- What is Production Sharing Contract(PSCs) ?
- Royalty-tax regime
- Problems faced by Oil/Gas exploration companies
- Present Gas Pricing Mechanism
- Criticism on Rangarajan’s gas pricing
- Summary points
Rangarajan is a noted economist, ex-Governer of RBI, ex-MP, Chairman of 12th Finance Commission and Chairman of Economic Advisory Council to the PM.
Mohan had appointed Rangarajan Committee to look into following matters
- Production sharing contracts with oil n gas exploration companies
- Contentious issues between those companies vs Government.
- How to decide the Price of domestically produced natural gas?
Rangarajan submitted report in December, 2012. It mainly revolves around following issues
- Production sharing contracts
- Problems faced companies
- CAG auditing
- Gas pricing mechanism
The PSCs work in the following fashion.
- This contract made between the government and a contractor (oil/gas exploration company).
- Contracts bids for specific oil block.
- If he wins the bid, he’ll start oil exploration in that block.
- Oil exploration =lot of investment and risk taking involved. This is borne by contractor. (let’s say 150 million dollars were invested).
- Once the oil is discovered, contractor will start commercial production and sells it.
- Let’s say he makes profit of 1 million dollar per month. According to contract, he has the right to first “recover” the investment.
- So for the first 150 months, he doesn’t need to share profit with Government. (because 1 million x 150 = 150 million.)
- Once contractor has recovered his the cost of exploration, then he’ll have to share part of his profit with the Government (as per the terms and conditions in production sharing contract.)
Sounds well and good, right? But CAG and Rangarajan Committee found some flows in ^this “Production sharing contract. (PSC)”
- This system encourages Contractor to inflate costs. (I would rather show cost of exploration as 2 billion dollars, even if it took me only 1 billion dollar.)
- Difficult for Government to check the accuracy of contractor’s account and get the correct share. (I may be making 1.5 million per month but I would doctor my accounts to show profit of only 1 million.)
- I intentionally don’t run my plant on full capacity. I’ll just wait till the oil prices in international market to sky rocket, and only during those days/ months, I’ll run plant on full capacity to make lot of profit.
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To solve ^these problems, Rangarajan made some recommendations. He proposed a
Under this system:
- From the total profit from selling the oil, a fixed royalty is to be paid to the govt.
- After royalty is paid, the rest of revenue is shared by the govt and contractor.
- Government should allocate block to a company that offers maximum share from profit.
Advantages of the system are:
- Encourages the contractor to reduce costs.
- In case of price rise, the contractor doesn’t get windfall gains.
- Government gets more money = more money for MNREGA, food security.
1. Policy Issues
3. Contractual Issues
- For Policy Related Issues – Make an Inter-Ministerial Committee to iron out the issues.
- To solve other issues, there is already an Empowered Committee of Secretaries(ECS). Give them more powers to resolve these issues.
- For companies exploring oil / gas in difficult terrains, should be given following extensions:
|Current system||Rangarajan wants|
|Tax holiday||7 years||10 years|
|Timeframe for exploration||8 years||10 years.|
Another controversial issue is : CAG auditing. Oil/ Gas exploration companies like Reliance, want following things:
- CAG should only check our financial accounts, he should not do performance auditing. (because Production sharing contract doesn’t mention performance auditing).
- CAG should not reveal details of audit to public( not even in Parliament) because that leads to bad publicity for our company.
- Audit should be within 2 years. If later, then under permission of the contractor.
Ranga on CAG
- The CAG is bound by the constitution to share all its audit with the Parliament. Just because some private company doesn’t want it, we cant change that!
- CAG is fully empowered to carry out audits. (including performance audits)
- If a block has high value, then CAG himself should audit it.
- If the block has low value, then CAG should outsource this auditing work to others. (reputed private audit firms selected by CAG)
India has 2 types of gas pricing mechanism
Since there are ^two mechanisms, the price of gas is neither constant nor predictable in Indian market.
Rangarajan’s gas pricing formula
|Value #1||price of imported liquefied natural gas (LNG).|
|Value #2||Weighted average price of gas in Global markets (US, UK and Japan)|
Then, take average of values #1 + #2. That’ll be the final pricing for gas in the country.
- There are two types of gases: Wet gas vs. dry gas. The wet gas contains crude oil too. So obviously wet gas is more useful. But Committee has not considered it in in the pricing mechanism.
- Countries that “export” LNG, donot openly declare the price. Because it depends on many variables. (e.g. Iran may sell us gas cheap, if we support their nuclear program.) So it is hard to determine value #1 objectively.
- While calculating Value #2 (weighted avg in global market), Rangarajan has included Japan in the list, but Japan doesn’t have its own gas production/suppliers. (counter: “Japan is a big buyer so whatever gas prices go in Japan, they reflect benchmark for Asia-Pacific region.)
- Rangarajan says take average of Value #1 + #2. This “Average” logic is unheard of in International markets. No country is doing this!
In free market, price of a commodity is determined by Supply demand, but Indian market is not yet ready to introduce direct market based gas pricing. Because
- there is huge gap in supply-demand of gas. And our sea-ports donot have sufficient capacity to handle lot of imported gas.
- Gas is essential for fertilizer, power industries and these sectors are essential for overall performance of economy and controlling inflation. So we can’t let the gas prices to be determined by free market.
So, use ^above pricing mechanism be used until such provision can be made.
- If Ranga’s pricing mechanism is implemented, we (public) will have to pay higher price for gas, just like we do for petrol right now.
- On the other hand, it’ll reduce the subsidy burden on Government = fiscal consolidation.