of gas, first you’ve to do “Exploration”. It may happen that you drill in a potential area but still donot find any gas, and yet you’ve to purchase expensive drilling instruments, vehicles, hire engineers and monthly salary to staff etc.
• So there is a “gestation” period involved, before you actually discover the gas, start selling it, recover your costs and then see the profits.
• If there is a direct “royalty” sharing formulas like conventional iron-ore mining, then private players will not be interested in taking the risk in this gas exploration activity.
• Hence government came up with a concept called “Production Sharing Contract (PSC)”
• Under this scheme, the company will have to share royalty, according to the profit made.
• Initially company makes low profit, government gets extremely low share, later company discovers more and more gas fields, its production increases and costs go down, then it has to share more profit to the government.
• This is not the standard royalty model as seen in mining systems, where revenue is shared regardless of profitability. This PSC model allows the operator (RIL) to substantially recover his costs before the sharing of revenue.
• However, once these costs are recovered, the sharing with the government is often large.
• But As you can understand Private contractors (RIL) have virtually no incentive to minimise capital expenditure and a substantial incentive to increase capital expenditure (they’ll buy more and more vehicles, machines etc) to keep their operation-cost high, which would result in low/lowest share of profit for the government of India

The crux of Reliance KG Basin controversy

• It is alleged that Reliance used false accounting-methods to show huge-costs and operating expenses to keep the profit low so that they have to pay less money to the Government.
• CAG found this out after auditing, media started reporting, right now matter in PAC (Public accounts committee) of parliament.
• Also, RIL had to take permission of government before raising the sale price of Gas.
• So citing the heavy cost and low-profit, Reliance also increased the sale price of gas with Government’s permission.
• And then this (expensive) gas was sold ot fertiliser companies, power plants and thus snow-balling effect: price of fertilisers, electricity also increased = inflation.
• Director-general of hydrocarbons (DGH) was responsible for looking after this exploration-activity, how much gas is generated, what is the operating cost, is there any real loss etc. (but as the common sense suggests) he might have taken “suitcases” to turn a blind eye to all this.

Timeline of Reliance KG Basin Controversy

• 1999 Vajpayee Government introduced NELP (NEw exploration licensing policy)
• 2000 Reliance got the licence to explore gas in Krishna Godavari Basin
• 2002 Reliance Industries discovered huge reserves of natural gas – and some small reserves of crude oil – in a block called D6.
• 2007 CAG starts auditing
• 2011 CAG submits audit report and media starts reporting this controversy

War of Words

CAG

Oil Ministry and its technical arm, the Directorate General of Hydrocarbons, “did not pay adequate attention to protecting the government’s financial interest.

CAG said in a report that Reliance Industries Ltd (RIL) had breached some terms of a production-sharing contract (PSC) with the government for one of its more lucrative blocks, and blamed the petroleum ministry and one of its arms for their failure to provide adequate oversight of the process.

A CAG report released in 2011 (initiated in 2007 but delayed due to non-co-operation) on Performance Audit of Hydrocarbon PSCs castigated the oil ministry along with Reliance to retain its entire KG-D6 block in contravention of the PSC. As per the PSC, Reliance should have relinquished 25 per cent of the total area outside the discoveries in 2004 and 2005, but the entire area was declared as a discovery area (after initial objections) and the company was allowed to retain it. Without drilling adequate wells, Reliance kept on claiming that there was potential for petroleum. In CAG’s words this was done to confuse potential/prospectivity with actual discovery of hydrocarbons. The move allowed Reliance to keep the entire area to itself without following the norms laid under the PSC. 

 

In a recent report CAG has said that Reliance moved directly from discovery to commercial production, skipping the intermediate appraisal programme step required as under PSC. CAG asks, without an appraisal programme how did the government and DGH ascertain the amount of gas in the well?

CAG also said the current PSC template encouraged companies to front-load expenditure as it correspondingly reduced the share of the government in the profit

CAG has begun examining the books of Reliance Industries Ltd (RIL) to see whether there was any loss to the exchequer at the company’s D6 block in the Krishna-Godavari (KG) basin in 2008-09 and 2009-10. This follows its review of the block until the 2007-08 fiscal year, which didn’t contain references to the so-called goldplating as production, and therefore, revenue from the KG-DWN-98/3 block started in 2009. CAG, however, did point out in the earlier report that RIL had declined to share information that would have enabled the auditor to critically examine the justification of the company for cost escalations

Reliance Industry’s response

CAG has not found any false inflation of the cost or any dishonesty in developing the nation’s largest gas fields.
Corporate rivalry motivated a few people with vested interests to indulge in a vicious smear campaign against us
CAG neither had any expertise in hydrocarbon exploration

Ashok Chawla Committee on “Pricing of Natural Resources”

Production Sharing Contracts like the one Reliance Industries signed for the gas-rich KG-D6 are designed to benefit private players at the government’s expense.

Tapan Sen, a Rajya Sabha MP

• if your production is increasing, then your expenditure per unit must come down. But, here, production cost almost quadrupled.
• even if you take into account the trial and error method of digging here and there, even if you take into account your wasted efforts of searching gas and exploring,
• your development cost cannot triple or quadruple.
• Reliance can’t charge the country like this. It’s a clear case of gold-plating the cost.’
• It would incur the government a big loss because only after recovering the cost of production would the government start getting a return on the national asset.
• inflated cost of Reliance has national ramifications. If the cost of gas exploration is too high, then it will affect the prices.
• Reliance, the company that had ‘gold-plated’ the expenditure of exploration
• Then Reliance hiked the price from $2.34 mmBtu to $4.2 mmBtu. So, fertilisers companies, power plants and common consumers are paying more to Reliance. This collective loss by the nation and to 1.2 billion people should be calculated.
• Whatever the money Reliance has to make, they have made.
• The government should have quantified the loss to the exchequer. The government should have calculated when would Reliance recover its cost and when would the government start sharing profits.
• The same Reliance sold 30 per cent stake to British Petroleum for $7.2 billion. It was approved by the government.
• Director General of Hydrocarbons should be prosecuted. The production-sharing contract should be re-written and price level should be revised.
• It will make electricity cheaper, fertilisers cheaper and industries would benefit.
• I don’t blame Reliance. If I get the opportunity to steal, am I going to leave it? It is the duty of the government to see that nobody takes people for a ride.