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BW Businessworld

The Pressure Builds Up

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The war of words between Reliance Industries (RIL) and the government is escalating. The oil ministry, on 3 May, slapped a penalty of $1 billion for not meeting the natural gas production targets. Of the $5.76 billion that Reliance invested in developing the deep-sea KG-D6 fields, the ministry has disallowed $1 billion from the ultimate cost recovery (which is 2.5 times the total investment) till the company scales up production to the promised level.

RIL has hit back, saying there was no provision in the production-sharing contract (PSC) to disallow any part of its investment. "The production fall and delay in drilling the promised number of wells are because of geological complexities," say RIL officials.

A bit of history places the battle in context. On 23 November 2011, RIL issued an arbitration notice under the provisions of the PSC on "wrongful denial of cost recovery on the ground of lower production or underutilisation of facilities". However, no arbitrator was appointed. So RIL filed a petition in the Supreme Court on 18 April 2012 under Section 11 of the Arbitration Act, pleading for the appointment of an arbitrator (by the government).

Under the PSC, RIL is entitled to deduct the cost incurred in developing the gas block from the revenue while calculating the share of profit to be paid to the government. The firm has already recovered $5.28 billion towards cost, but the government's argument is that the cost recovery that RIL is entitled to should be proportionate to the actual level of production.

The current output of 34 million metric standard cubic metres per day (mmscmd) from KG-D6 basin is way below the target of 80 mmscmd for this time of the year. Output from the fields is expected to fall further. On 6 May, petroleum minister Jaipal Reddy told Parliament that the gas output is projected to decline to 20 mmscmd by March 2015; that's below the 34 mmscmd of gas that RIL will produce in 2012-13, and well below the peak of 60 mmscmd achieved in 2010.

After RIL found huge gas reserves on the east coast in 2002, it changed the initial plan for producing 40 mmscmd of gas at a cost of $2.5 billion to 80 mmscmd at a capex of $5.2 billion. RIL's executive director P.M.S. Prasad told Businessworld that it added $3.6 billion in Phase II, taking its investments to $8.8 billion over 9-10 years, which was disputed by the DGH.

This might put RIL on a weak wicket while going for arbitration. When RIL's high investment was questioned by the Comptroller and Auditor General of India, the pacifying factor was the promised output (80 mmscmd). Now with  production below the initial target of 40 mmscmd, RIL's interest in doubling the target might invite criticism, say analysts.

34 mmscmd is the current production at D6, way below the
target of 80 mmscmd at this time of the year
(BW Pic by Sanjay sakaria)

At the same time, the government cannot ignore the risk factors involved in the exploration business. "Natural calamities can alter the geology of the entire reservoir. The contractor is taking a financial risk while going for such huge investments," says an RIL official.

RIL chairman Mukesh Ambani, in a letter to shareholders that was published in the company's annual report, said that production from D6 was impacted due to "unforeseen reservoir complexities". RIL sources say the KG basin was a virgin area when production started in 2009. So the geological issues were unknown. "That is why we roped in British energy giant BP." BP paid $7.2 billion to acquire a 30 per cent stake in 21 of RIL's oil and gas fields.

RIL said it has cut the estimates of its proven gas reserves by 0.43 trillion cubic ft at the beginning of FY2012. RIL's reduced estimates reflect the firm's reassessment of its portfolio and the relinquishment of five blocks during FY2012.

The government has rubbished claims that RIL has not violated the PSC with regard to output; it has warned RIL of further action if it fails to submit detailed plans with timelines and steps being taken to remedy the default.

Some of the language of the PSC seems ambivalent; Clause 151 says the contractor can recover costs out of a percentage of total value of petroleum produced and saved from the contract area in the year. Separately, Clause 15.11 says: "…Such provisional determination of cost petroleum shall be made every quarter on an accumulative basis. Within 60 days of the end of each year, a final calculation of the contractor's entitlement to cost petroleum, based on actual production quantities costs and prices for the entire year shall be undertaken and any necessary adjustments to the cost petroleum entitlement shall be agreed upon between the govern- ment and the contractor within 30 days and made within 30 days thereafter."

Therein lies the core of the dispute: how clear the PSC is in regard to linking production targets to cost recovery. RIL wants to arbitrate the Minimum Work Programme stipulated in the PSC for four blocks relinquished by the firm. "The firm has been advised that the government cannot deny cost recovery for any element of contract costs on the ground that the levels of production mentioned in the develop- ment plan were not being achieved. The company is following the required procedure for progressing the arbitrations," RIL's annual report says.

In a letter to Prasad, oil ministry joint secretary Giridhar Aramane stated: "In terms of the approved initial field development plan (IDP) as amended, you were required to drill, connect and put on stream 22 wells by 1 April 2011 with an envisaged production rate of 61.88 mmscmd and 31 wells by 1 April 2012, with an envisaged production rate of 80 mmscmd." But RIL has completed just 18 wells. Of which only 12 are in operation now, which the joint secretary cites as the reason for production fall.

RIL shares fell to Rs 671 on 8 May, compared to its 52-week high of Rs 967.90. When elephants fight, the grass gets trampled.

(With Anup Jayaram)

(This story was published in Businessworld Issue Dated 21-05-2012)