The
Comptroller and Auditor General's (CAG) performance
audit of some production sharing contracts instituted
as part of the liberalisation of India's oil exploration
and production policy may turn out to be the next
big scam with more than a whiff of corruption. But,
in this season of scams, danger lurks. The danger
that much of society can for a considerable period
of time miss the wood for the trees. Circumstances
strengthen this tendency. In particular the surprising
coincidence of a host of revelations of lack of due
diligence, bending of the rules, outright manipulation
or a combination of all of this that hugely enriches
a few individuals and corporations in the private
sector and a few functionaries of the state, most
often at the expense of the exchequer. Not a day passes
without evidence of some new scam.
Whatever may be the cause for this recent increase
in scam-related revelations, the surge feeds the notion
that corruption has reached unprecedented levels and
constitutes the fundamental problem facing India today.
The fact that, besides being ethically wrong or morally
abhorrent, corruption can influence growth in ways
that serve the interests of a few, and can therefore
be deeply inequalising cannot be denied. But the reason
these developments that are seen as mere instances
of corruption have multiplied in number could be systemic
and reflect policy shifts that aim to use state resources
to inflate private profit. Private enrichment at the
expense of the state exchequer may be embedded in
the direction that policy in India has taken since
the early 1990s. In the process, there may be some
in government who use the opportunity to enrich themselves.
But to presume that outcomes would have been different
had corruption not played a role, may be wrong. Preventing
observed outcomes may require more fundamental changes.
Ignoring those and focusing on corruption may result
in an unconscious alliance between those who want
such outcomes and those who are opposed to them.
Consider for example recent allegations of malpractice
in India's oil sector. They are based on a leaked
draft performance audit report by the CAG of certain
blocks of gas and petroleum reserves being exploited
under the system of production sharing contracts (PSCs)
between the private and the public sectors. Those
PSCs, in turn, were designed under the liberalised
New Exploration Licensing Policy (NELP) aimed at attracting
private capital to do the job that the public sector
undertook for long in India. The controversy relates
in particular to the D6 Block in the Krishna-Godavari
Basin. The right to exploit the block under a PSC
was awarded in the first round of bidding (NELP-1)
to a joint venture of Reliance Industries Ltd and
Niko Resources Ltd (in which the former held an overwhelming
majority of shares). The CAG's conclusion is that
officials in the Directorate General of Hydrocarbons
and the Petroleum Ministry allowed RIL to work the
contract in a manner which inflated its profits, while
reducing the revenues accruing to the exchequer. In
sum, the argument is that RIL was favoured in ways
that defrauded the tax payer to increase its profits.
Allegations of corruption are only short step away
from this conclusion, making it the cause of the transfer
from the state to the private sector.
The focus here is on the PSC. Under the liberalisation
of rules governing a sector that was earlier reserved
solely for the public sector, production-sharing contracts
have been designed such that the private contractor,
who incurs the capital expenditure and is seen as
taking all the risks involved in discovering and supplying
gas to the market, has a greater right to the revenue
stream that flows from the sale of the gas till capital
costs are covered. Even after that, the private contractor
has a greater right because it needs to cover operating
costs besides getting a share of the profit. It is
when the revenues earned rise relative to capital
and operating costs that the government's share in
production and revenues, which is sheer ''profit'',
turns significant. In the case of KG-D6, the contract
was structured such that, RIL paid the government
10 per cent of the total revenue computed at a mutually
agreed arms length price, until Reliance recovers
1.5 times its investment. The government's take would
rise to 16 per cent of that gas value when revenues
amount to 1.5 times to two times the RIL's investment,
to 28 per cent when revenues amount to two to 2.5
times the investment and 85 per cent thereafter.
Since the government's revenues (embedded in its share
of the gas marketed under the production-sharing contracts
awarded under various rounds of NELP) are computed
in this manner, its interest lies in keeping capital
and operating costs needed for any level of production
down and in ensuring early realisation of the targeted
production levels, so that revenues exceed capital
and operating costs by a significant margin. It should
be clear from this structure of production sharing
contracts that revenues accruing to the private sector
are influenced by: (i) the capital and operating costs
it is estimated to be incurring; and (ii) to the ''surplus''
revenues it garners depending on the volume of production
and the price at which gas is sold, which it shares
with the government. If costs are inflated, the profits
accruing to the private contractor would be larger
than ''legally'' permissible under the contract. And
if the costs are inflated and/or the volume of output
restricted, the smaller would be the revenues (and
profits) accruing to the government. The latter is
important because, at any mutually agreed price, if
costs can be inflated, it pays the private sector
to keep production down, since it would have to hand
over a smaller share of revenues to the government,
increasing its share in profits substantially. Though
the volume of private profit would be lower in any
given year because of lower output and revenues, the
cumulative profits it earns over time would be much
larger.
The CAG's suspicion in its draft performance audit
(relating to financial years 2006-07 and 2007-08)
seems to be that, in the case of the KG-D6 gas fields,
RIL has inflated capital costs substantially. The
basis for this suspicion is the fact that the development
cost of the block was raised from the original estimate
of $2.4 billion when the contract was awarded in 2004
to figures of $8.5 billion in 2006: $5.2 billion for
the first phase and $3.3 billion for the second phase.
This revision was made through an ''addendum'' to the
initial development plan rather than through the preparation
of a revised comprehensive development plan. Moreover,
the CAG finds that there is a lack of adequate detail
with regard to the Phase-II development estimated
to cost $3.3 billion. This makes it extremely likely
that the private contractor would hike the Phase II
development costs through further such ''addendums''
in the future. The net result is a huge loss of revenues
to the state, which the CAG leaves unestimated. Presumptions
are that, if true, the actual inflation of profits
and loss to the exchequer would have been substantial.
There are two ways in which such gain, if any, to
Reliance can be interpreted. The first is that it
is the lack of due diligence on the part of the government
and the officials it nominated to the management committee
of the project. Such lack of diligence may, in turn,
be attributed to sheer incompetence, lethargy or deliberate
omission in return for illegal gratification and this
is what, many argue, needs to be investigated. The
other is that it may be the result of conscious policy,
of which the NELP was a part, to favour private players
so as to ''induce them'' to undertake the investments
that the government was reluctant to make. That reluctance,
it must be noted, cannot in this case be attributed
to lack of resources, given the ease with which the
initial investment could be recouped.
However, this is not the only way in which Reliance
has been favoured. It was also the beneficiary of
the pricing policy for petroleum products adopted
post reforms, where the belief was that given India's
substantial dependence on imported petroleum products,
domestic price levels should be calibrated to reflect
international prices so as to reduce the subsidy being
provided to consumers. In 2004, RIL won a bid to supply
12 mscmd (million standard cubic metres per day) of
gas to the National Thermal Power Corporation at a
price of $2.34 per mBtmu (million British thermal
units). Further, at the time of split between the
Ambani brothers leading to an asset sharing agreement,
this was the price at which gas was offered to the
Anil Ambani-controlled RNRL for use in two power plant
projects that it was to set up at Dadri in Uttar Pradesh
and Patalganga in Maharashtra.
That was the then prevailing market price. But thereafter
the market/international price rose significantly.
Taking the cue from there and the principle whereby
RIL could set a price for gas in negotiation with
the government which earned from it a share in profits,
RIL proposed in 2007 a higher price to the government
of $4.33 per mBtmu, based on limited bids from a shortlisted
set of power and fertilizer companies which would
consume the gas. This price was examined by a committee
of Secretaries, which recommended lowering it to $4.20
per mBtmu, to take account of the appreciation of
the rupee. The pricing formula was subsequently accepted
by the government based on the recommendation of an
Empowered Group of Ministers (EGoM), which felt that
accepting it was important since: ''it would not be
in the country's interest to renege on the contractual
provisions under the PSCs [production sharing contracts]
entered into in good faith under the New Exploration
and Licensing Policy."
In sum, the price was not a cost plus price taking
account of costs incurred at KG-D6 field, but the
rupee equivalent of the prevailing international price.
However, once fixed it does not seem likely that the
price would be adjusted downwards when international
prices decline. Reform first involves large concessions,
which once offered cannot be withdrawn since it would
ostensibly amount to a breach of faith. If the original
price of $2.34 per mBtmu is indicative of where the
cost plus price should settle, it could be expected
that Reliance would be covering costs in a short period
of time and making significant profits, if costs had
been inflated as the CAG suspects. The difficulty
is that public sector units like the NTPC that are
reliant on KG-D6 gas are paying this higher price,
reducing their profits and surpluses, which also are
state revenues.
But this, possibly, does not complete the story on
how RIL is reaping huge gains from KG-D6. The other
route is by restricting output, so as to reduce payout
to the government as per the production and profit-sharing
formula described above. As per the original PSC,
the D6 was to produce 40 million mscmd. This was raised
to 80 mscmd from a total of 31 wells, which was to
be achieved by April 2012. According to the time line
in the field development plan, Reliance had committed
to putting 22 wells on stream by April 2011, producing
61.88 mscmd of gas. However, as of April there were
only 18 wells in production. Moreover, output from
these wells has been falling over time. According
to reports, Reliance had achieved a production of
53 million cubic metres per day from 16 wells in March
last year but since then there has been a drop in
production to about 42 mscmd. This has led to a spat
between RIL and the government on two counts. To start
with, the government has issued an order diverting
a larger share of the lower output to core industries
such as power and fertiliser. But RIL wants to service
non-core sectors including steel, on the ground that
diversion to core industries would have financial
implications. Essar Steel, which was allocated 3.2
mscmd and is now getting less than one-fifth of that
amount, has moved the Delhi High Court, which as of
now has upheld the government's position. Secondly,
since Reliance has built production facilities to
support 80 mscmd of production but production is much
less, the DGH wants to protect the government's profit
share by reducing the recovery of capital costs to
two-thirds of that spent in building those facilities,
releasing more surpluses to be shared by the government.
These conflicts are yet to be resolved, but the government
is clearly not buying the line that reduced production
is the result of a drop in reservoir pressure as RIL
claims.
Whatever may be the situation, there appears to be
more than one way in which Reliance seems to be garnering
additional profits at the expense of the exchequer.
And not in all cases is that because of explicit collusion
with government officials. It really stems from the
neoliberal reform that sought to attract private capital
into a lucrative and sensitive area like petroleum,
believed that it should offer substantial concessions
to attract such capital even if at the expense of
the exchequer, and opted out of even regulation. It
is reform of this kind that is the real problem facing
the country. That it provided the ground for increase
in corruption should not lead to a diversion of attention
from the principal problem at hand. That would amount
to gassing the state and shielding the private sector.
Note:
This article was originally published in The Frontline,
Volume 28 Issue 14: July 02-15, 2011.
