INDIA’s MARGINAL FIELDS: LAND OF THE BRAVE?

 

Author – Minna Joshi, Legal Advisor, Domestic & Multinational Banks

The World’s production of hydrocarbons has for a long time been held at stake, due to the marginalisation of fields. Marginal fields, by definition are fields that, at a given point in time, were not considered viable for production, due to numerous factors such as geological, geographical, technological, legislative, and political to economical. In the recent past, war and economic sanctions have caused even large fields across the globe such as those in Russia, Africa and Afghanistan, to be treated as ‘marginal’. However, with any of these factors changing, such fields could potentially become commercially viable.

This year the Government of India announced the auction of 69 ‘marginal fields’ which had been relinquished back in 2012, by Oil and Natural Gas Corporation Limited (“ONGC”) and Oil India Corporation (“OIL”); the sole players in the exploration and production (“E&P”) sector in India, till liberalisation in the 1990’s.

While some of the location and size based challenges faced by ONGC and OIL may still remain and require strategic technological solutions for viability, the ‘game changer’ being offered up by the Indian Government is in the form of a set of legislative and fiscal reforms, reiterating the argument that legislative certainty goes a long way in optimising profits.

THE CRY FOR HELP: Recent Regulatory Changes

On 30th March 2016, the Hydrocarbon Exploration and Licensing Policy (“HELP”), touted to be the evolution and an outcome of two decades of learning’s, was notified after New Exploration Licensing Policy’s (“NELP”) 18 year run.

The NELP had ushered in the first wave of liberalisation by permitting private players and permitting 100 per cent foreign direct investment. However, despite its efforts the NELP reeked of the previous era’s unfairness towards Governmental control. In an effort to keep a check on the system, various policies were formulated. There were separate policies, separate licenses and different fiscal terms for allocation of acreages for exploration of different hydrocarbons. To add to the circus, policy overlapping for some hydrocarbons was also noticed.

The HELP has initiated a critical change here. By providing for a single license to enable E&P operators to explore and extract ALL hydrocarbon resources covered under multiple legislations ranging from coal bed methane, shale oil, gas hydrates to even resources identified in future, the HELP undoubtedly promises operational convenience.

The potential investors with access to promising geological data of their own on potential fields could not act as the exploration permission was confined to only those blocks which were disclosed by the government in the respective tender thus incapacitating initiatives – an another  critique on NELP  resulting to chaos in the market.

Agreeably, the long awaited the open acreage licensing policy under the new framework, which allows contractors to identify the exploration blocks, and submit an expression of interest and thus initiate a bid on their own accord without having to wait for the cyclic bidding rounds to claim acreages that they may not be interest in, could make technical collaboration worthwhile.

Previously even for those investors who bravely ventured forth faced operational nightmares. New discoveries required new licenses. In fact unconventional hydrocarbons (shale gas and shale oil) did not even form part of the policy structure since they were unknown when it was framed!

The tipping point however, was not reached till the actual implementation of the contracts commenced. Under the NELP model, contracts were on a pre-tax, post investment, profit sharing basis (“Profit Sharing Contracts”). Thus the Government was entitled to revenue only after the contractor’s development linked costs had been met. This required immense Governmental oversight into all aspects and led to detailed audits eventually leading to fertile ground for delays and disputes.

Yet, for all its failings, recovery of operational costs was assured by the Government, under the NELP regime. This was perhaps, at the time, was a practical necessity to attract investments.

When the Rangarajan Committee in 2012 sat down to examine the Profit Sharing Contracts, it proposed a model similar to what was being used for coal bed methane and by a number of countries, including the United States, Columbia and some African nations. This model placed the risk (fiscal and otherwise) associated with exploration, development and productions costs, squarely on the shoulders of the contractor. In lieu of the risks the contractor was entitled to a stipulated share of revenue from the profits. The share was determined by the bids placed on an incremental production based scale combined with a fixed scale.

Amid low crude prices, the burden of developing without a backing may have been a cause for concern. This was offset under the regime with a waiver of cess, equipment import levies and reduced the royalty rates (including a graded system of royalty rates, in which royalty rates decreases from shallow water to deep water and ultra-deep water) coupled with free market pricing.   The pricing while pitched as free market pricing is restricted to exclusive domestic sale, arms-length transactions and transparent bidding, in case of crude oil whereas for natural gas it is linked merely to obtaining at arms-length price. Thus, in theory market, rates may be discovered freely subject to provide a minimum rate to the government. This minimum price for crude and its condensates shall be based on the price of Indian Basket of Crude Oil as calculated by the Petroleum Planning and Analysis Cell on a monthly basis. Similarly for natural gas, the Government’s share will be calculated based on the domestic pricing guidelines.

In both cases, if the price arrived through bidding is more than the determined price then the Government’s take will be calculated based on the actual price realised. Thus while the pricing model in itself appears fair, incentivised even, with cess out of the picture and the lower rates at which hydrocarbons are available to the Government, a few issues still needs to be considered.

Firstly, this pricing mechanism may impact some of the more traditional ‘take or pay’ contract structures prevalent in the industry. The long term take or pay structures provide financial certainty by fructifying the prices at the time of the contract and reducing the risk of dramatic changes in the market conditions, such as a sudden price rise. Additionally they ensure regular off take which turns critical to reduce storage costs and in cases where relevant, justify the costs associated with pipeline sharing.

Secondly, there would be the challenge in obtaining funding, given the high risk and low certainty. Potentially high loan security creation costs (which in line with a recent Supreme Court ruling, increase exponentially with the number of lenders involved) and the inevitably higher interest rates would also need to be factored.

Thirdly, a large amount of funding may be required for developing the offtake infrastructure. That one factor may as a matter of fact be the detriment of the cluster system, since the cost will fall on the individual contractors. If however there is an existing system of off take; time share and usage costs would be required. To an extent, usage costs may hinge on the outcome of the Mahanagar Gas dispute and the notification of the pricing framework for the contract or common gas carriers to share existing infrastructure.

UNKNOWN WATERS

In the world’s fourth largest consumer of oil, the road show is on. Despite the odds, since the launch of the rounds on 25th May 2016, interest has been brewing. Even ONGC announced its renewed interest in the relinquished fields and perhaps inadvertently high interest in the auction process. Tenders were even floated for an ‘event management company’ to manage the bidding process! It remains to be seen what the commercial viability of the fields will be. Various specialised market players have emerged in the past decade that have claimed to improve viability of marginal fields using computational fluid dynamics, localised finite element analysis techniques, amongst a host of other evolved techniques that only the industry players may be able to estimate.

Apart from the technical solution management, marginal field operator in developing nations also face issues such as theft, pipeline vandalism and, basic pipeline and road infrastructure deficit. Even the HELP does not address legislative and regulatory issues that may arise in related sectors and it does well to remember that the Supreme Court made it amply clear that in resources such as natural gas, people of the entire country have a stake so policy on resources could be examined and added to that issues on that royalty and Government dues being matters of public concern, cannot be resolved by means other than approaching the courts.

As Salvador Dali once said, “I always saw what others could not see” All in all, it’s an interesting time to be a big player in the Indian market or to know a few global sportsmen!