Rs 31k-cr gift to RIL?

Even before the first cubic metre of natural gas has been produced from the Krishna-Godavari basin, questions are being raised about why the Mukesh Ambani-headed Reliance Industries hiked the capital expenditure to mine 80 mmscmd of natural gas from Rs 20,000 crore to Rs 36,000 crore without a corresponding increase in the production of gas. Also, after initially offering to sell gas to the NTPC at a competitive price of US$ 2.34 mmbtu, RIL hiked the price to more than US$5 mmbtu.The Cabinet Secretary, the Prime Minister's Economic Advisory Council, the Union ministers for power and fertilisers, and the chief minister of Andhra Pradesh are all opposed to Mukesh's machinations. Quoting policy in his support is none other than Petroleum Minister Murli Deora. The UPA's man for all seasons, Pranab Mukherjee, is now heading the EGoM to resolve the issue.

By Shahid Faridi

The issue of production and sale of natural gas from the world’s largest gas reserve discovered by the Mukesh Ambani-headed Reliance Industries Limited (RIL) in 2002 in the Krishna-Godavari basin off the east coast of India in the Bay of Bengal has returned to the political centrestage.
Members of Parliament, cutting across party lines, have demanded a Centra Bureau of Investigation (CBI) inquiry into the pricing of gas produced from this reserve and the capital expenditure approved by the government for the development of the reserves.

The Deepwater Block KG-DWN-98/3 in the Krishna-Godavari Basin (KG-D6) off the east coast of India in the Bay of Bengal, covers an area of 7,645 sq km. Its northwestern boundary is 40-60 km southeast of Kakinada in Andhra Pradesh. The water depth in the block ranges down to 2,700 metres.

Based on the initial reserve estimates of the block, RIL prepared an Initial Development Plan (IDP) to develop two discoveries—Dhirubhai 1 and Dhirubhai 3—in the block. The Initial Development Plan envisaged production plateau of 40 mega million standard cubic metres (mmscmd) every day.
The IDP, with a capital expenditure of Rs 10,100 crore, was submitted to the Directorate-General of Hydrocarbons (DGH) in May 2004, and was approved in November 2004. This was during the time when Mani Shankar Aiyar was the Union minister for petroleum and natural gas.

After the change of guard at the ministry of petroleum and natural gas brought Murli Deora to the helm in 2006, RIL submitted a revised development plan in November that year under which the production rate was sought to be enhanced from 40 to 80 mmscmd. The capital expenditure required for the production enhancement was first pegged at Rs 20,000 crore and then revised again to Rs 36,000 crore. The DGH took just 42 days to approve the revised development plan.
While RIL’s capital expenditure increased nearly four-fold from Rs 10,100 crore to Rs 36,000 crore, the production merely doubled from 40 to 80 mmscmd. This invited allegations of what the corporate world calls ‘gold-plating of costs’—the upscaling of costs by, so to speak, covering junk with bling.

The Production Sharing Contract, through which the government allowed RIL to explore and produce the scarce national resource of natural gas, permits RIL to recover its capital cost
prior to sharing profits with the government. As allegations of ‘gold-plating’ started flying thick and fast, the issue was taken out of the hands of the petroleum and natural gas ministry, and the Prime Minister’s Economic Advisory Council was asked to look into it.

This is what the Prime Minister’s Economic Advisory Council (EAC) said after examining the issue: “…M/s RIL has twice revised the capex [capital expenditure] without a proportionate increase in projected revenues. Higher capex and/or lower rates of extraction of gas would also reduce the pre- tax investment multiple on the basis of which the profit petroleum is shared between government and RIL.”

The prime minister’s EAC recommended that the ministry of petroleum and natural gas “take appropriate action to put in place suitable mechanisms for proper scrutiny of capex, developmental expenditure and production profiles to ensure that gains to government are maximized under profit-sharing arrangements.”

The Cabinet secretary, K M Chandrasekhar, who was asked to go into the controversy of gold-
plating separately, said in his report: “PSC (Production Sharing Contract) provides a mechanism to control capex, development plan, approval of budget estimates, monitoring of cost recovery estimates, computing investment multiples and approval of additional investment proposals. Presently, there is no independent verification of the capital cost by any agency other than the Management Committee wherein the contractor (which in this case is RIL) sits on the approval of its own proposal by virtue of being a member of the management Committee.

“Capital expenditure is critical to determine the cost of gas and government share of profit petroleum. The government nominees on the Management Committee who are nominated by the ministry of petroleum and natural gas from the officials of the Directorate general of Hydrocarbons have a key role in cost control.”

The Cabinet Secretary’s report further said that the “Chief Advisor (Costs), Ministry of Finance, after reviewing the capex plan of KG-DWN-98/3 Block has opined that the DGH scrutiny is more focused on technical assessment and broad cost estimates in terms of viability of the projects rather than the profit share of the government…”

Under attack from all around, the DGH tried to get Calgary-based consultants DeGolyer & Mac Naughton to evaluate RIL’s nearly four-fold increase in capital expenditure. The DGH sought this appointment completely ignoring the fact that DeGolyer & MacNaughton had worked as consultants for RIL in the initial development plan of KG Basin.

Sure enough, the DGH move led to a furore and the government had to spike it. The DGH is now on a lookout for another internationally reputed consultant to examine the gold-plating charges against RIL.An investigation into allegations of ‘gold-plating’ is essential as capital expenditure in exploration and production of oil and gas blocks is the most important factor affecting the government’s profit share.

Under the New Exploration and Licensing Policy, the government has completed six rounds of
awarding blocks and signed 162 Production Sharing Contracts with various parties who are
termed ‘Contractors’. One of the most lucrative benefits available under Indian PSCs is complete recovery of the entire capital cost and operating cost incurred in exploration and development of blocks before sharing profits with the government.

The Union government stands to lose thousands of crores of rupees due to gold-plating of capital
expenditure by contractors. Highly placed government sources involved in resolving the issue told Realpolitik that RIL’s capital expenditure hike from Rs 20,000 crore to Rs 36,000 crore would result in additional profit of about Rs 16,500 crore to RIL. In addition to this, RIL will recover an additional capital cost to the tune of nearly Rs 15,000 crore. The recovery of additional cost and the increase in profit will together generate about Rs 31,000 crore for RIL with the new capital expenditure of Rs 36,000 crore approved by the government.

RIL attributes increase in capital cost mainly to increase in rig cost. However, sources say that the examination of RIL’s capital expenditure reveals that the cost of rigs as a percentage of total capital cost has in fact come down from 38 per cent to 27 per cent. This means that other costs went up substantially. The project management cost, which is attributable to RIL’s internal costs, has increased by 350 per cent, the cost of pipelines has gone up by 750 per cent, and a new cost of Rs 275 crore is added for the purchase of helicopters, etc.

Andhra Pradesh Chief Minister Y S Rajasekhara Reddy, who has written a series of letters to Prime Minister Manmohan Singh questioning RIL’s pricing of gas and the hike in its capital expenditure, demanded that the government monitor the investments by the contractors and have it scrutinised by independent and autonomous authority “so that the costs are not unduly inflated, as is presently alleged in case of RIL, which has hiked the cost of investment by Rs 16,000 crore overnight, even while the original capex of Rs 20,000 crores is itself questioned as being very high”.
In one of the letters dated June 29, 2007, the Andhra Pradesh chief minister said: “Naturally, higher the capex, higher is the profit to the contractors (RIL) and in the end the poor people of the country will be the casualty. A strong mechanism for verification of capex has to be put in place so as to ensure that the nation is not taken for a ride. I may be permitted to draw your kind attention to what happened in Enron project, which got away with a 100 per cent hike in its capex
and the country is now facing its consequences.”

There is clearly a case for having an effective cost control mechanism in the exploration and production sector on the lines of mechanisms in other sectors such as power and telecom.
Besides the allegedly inflated capital expenditure, RIL’s pricing of gas from the KG basin has also kicked up a controversy. Not only is the price at which RIL plans to sell the gas is said to be very high but also relies on an allegedly unfair price computation formula. However, Petroleum and Natural Gas Minister Murli Deora has expressed his inability to do anything to bring down the price.

He argues that as per the Production Sharing Contract, the government’s role in the pricing issue is limited to ensuring that the price proposed by the contractor conformed to an arms-length
pricing. He emphasises that “the government cannot impose differential pricing if the market can bear higher price.”

The war over pricing of RIL’s KG basin gas started on June 17, 2005. While the trusted lieutenants of the warring Ambani brothers, Mukesh and Anil, were working in Mumbai on the nuts and bolts of the division of Dhirubhai Ambani’s corporate empire, a Delhi-based Reliance Industries Ltd functionary, R P Sharma, shot off a letter to NTPC chairperson and managing director C P Jain. This was the letter that ignited the controversy over gas pricing in India. This controversy now engulfs the prime minister, his economic advisory council, the Cabinet Secretary, Cabinet ministers for power and fertilisers, the chief minister of Andhra Pradesh, and the Mumbai High Court.

Through his letter dated June 17, 2005 to the NTPC CMD, Sharma conveyed his company RIL’s
inability to honour the deal to supply 132 Tbtu of natural gas (12 mmscmd) for NTPC’s Kawas and Gandhar plants.

Sharma said in that letter: “As a result of the risk review carried out, and indications from lenders, RIL has concluded that the risk profile in the NTPC gas supply purchase agreement (as currently proposed) does not meet RIL’s requirements and would set an unfavourable precedent for RIL in future.”

Sharma’s missive to NTPC raised the hackles of younger brother Anil Ambani because he was to receive gas supply for his power plants from RIL at the same price at which RIL was supplying it to NTPC. As part of the demerger agreement, Anil Ambani was to get the power business of the Reliance group. And Mukesh, who was to keep the group’s petrochemical business, was to ensure supply of gas to run Anil’s power plants.

With the benefit of hindsight, experts appear unanimous that the Mukesh-run RIL’s refusal to supply gas to NTPC at an extremely competitive price of US$ 2.34/mmbtu was actually meant to prepare the ground to refuse gas to the power plants owned by Anil Ambani.

The Mukesh-Anil settlement reached on June 18, 2005 after a prolonged battle, clearly said that NTPC, with whom RIL has entered into draft supply agreement for the supply of 12 mmscmd gas, will have the first claim on RIL’s gas. But in the event that the NTPC contract does not materialise or is cancelled, the entitlement of NTPC to the said extent shall go to the Anil Ambani group. This supply will be in addition to Anil Ambani group’s own entitlement of 28 mmscmd.

It was also agreed and clearly spelt out in the in the demerger agreement that RIL will supply gas to Anil Ambani group at price no greater than the NTPC price which in this case was US$ 2.34/mmbtu. Experts now say that Mukesh Ambani and RIL, with prior knowledge of the contents of the family settlement decided to revoke the NTPC contract, which, in RIL functionary R P Sharma’s June 17, 2005 letter to NTPC, was termed as a contract that “would set an unfavourable precedent for RIL in future.”

Expectedly, both NTPC and Anil Ambani took RIL to court for “reneging” on gas supply deal on agreed price. Both NTPC and the Anil Ambani group are extremely cut up with the petroleum and natural gas ministry which has claimed that it has no role in price fixing. Petroleum and natural gas ministry’s stand on the issue became clear long back on January 9, 2006. In response to Power Secretary R V Shahi’s letters dated December 5 and 7, 2005 seeking resolution of the RIL-NTPC gas pricing and supply row, petroleum secretary M S Srinivasan wrote back on January 9, 2006 saying “with respect to the issue of this ministry intervening to impress upon RIL in expediting finalisation of the Gas Supply Purchase Agreement (GSPA), you will appreciate that the provisions of the Production Sharing Contract don’t normally provide for the government to determine the outcome of commercial transactions between a buyer and seller. The PSC provides that the contractor has freedom to sell the gas and the basis/formula for gas pricing requires government approval, prior to the commencement of gas production; RIL is yet to apply for approval which will be considered under the provision of the PSC as and when the company seeks such approval.”
But Union ministers for power, fertiliser, the Cabinet Secretary and the Prime Minister’s Economic Advisory council did not agree with this contention. After examining the PSC, they have opined that the government does have the right to intervene and bring the price to reasonable level in order to protect the crucial sectors of power and fertiliser who are the biggest consumers of gas.

While the case is pending in Mumbai High Court, RIL has, in the meanwhile, obtained bids from other consumers as per which it will sell gas for a price between US$ 4.5 to US$ 5/mmbtu. Though some individual power producers accepted RIL’s pricing formula as they desperately needed gas, the power and fertiliser sectors as a whole revolted in protest against Reliance Industries’ gas pricing. Union ministers for power and fertiliser first wrote to the petroleum
minister seeking his intervention.

But when they did not find a favourable response from him, they approached the prime minister.
The prime minister has appointed an empowered group of ministers under external affairs minister Pranab Mukherjee to resolve the issue.

The EGoM was scheduled to meet on August 27, 2007. Abani Roy, Member of Parliament belonging to the Revolutionary Socialist Party, shot off a letter to EGoM head Pranab Mukherjee.
In his letter, Roy drew Mukherjee's attention to a report submitted by the petroleum ministry to the EGoM in which it had rejected the recommendations of the prime minister's EAC and the Cabinet Secretary.

Roy also asked Mukherjee to note the striking similarity between the contents of the report of the
petroleum ministry and a presentation made by RIL some time back on the same issue.
The RSP leader alleges that the similarity "compromises the integrity of the administrative ministry's comments on this critical issue. He said that the petroleum ministry's report "is a straight carbon copy of the Reliance Industries' presentation, thereby prompting on to ask the question—has this report been written by the petroleum ministry of Reliance Industries?"