Stepping on the gas

The governments approval of Reliances pricing formula for gas from the Krishna-Godavari basin triggers a major controversy.

RIL Chairman Mukesh

THE ghost of Enron continues to stalk the energy sector. The governments approval of Reliance Industries Limiteds (RIL) pricing formula for its gas from finds in the Krishna-Godavari (K-G) deepwater blocks has all the essential elements of the Enron controversy. The terms on which the largest Indian private corporate entity and flagship of the Mukesh Ambani empire has been allowed to exploit and price its new gas find, which is enough to fuel a dozen Enron-size power plants, has raised the spectre of another Enron in the making. There have been allegations of a lack of transparency, fears of profit gouging, of a resort to cost padding in a cost-plus pricing regime and indignation over the governments inability to restrain a company that is emerging with monopoly power in the petroleum exploration and extraction business (see separate story).

There is no doubt that the terms offered to Reliance will set gas prices ablaze. More importantly, this will have a cascading effect on two critical segments of gas users electricity utilities and fertilizer companies which will have economy-wide repercussions. Higher electricity tariffs are only one aspect of the issue. There is a substantive food security angle as well. If fertilizer units become unviable, India is likely to become more dependent on imports. Higher fertilizer prices are the last thing that the heavily burdened Indian farmer needs.

In fact, the Union Ministry of Power and the Union Ministry of Fertilizers raised serious objections with the Union Ministry of Petroleum and Natural Gas, and in different for a, over the non-transparency of RILs pricing scheme.

Since June, when RIL announced its controversial scheme, Andhra Pradesh Chief Minister Y.S. Rajasekhara Reddy wrote several times to Prime Minister Manmohan Singh seeking a fair price for the gas from RILs D-6 block in the K-G basin. The State had planned several gas-based power projects and these were in danger of becoming unviable if RIL had its way.

In his presentations before the various committees, the Chief Minister pointed out that the real demand for gas depended on the price at which it was sold. He also pointed out that if the gas was priced too high, gas-based power projects could become unviable vis--vis those based on other fuels such as coal. In particular, he asserted that the price of gas from the K-G fields should be positively lower than the price that RIL had committed to the National Thermal Power Corporation (NTPC), the biggest Indian power utility company, in 2003.

The outrage within wings of the government forced it to establish a Committee of Secretaries (CoS) to examine the issue. The committee did a tightrope walk without actually resolving the issue. The matter was discussed by the Prime Ministers Economic Advisory Council (EAC) before it was handed over to a specially constituted Empowered Group of Ministers (EGoM), headed by External Affairs Minister Pranab Mukherjee, for a final ruling. On September 12, the EGoM gave its stamp of approval for RILs pricing scheme with minor modifications that appear, at best, cosmetic.

At the crux of the controversy is Reliances scheme to fix a well-head price of $4.59 per million metric British thermal units (mmbtu), which it later scaled down to $4.33 per mmbtu (see box). This would translate into a delivered price of $4.76 to $5.98 per mmbtu (excluding taxes) for consumers.

RILs critics say this price is unconscionably high. They point out that RIL had quoted a delivered price of $2.97 per mmbtu in 2003 when it won the bid for supplying gas from the D-6 block in the K-G basin to the NTPC in an international competitive bidding process. But it refused to sign the contract, and the NTPC went to the Bombay High Court in 2005. RILs demand that consumers pay almost twice as much as the last major gas contract has come as a shock.

On June 20, 2007, the Bombay High Court restrained RIL from creating any third party interest in its gas from the D-6 block. It ruled that NTPC had the first right to 12 mscmd (million standard cubic metres a day) of the gas. Reliance Natural Resources Ltd. (RNRL), the company belonging Mukesh Ambanis feuding brother Anil Ambani, would have the next right, to the extent of 28 mscmd. Since RIL had rights to 25 mscmd for its own use and RNRL was entitled to further supplies amounting to 16 mscmd, this meant exhausting the maximum possible capacity of 80 mscmd from the D-6 block.

When the Ambani brothers fell out, a demerger agreement was worked out (Frontline, January 1 and July 2, 2005). According to the deal, RIL was to supply 28 mscmd of gas for RNRLs power plant at Dadri in Uttar Pradesh. The gas price was to be benchmarked to the price RIL had quoted for supply to the NTPC in 2003.

Steel pipes being

Soon after Reliance announced the price for its D-6 gas, the chairman and managing director of the NTPC, T. Sankaralingam, sought the governments intervention. In particular, he attacked RIL for the manner in which it discovered the price for its gas. RIL apparently sought bids from select bidders when casting a wider net for prospective buyers may have yielded a more representative price for the gas. The NTPC and other critics of RIL have pointed out that the companys search for buyers was restricted to power generation and fertilizer companies which had stranded assets. In short, RIL, they alleged, sought bids only from those who were desperate to get gas supplies quickly.

The NTPC also sought an independent prudence check into the capital expenditure claimed by RIL. In 2006, RIL claimed that the field development plan for the D-6 block stood at $8.84 billion; earlier in the year the costs were estimated at $5.2 billion, while it was only $2.47 billion in 2004.

Sankaralingam asked the government to approve these cost increases only if they reflected benefits accruing from economies of scale. He was referring to the fact that while capital expenditure increased fourfold, production was projected to increase only twofold.

The cost escalation is significant given the concept of profit petroleum that the government has adopted as part of the New Exploration and Licensing Policy (NELP), which came into effect in 1999-2000. In order to attract bidders to prospect for oil, the government allowed successful bidders to price gas outside the administered pricing mechanism (APM), which is basically a cost-plus approach in a situation where the entire oil and gas sector was in the public sector. However, it is not as if the new approach is anything close to a market-driven mechanism.

At a gas

The concept of profit petroleum was critical because the government, as the licensor, had a right to a share of the contract, in cash or in kind, from the fields. However, profits can only be arrived at after costs are deducted. This mechanism is obviously open to abuse by a winning bidder in the absence of stringent checks and balances. The system, in the absence of such checks, provides incentives to a private operator to cheat, by overstating costs to show lower profits, which the operator has to share with the government. The EAC, for instance, observed, M/s RIL has twice revised the capex without a proportionate increase in revenues. The escalation of capex without a proportionate increase in earnings is reminiscent of the Enron deal, in which there was considerable cost padding in a regime that guaranteed a minimum rate of return on investment (Frontline, March 25, 1995).

Tapan Sen, a Communist Party of India (Marxist) Member of Parliament and a member of the Parliamentary Standing Committee on Petroleum and Natural Gas, wrote several times to Minister for Petroleum and Natural Gas Murli Deora and the Prime Minister that RILs revised capex reflected gold-plating. He warned that the leeway given to RIL might embolden the company to demand parity with imported gas from Iran if and when it became available. That would enable the company to charge $6-7 per mmbtu.

He alleged that the Directorate of Hydrocarbons (DGH) acted with extreme haste in clearing the revised capex. He cited the provisions of the production sharing contract (PSC) to back his claim that the government could invoke the APM for setting prices from the NELP blocks. He said it was unfathomable why the government did not invoke these provisions to back the just claim of a public sector company like NTPC instead of forcing it to seek redress from the courts.

Both the CoS and the EAC had found serious problems with RILs pricing method. The CoS observed that the government had to have a gas utilisation policy and a gas pricing policy in order to exercise its right to approve or disapprove the pricing formula of a gas field operator. It also observed that this ought to enable balancing the interests of consumers and producers. It categorically asserted that the RIL formula may be taken up for approval after a policy (gas pricing) is put in place. Prima facie, the formula appears to suffer from several infirmities in respect of the formula employed and the bidding process, it said.

The EAC pointed out that since RIL did not publicise the request for bids and since it did not indicate upfront how much of gas was on offer, there does appear to be some avoidable lack of transparency from the viewpoint of natural justice. Although it was broadly satisfied with RILs pricing formula, the EAC asked the government to take immediate action to invite fresh bids in a transparent and well-publicised manner so as to discover the true arms length competitive price for gas. It also recommended that longer term contracts be executed, unlike the three-year contracts in the RIL scheme.

The EGoM reduced the price of RILs K-G gas to $4.20 per mmbtu but approved the pricing scheme. Among others, the EGoM included Murli Deora, Finance Minister P. Chidambaram, Minister for Power Sushil Kumar Shinde and Planning Commission Deputy Chairman Montek Singh Ahluwalia.

Media reports about the earlier round of discussion within the EGoM indicated that bureaucrats in the Petroleum Ministry were not inclined to interfere with Reliances right to set prices for gas from its fields. That, they appeared to argue, would be tantamount to a deviation from the sovereign commitment made by the government as part of its NELP policy regime. There was no reference to the deviations that the company had made from the PSC it had signed with the government under the same policy regime. The Finance Ministry, too, appeared to be more interested in increasing the take from profit petroleum, instead of being bothered about its consequences for the energy sector. The Left parties, which have been consistent critics of the governments liberal policy in the petroleum sector, reacted immediately (Frontline, July 16, 2005). The CPI(M) alleged that the EGoMs approval amounted to an approval for linking the K-G gas price to international oil prices instead of basing them on the actual cost of production (inclusive of a reasonable profit margin) within the country. There is absolutely no justification for such linkage, which is being made only to find a route to artificially inflate the price for windfall gain of the private company, it said in a statement issued after the EGoM approved RILs scheme. The party demanded that the EGoMs recommendation be rejected in public interest.

On October 1, CPI (M) general secretary Prakash Karat said in Kolkata that the United Progressive Alliance government would be held responsible for the shameful, pro-big business decision which would affect the interests of farmers and common people.

It is evident that the merry-go-round of committees chose to highlight specific aspects of RILs pricing scheme without considering the serious anomalies in it. The EAC came nearest to a fair solution by asking for a fresh invitation for bids, but its perspective was blinded by its extraordinary faith in the markets. Although the CoS acted as a postbox for all sides to present their views, the very nature of the committee resulted in its doing a tightrope walk. However, it is evident that the EGoM had made up its mind. It seems to have been more worried about how investors in general and Reliance in particular would react to any effort to discipline errant behaviour by winning bidders.

In fact, RIL and even the government-owned Oil and Natural Gas Corporation (ONGC) have been asking for a market-driven pricing mechanism. However, given the fact that the government does not have specific policies for utilisation, pricing or even bidding, what is available today is hardly a free market in natural gas. Reliance and the foreign companies interested in the Indian market for natural gas are perfectly aware of this. What they are demanding is the freedom to do what they please, all in the name of a free market. In effect, the freedom to indulge in extortionate pricing is being equated with the notion of free markets.