Clarity begins at home

It is only through stepping up domestic production and improving technology, that India will attain self-reliance in energy.

The failure of the Indian oil and natural gas industry to attract investment is symptomatic of the malaise gripping the Indian economy. The results are visible: hydrocarbons are in ever shorter supply domestically, imports are rising, and the power, fuel and fertiliser sectors account for a major chunk of government subsidies. That is, while we import at market prices, we are selling at a discount. This does no favours to our economy and balance of trade.


The obvious solution would be to promote domestic Exploration and Production (E&P) wherever possible. Curiously, while leading International Oil Companies (IOCs) and Nationalised Oil Companies (NOCs) are active in E&P the world over, in India they are conspicuous in their absence. Despite the potential for development, this sector languishes because confused, contradictory and perverse policies have driven investors away.

Investing in E&P is a complex decision, involving substantial amounts which must be invested regularly across five (or more) years before yielding returns – and there is always the risk that a particular project fails. An investor will fund a project only when he believes it will be profitable. The terms on which he is ready to invest are spelled out in the relevant contracts and agreements, but that assessment itself relies on certain fundamental assumptions about the legal and regulatory environment in the country. Broadly speaking, these assumptions are that contracts are negotiated and performed in good faith, and that the regulatory authorities are impartial and promote fair competition. India, however, has shaken the confidence of the investor in these prerequisites; the resultant uncertainty is the single largest factor starving key Indian sectors of desperately needed capital and expertise.

Potential investors hedge their bets by participating in various projects. Very crudely, each successful project would lead to diminishing returns for the next, as it drives global supply up and global prices down. The opposite is true if a string of projects fail. On balance, the investor makes a profit precisely due to such variations. Where a government moves to appropriate such profits, it makes such a strategy unviable. The government is saying: you bear the risks, and any losses, but we will corner the rewards. To the investor, this means that success and failure both entail a loss. If you lose even when you win, why play?

The willingness to alter production-sharing or long-term supply agreements is part of this impression, but it is hardly a new concern. After all, even if renegotiation is attempted, the parties are still “playing by the rules” to come to a new arrangement. The real problem is when a nation ‘cheats’ by altering the rules underlying the agreement itself. India has done this through various changes in tax categories and assessment rules, especially as it is related to capital gains. The decision to impose the “General Anti-Avoidance Rules” (GAAR) with retrospective impact was seen as a cynical step, taken by a government ready to bypass even its own Supreme Court.

The current controversial proposal for renegotiation of gas prices is also perceived widely as a cynical step, undertaken to benefit a single private player. In fact, firms participating in the last three rounds of the National Exploration Licensing Process (NELP) have complained that the same player has enjoyed an undue advantage in its bids; other firms have also petitioned to have limits on the amount of acreage for which state-run firms (especially ONGC) can bid. While such perceptions do not evince great faith in the impartiality of the process or the authorities, one can hope that better guidelines will evolve for such situations, especially as the still-young field of Competition Law comes into its own in India.

None of this would matter much if India planned to follow the Chinese or Russian model of state-led exploitation of hydrocarbons. Unlike China, however, we can scarce afford to pump in the requisite investment on its own, and must turn to outside investors. (Russia has turned to the Chinese, but that too is an unpalatable option for India.) In diplomacy, one often hears of Confidence Building Measures (CBMs) between hostile nations. Today, we need shrewd economic diplomacy, and we urgently need CBMs targeted at potential investors.

One possible measure would be for the government to show that it is serious about promoting investment in hydrocarbons, by investing its own money in building up the support infrastructure. Pipeline networks in India tend to be concentrated in specific regions. Access, especially at ports and to the trunk line, is jealously guarded. Accelerated progress on the national grid as proposed by key distributor NOCs (Gas Authority of India Limited – GAIL and Oil India Limited – OIL), combined with priority or subsidised access for successful wells, would assure investors that they could transport extracted oil to refineries. This would be particularly beneficial in considering blocks in more remote parts of the country. Along with work on ports and storage facilities, it would also convey that the government is geared up for higher domestic production, and if we eventually succeed in laying overland pipelines through the Pakistan or Myanmar-Bangladesh routes, this national grid will help take gas from those sources to every corner of the country as well.

The most crucial signal, though, concerns not physical but legal infrastructure. Determining a policy on oil and gas pricing – whether calculated through a weighted-average formula, or by any other method – is the most urgent need. A committee headed by Vijay Kelkar (former Secretary in the Ministry of Petroleum) is seized of this question. Once its report is presented, and presuming it is accepted, the government must formulate a detailed “Model Production Sharing Agreement” that incorporates those recommendations. Such a model document, especially one that specifies and limits the conditions for renegotiation, would go a long way in returning clarity to the pricing debate.

Just as importantly, it would place unambiguous guidelines before the government itself, and remind various functionaries of the goal of such an exercise – that is, to promote domestic production of oil and natural gas. The nature of the industry is such that the proportion of available reserves technically recoverable rises as the price offered increases. Ultimately, while imports are here to stay, it is only through stepping up domestic production and improving technology that we will attain some measure of self-reliance in energy; a reminder that this entails market-driven prices may curtail future cynical measures.

Photo: Deepwater Horizon Response