What price profits?

Published : Aug 28, 2009 00:00 IST

Mukesh Ambani, Chairman, Reliance Industries Ltd.-RAJEEV BHATT

Mukesh Ambani, Chairman, Reliance Industries Ltd.-RAJEEV BHATT

IT was a dispute waiting to arise. When the government, under its New Exploration and Licensing Policy (NELP), decided a decade back to let the private sector exploit Indias limited oil and gas reserves through production sharing contracts (PSCs), the question of who owns those reserves was at least partially sidestepped. In principle, the fact that the private sector was to invest in extracting the oil and gas and the government was to get a share of the output amounted to an implicit recognition of the governments right over these reserves. However, there was no clear equation made between sharing production and sharing revenues. This allowed for the possibility that at least a part of the gas could be disposed of by private contractors to buyers they select at prices they choose so long as the government was paid a royalty computed on revenues earned at an arms-length or transparently discovered price approved by it.

Among the successful bidders in the different rounds of licensing under the NELP was Reliance Industries Limited (RIL), which, by 2004, held more than a quarter of the acreage leased for drilling. The companys success was not restricted to winning the right to drill and explore for oil and gas reserves. It had, by 2004, also made two large discoveries a 14-trillion-cubic-feet-field in the Krishna-Godavari (KG) basin (October 2002) and a large field in the Orissa block (June 2004). In the KG basin, gas was discovered in the very first well that Reliance drilled in the deepwater block D6.

In its PSC with the government, RIL was required to pay the government 10 per cent of the total revenue computed at a mutually agreed arms-length price, until Reliance recovers 1.5 times its investment. The governments take will rise to 16 per cent of the gas value when revenues amount to 1.5 times to two times RILs investment, to 28 per cent when revenues amount to two to 2.5 times the investment, and 85 per cent thereafter.

There are two issues that are unclear here. First, whether RIL is allowed to sell gas at a price lower than the valuation price approved by the government for computing its share in revenues at different levels of RILs earnings relative to its investments. Second, whether the computation of RILs revenues, aimed at ensuring the viability of its investments, would be based on the valuation price or the price at which it actually sells gas to different buyers.

Two years back, the government fixed the base price of the gas to be produced at KG-D6 at $4.20 per million British thermal units (mBtu). RIL had proposed a value of $4.33 per mBtu, which was examined by a committee of Secretaries. The committee recommended lowering of the price to take into account the appreciation of the rupee.

The Empowered Group of Ministers (EGoM), after considering various factors, felt that it was important to accept the pricing formula since it would not be in the countrys interest to renege on the contractual provisions under the PSCs [production sharing contracts] entered into in good faith under the New Exploration and Licensing Policy.

There were, however, two problems. First, RIL had arrived at the $4.33 per mBtu price on the basis of bids it invited from a shortlisted set of power and fertilizer companies, and therefore considered by some observers to be a trifle arbitrary and not all arms-length. Second, at the time of the split of the Reliance empire in 2005, which resulted in a de-merger of companies as part of an asset-sharing arrangement between brothers Mukesh and Anil Ambani, RIL had worked out a deal with sister company Reliance Natural Resources Limited (RNRL) to sell 35 per cent of the gas, or 28 million cubic metres a day (mcmd) of the projected peak output of 80 mcmd, at the KG-D6 field at a price of $2.34 per mBtu. This gas was to be used by the Anil Ambani-controlled RNRL in two power plant projects that it was to set up at Dadri in Uttar Pradesh and Patalganga in Maharashtra.

The price specified as part of the memorandum of understanding (MoU) between the brothers was not without any basis. 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 the price rose significantly, permitting RIL to propose a higher price in 2007, when it arrived at an agreement with the government to price gas from the KG-D6 field at $4.20 per mBtu.

Given the obvious benefits that RIL would derive from the higher price, it has since been demanding that this should be the price at which gas is sold to all its clients. And given the higher revenue share that the government would derive if this is the price at which revenue is computed, it too has been supporting RILs contention on the grounds that the $2.34 price is not an arms-length price. However, that is a contention that even public sector NTPC disputes.

It is indeed true that Mukesh Ambanis RIL is using the governments current position to renege on the agreement it entered into with Anil Ambanis RNRL. It is dressing up this opportunistic position with five arguments.

First, the price it had settled with NTPC is no more a market price and therefore an arms-length price. Besides, it had not converted the MoU with NTPC into a binding agreement. Second, an MoU between the brothers was not the equivalent of a contract between the two corporate entities RIL and RNRL.

Third, given the development costs it has incurred, selling the gas at the $2.34 per mBtu price would result in an annual loss of around $1.2 billion to the company. Fourth, if RNRL was sold the stipulated volume of gas at $2.34 per mBtu, the government would lose close to $15 billion over the next eight years.

Finally, since the power plants that are to use the gas from the KG-D6 field have been indefinitely delayed, RNRL would be trading in the gas for profit rather than using it for its own production activities.

Anil Ambanis plea is that the agreement between RIL and RNRL has nothing to do with the contract with the government. The former has to be honoured by providing RNRL 28 mcmd of gas at $2.34 per mBtu, while the latter 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. Implicit in this stand is a distinction between the sale price and the valuation price. This would mean that 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.

This is a position the government has on occasion erroneously entertained. Thus in an e-mailed interview given to Business Line (August 4, 2009), Anil Ambani has said: 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 arms 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 Governments take.

RNRLs strength derives from the fact that in its legal dispute with RIL over the issue, the Bombay High Court, while calling for a new arrangement between the two companies, has upheld RNRLs position on the gas price and supply issue. Two verdicts have favoured RNRL one from the Company Judge of the Bombay High Court in October 2007 and the other from the Division Bench of the same court in June 2009. Both have held the MoU between the brothers to be binding on the two companies as it was a part of the officially sanctioned scheme of de-merger.

With the government implicitly on its side, however, RIL is not willing to comply, taking the fight to the Supreme Court. There are four players here: RIL, RNRL, the government, and the courts. The court is merely reading and interpreting a set of contracts, in the light of the statements and actions of those who entered into them. The government, on the other hand, has more recently chosen to take the principled position that it is the people and the government as their representative who own the nations 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. Both RIL and RNRL, being profit-seeking entities, are attempting to maximise their gains from the right to mine the nations resources, a right that the government gave the entity they jointly managed before 2005.

Unfortunately, in the long-drawn out interaction between RIL and RNRL on this issue, the government has not held a consistent position. This ambivalence, attributed by some to manipulation by individual decision-makers, also reflects the changed relationship between the state and private capital in India ever since reform began in the early 1990s. In the first three to four decades after Independence, India was characterised by the fact that even though the state and private capital were clear that development must occur within a mixed economy framework, in which decision-making on private investment had an important role to play, the state sought to maintain some distance from private capital. It did circumscribe, through regulation, the area of operation of private industrialists. But within the circumscribed sphere it let industrialists pursue their own designs, taking care to make clear that it did not favour one business group or another.

The creeping reform of the 1980s and the accelerated liberalisation of the 1990s and after changed that relationship. The rise of the Reliance group is itself attributed to that change. Increasingly, the government has presented itself as being in partnership with private capital and eager to prove that it would not renege on the contractual relationships it forged with private industrialists. In the process it was inevitable that at different times and different circumstances one or the other business group had a special relationship with one or the other segment of the state.

Offering access to the nations mineral reserves in the name of finding resources to exploit them has been one way in which that partnership between the state and private capital has evolved. Unfortunately, mineral, oil and gas reserves are limited. So, providing access to some implies excluding others. This meant that the state had to favour some relative to others, even when it claimed it was not doing so. The problem is that actions that in the first instance are justified in terms of expediency are soon influenced by design.

This is true of many areas. But it has stood out in the present episode because of a peculiar turn in the relationship between two joint partners to the original contract. That turn has revealed how much is at stake in terms of private profit to be made from common public resources. It also reveals the new state-supported forms that primitive accumulation has taken in the neoliberal era. The spat between two brothers has forced the government to reveal its bias. Given its past actions, many would argue that the claim of being principled is just a ruse to defend the fact that expensive resources have been handed over to the private sector.

In fact, taking a new track, Anil Ambani has alleged that the government consciously or otherwise ignored the inflation of capital expenditure estimates by Reliance Industries, which increases its share of profits and leads to losses to the exchequer.

As the financial crisis has demonstrated, in the new world order the state works to rescue and strengthen private capital even while it declares that the rest of society, including the poor and the marginalised, have to learn to deal with a world of market-mediated relationships. But in the process the relationship between state and private capital has increasingly turned murky.

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