Resources & rights

Published : Jun 04, 2010 00:00 IST

ANIL AND MUKESH Ambani. According to the 2005 demerger agreement, RIL, led by Mukesh, was to supply natural gas to Anil's RNRL power projects at Dadri in Uttar Pradesh and Patalganga in Maharashtra. But a prolonged squabble ensued over the price at which the gas would be supplied.-RAJESH NIRGUDE/AP

ANIL AND MUKESH Ambani. According to the 2005 demerger agreement, RIL, led by Mukesh, was to supply natural gas to Anil's RNRL power projects at Dadri in Uttar Pradesh and Patalganga in Maharashtra. But a prolonged squabble ensued over the price at which the gas would be supplied.-RAJESH NIRGUDE/AP

IN a judgment that stood by principle, the Supreme Court brought to an end the squabble between the two Ambani brothers, Mukesh and Anil, over gas pricing, which was triggered by the split.

The point of principle was that natural resources such as natural gas belong to the people and, therefore, their representative, the Government of India, which holds those resources on trust, has the right to decide the quantum of extraction and the pricing and supply of natural gas. According to the Supreme Court, a production-sharing agreement under which a private investor is allowed to extract the gas in return for a share of the proceeds from the sale of gas does not violate this right of the people and the government.

In fact, the court has noted that the best scenario would be one where the extraction of natural resources is restricted to public sector companies. Even if the government brings in the private sector (erroneous, some would say) on the grounds that it does not have the financial resources to invest adequately in extraction, this principle would hold.

This judgment came at the end of a prolonged dispute between the Ambani brothers over the price at which a pre-specified quantum of natural gas would be supplied by the Mukesh Ambani-led Reliance Industries Limited (RIL) to the Anil Ambani group company Reliance Natural Resources Limited (RNRL).

According to the demerger agreement between the two brothers signed in 2005, when they split the Reliance behemoth between themselves, the RIL had promised to supply RNRL 35 per cent of the production from the relevant fields or 28 million cubic metres of gas a day, at a price of $2.34 per million British thermal units (mBtu).

This gas was to be used by RNRL in two power plant projects that it was to set up at Dadri in Uttar Pradesh and Patalganga in Maharashtra.

RIL's arguments

Subsequent to this, as part of the valuation associated with the revenue-sharing arrangement between the government and Reliance Industries, the government after due process fixed the base price of the gas to be produced at KG-D6 gas field at $4.20 per mBtu. It was after this that RIL used the government's valuation to renege on the agreement it had entered into with RNRL.

Besides insisting that a memorandum of understanding (MoU) between the brothers was not equivalent to a contract between RIL and RNRL, it justified the change of stand with a varied set of arguments. It claimed that if it sold RNRL gas at $2.34 per mBtu it would suffer an annual loss of around $1.2 million, given the development costs it had incurred. It argued that this price would imply large losses for the government as well, since revenues would be shared on the basis of the actual price and not the government's valuation. It estimated the government's losses at close to $15 billion over eight years.

Further, it insisted that it was the government which had the right to price the gas, of course, on the basis of appropriate cost calculations. And finally, it pointed to the fact that the power plants for which the gas from the KG-D6 field was earmarked had been indefinitely delayed, so that RNRL would be exploiting the special price to sell the gas for profit rather than use it for its own operations.

RIL's production-sharing contract with the government required that it pay the latter 10 per cent of the total revenue computed at a mutually agreed arm's-length price, until Reliance recovers 1.5 times its investment. The government's take would rise to 16 per cent of that gas value when revenues amount to 1.5 times to two times RIL's investment, and to 28 per cent when revenues amount to two to 2.5 times the investment and 85 per cent thereafter.

What was left unclear was whether RIL was allowed to sell gas to RNRL or anyone else at a price lower than the valuation price approved by the government for computing its share in revenues at different levels of RIL's earnings relative to its investments.

RNRL's stand

RNRL's plea was that the agreement between RIL and RNRL had nothing to do with the contract with the government. The agreement has to be honoured by providing RNRL 28 mcmd of gas at $2.34 per mBtu, while the contract must be honoured by providing the specified revenue share to the government by valuing all output sold from the KG field at $4.20 per mBtu.

By taking this stand, RNRL was implicitly arguing that it is possible to distinguish between the sale price and the valuation price. According to this view, a contractor in a production-sharing agreement has the right to dispose of the output to whomsoever he chooses at whatever price, so long as the royalty on sales is paid by computing revenues at the valuation price.

According to Anil Ambani, this was also originally the government's position.

He advanced this view in an e-mail interview given to Business Line (August 4, 2009): On August 30, 2007, the government told Parliament in a written answer, and I quote: As per the PSC signed by the government under the New Exploration Licensing Policy (NELP), the operators have the freedom to market the gas in the domestic market on an arm's-length basis. The government does not fix the price of gas. The role of the government is to approve the valuation of gas for determining government's take.'

In sum, RNRL's contention was that RIL should stick by its commitment to sell a pre-specified quantum at a pre-specified price independent of the pricing formula adopted for revenue sharing with the government, and should forego the difference in revenues, if any, which results from this. Moreover, it held that the $2.34 per mBtu price was an arms-length price, since it was the price at which RIL had won a bid to supply 12 mcmd of gas to NTPC in 2004.

That was the then prevailing market price. But thereafter global prices rose significantly, and RIL used that as a benchmark to propose a higher price of $4.33 per mBtu to the government in 2007. On the basis of that, and its own assessment, the government chose to price gas from the KG-D6 field at $4.20 per mBtu. Finally, RNRL has argued that the price of $4.33 per mBtu, which the RIL initially proposed to the government, was not an arm's-length price but an arbitrary one derived from a suspect process involving bids invited from a shortlisted set of power and fertilizer companies.

RNRL's position was initially backed by the courts. In the long-drawn legal dispute between the two companies over the issue, the Bombay High Court, while calling for a new arrangement between RNRL and RIL, had upheld RNRL's position on the gas price and supply issue.

Two verdicts had favoured RNRL one from the Company Judge of the Bombay High Court in October 2007 and another from the Division Bench of the same court in June 2009. Both had held that the MoU between the brothers was binding on the two companies as it was a part of the scheme of demerger that was officially sanctioned.

Apex court's stand

However, when RIL decided to take the case to the Supreme Court, the government as a party to the case chose to change its stand and take the principled position that it is the people, and the government as their representative, who own the nation's mineral resources.

Hence, a private contractor in a production-sharing agreement under which the right to mine a specific leased area has been provided in return for payment of a royalty to the government does not have the right to decide the allocation and pricing of output.

Given this background, the Supreme Court judgment is indeed a welcome departure from the legal trail left by the case thus far. A Bench comprising three judges has given sanction for the view that the people own natural resources, and private players, involved in extraction under production-sharing agreements, are not owners and do not have the right to determine the pricing and allocation of output.

Having done this, the Supreme Court seems to have opened a Pandora's box by asking the two brothers to renegotiate the terms of the Gas Sales and Master Agreement (GSMA) between them. The court directed RIL to initiate renegotiation with RNRL within six weeks of the date of the order and work out the terms of the GSMA, so that the interests of shareholders are safeguarded.

They have also been set a deadline of eight weeks thereafter to finalise the renegotiated terms and submit it before the Company Judge of the Bombay High Court. But what is to be renegotiated is by no means clear. If the decision with regard to pricing and quantum of allocation is a government responsibility, what would be the terms of an agreement between the two companies?

One possibility could be that the two companies agree to approach the government to allow RIL to allocate 28 mcmd of gas to RNRL at $4.20 per mBtu. But how this would benefit RNRL's shareholders is again unclear.

To make matters worse, the Supreme Court Bench was divided on the question as to whether the original MoU between the brothers should form the basis for the negotiations on a new agreement. Two of the judges, including the Chief Justice, held that RIL and RNRL should take into account the MoU, since it is a commitment which reflects the good interests of both the parties. Justice B. Sudershan Reddy differed from this view and held that the MoU should not be the basis for further negotiations between the two companies.

This division introduces another element of uncertainty. The original MoU was rejected by RIL and not RNRL. But it is RIL that has won the case. Does this mean that RIL had read the MoU wrong? These are questions that are likely to remain despite the fact that the Supreme Court's judgment has cleared the air on an important point of principle.

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