1. Introduction
  2. What is Production Sharing Contract(PSCs) ?
  3. Royalty-tax regime
  4. Problems faced by Oil/Gas exploration companies
  5. CAG-Audit
  6. Present Gas Pricing Mechanism
  7. Criticism on Rangarajan’s gas pricing
  8. Summary points

Introduction

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

  1. Production sharing contracts with oil n gas exploration companies
  2. Contentious issues between those companies vs Government.
  3. How to decide the Price of domestically produced natural gas?

Rangarajan submitted report in December, 2012. It mainly revolves around following issues

  1. Production sharing contracts
  2. Problems faced companies
  3. CAG auditing
  4. Gas pricing mechanism

#1: Production Sharing Contract(PSCs) ?

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)”

  1. 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.)
  2. 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.)
  3. 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

Royalty-tax regime

Under this system:

  1. From the total profit from selling the oil, a fixed royalty is to be paid to the govt.
  2. After royalty is paid, the rest of revenue is shared by the govt and contractor.
  3. Government should allocate block to a company that offers maximum share from profit.

Advantages of the system are:

  1. Encourages the contractor to reduce costs.
  2. In case of price rise, the contractor doesn’t get windfall gains.
  3. Government gets more money = more money for MNREGA, food security.

#2: Problems faced by Oil/Gas exploration companies

3 problem areas:

1. Policy Issues
  1. Environment ministry cancelled the NOCs given to areas under the oil blocks.
  2. Contractors have difficulty in oil-exploration in North East and Naxal affected regions.
  3. Once oil is found, contract would want to dig more wells but he won’t be allowed under the license granted.

2.Management Issues
  1. If there are merger/acquisitions of companies, the Production sharing contract doesn’t recognize them.
  2. In the difficult terrain, it takes many years to complete survey, research, exploration. But production sharing contracts allow only 8 years to finish this.

3. Contractual Issues
  1. Concerns of inflation of costs. (from Government’s side
  2. Procurement of goods and services has to be done according to the PSC. (e.g. Government would say buy xyz machinery only from Government controlled PSU, even if a foreign company is providing better equipment at cheaper cost.)

Ranga recommends:

  • 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:
What Ranga recommends?
Current system Rangarajan wants
Tax holiday 7 years 10 years
Timeframe for exploration 8 years 10 years.

#3:CAG-Audit

Another controversial issue is : CAG auditing.  Oil/ Gas exploration companies like Reliance, want following things:

  1. CAG should only check our financial accounts, he should not do performance auditing. (because Production sharing contract doesn’t mention performance auditing).
  2. CAG should not reveal details of audit to public( not even in Parliament) because that leads to bad publicity for our company.
  3. 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)

#4: Rangarajan’s Gas Pricing Mechanism

India has 2 types of gas pricing mechanism

1. Administered Pricing Mechanism (APM)2. Non-APM
  • Government  fixes this price for National Oil Companies .
  • This is the price at which gas is provided to fertilizer, power companies, etc. (so if National company makes losses, then Government pay money = subsidy).
  • This system is already regulated under Gas Utilization Policy(GUP).
 This is applied to:

  • Imported LNG. (because Imported gas comes at a price agreed upon by the 2 countries in agreement.)
  • Gas obtained from National Exploration and Licensing Policy (NELP) era and pre-NELP era gas fields. (because Pre-NELP era licenses sell gas according to the Production Sharing Contracts signed.)
  • Not yet regulated.

Since there are ^two mechanisms, the price of gas is neither constant nor predictable in Indian market.

Rangarajan’s gas pricing formula

Rangarajan says, first you gather two values.
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.

Criticism on Ranga’s gas pricing

  1. 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.
  2. 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.
  3. 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.)
  4. Rangarajan says take average of Value #1 + #2. This “Average” logic is unheard of in International markets. No country is doing this!

Ranga Defends

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

  1. there is huge gap in supply-demand of gas. And our sea-ports donot have sufficient capacity to handle lot of imported gas.
  2. 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.

Ranga’s implication?

  • 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.

Comic Rangarajan no comments

Rangarajan: Summary points
Feature What was there earlier Recommendation of Rangarajan
1. PSC Cost Recovery by contractor first, then profits shared between govt and contractor. Move to a royalty-tax regime after which the balance revenue is shared by govt and contractor.
2. Issues North east, naxal area, company mergers, # of wells etc. 1. Create an Inter-Ministerial Committee to solve policy related issues.
2. Give more powers Secretaries(ECS)
3. tax holiday, more time to explore
3. Audit Lot of issues between the contractor and CAG over what type of audit can be performed. 1. CAG has the right to perform audit over oil/gas blocks and publish report.
2. CAG to directly audit big blocks.
3. CAG to outsource auditing for small blocks.
4. Pricing for domestically produced Gas Two models: APM, Non-APM Average of (imported LNG + wt.avg of prices in US, UK  and Japan)

ref

  1. Major Inputs from Mr.Shiva Ram
  2. http://eac.gov.in/reports/rep_psc0201.pdf
  3. http://www.thehindu.com/opinion/lead/making-a-mockery-of-domestic-gas-pricing/article4316958.ece
  4. http://www.livemint.com/Politics/P6M3Mcn7LIjC4cMhdGfMqL/Rangarajan-committee-seeks-freeing-gas-prices.html