15th September 2011

Prabir Purkayastha

The CAG Report on the audit of the Production Sharing Contracts for the on-shore and off-shore oil and gas blocks once again shows the unholy nexus between the UPA and big capital in the country. The CAG has shown how the Directorate General of Hydrocarbons (DGH) and the Ministry of Petroleum and Natural Gas (MoPNG) connived with Reliance Industries and other private operators against the interests of the people. Some of the salient issues brought out by CAG are:

• Private operators grossly inflating the capital costs for equipment to claim a much higher share of the profit petroleum

• In procurement of equipment, a number of one party financial bids, major revision of scope/quantities/specifications, substantial variation in order quantities, post bid modifications in major high value contracts

• Allowing the whole 7645 sq km exploration area to be retained by Reliance instead of of their entitlement of retaining only 5% of this area after 2009 in complete violation of the Production Sharing Contract.

There has been some criticism that CAG's draft report has been diluted in the final report. This is not borne out by facts. CAG's language might become a little softer, but its conclusions remain essentially unchanged.

A major part of the report is devoted to the KG Basin – KG-DWN-98/3 deep-water Block, also known as KG D-6 Block. Reliance has argued that the increase of capital cost from $2.4 billion to $8.8 billion was for augmenting gas field output from 40 mmscmd to 80 mmscmd. The CAG Report now makes clear that the increase from $2.4 billion to $5.2 billion took place for the first phase itself, where no augmentation of capacity was involved.

It is important to note that the evaluation of bids that were made for the award of of the exploration blocks is linked to the financial packages that the bidders offered. As the profit share and other measures promised by the bidders in the financial package are linked to capital costs, this huge change in capital costs makes nonsense of the bidding procedure for awarding of blocks.

Worse is the timing of the approvals. The original cost estimates of $2.4 billion was a part of the Initial Development Plan (IDP) submitted by Reliance in May 2004. In October 2006, Reliance submitted an Addendum to the IDP for an upward revision of the costs to $ 5.2 billion for the 1^st phase and another $ 3.6 billion for the second phase – a whopping increase of $6.2 billion over the original estimate. The Management Committee which had 50% representation from the Government cleared this increase by December 12^th 2006 – in a period of less than 2 months!

In a single party financial bid, a contract of $ 1.1 billion was given to Aker Floating Production, a part of the Aker group for a 10-year lease on a Floating Production and Storage and Offloading (FPSO) Vessel Another contract of $200 million for O&M services was also given to Aker for the same FPSO. This was originally budgeted for $300 million. All other bidders were disqualified and only Aker's financial bid was opened.

CAG has also pointed out the following with respect to the Aker's above contract:

• Aker did not meet the requirements of the specifications with respect to its experience in such contracts

• Its financial bid was not signed and should not have been considered

• It was allowed to make post technical bid modifications – an opportunity not given to the other bidders

• Aker had brought to two oil tankers for $55 million and the conversion cost of the two tankers to FPSO by Jurong Shipyard was $ 88 million.

The CAG Report has pointed out 8 contracts were given to Aker group out of 10 single party bids on what appears prima facie to be sweet-heart deals. CAG has rejected Reliance's claims that its procurement procedures cannot be subjected to CAG audit and stated that it is going to examine these issues in greater detail in a subsequent audit.

The issue of high capital cost is not merely that of skimming off the top by incurring fictitious or inflated capital expenditure. It changes the revenue share between the private party and the Government completely. The Investment Multiple to which profits of GoI and private parties are indexed, is the ratio of the cumulative net cash income to the cumulative exploration and development costs – it is a measure of the capital intensive nature of the project. CAG has pointed out, “The slabs for profit sharing are so designed that more capital expensive the project (i.e. lower IM), the lower the GoI's share of the “profit petroleum” (which could be as low as 5-10%). Contrarily, the higher the IM (i.e. less capital intensive vis-a-vis the income) higher the GOI's share of the profit petroleum (which could be as high as 85%).”

Recent press reports indicate that Reliance's basis of capital cost increase – augmenting gas flow from 40 mmscmd to 80 mmscmd has fallen far short of its promise – the gas output is now well below 60 mmscmd. The Solicitor General has given his opinion – as per news reports – that GoI's profit share should not be reduced due to this capital expenditure as prima facie this is not a valid expenditure.

The CAG report has also given a chart of the receipts of the GoI from royalties and Profit Petroleum from 2005-06 to 2010-2011. It shows that while royalties have been rising steadily showing an increase in oil production from the Production Sharing Contracts, the receipt from profit petroleum falls abruptly from Rs. 5,926 crore in 2009-2010 to Rs. 3,610 in 2010-2011. This is in spite of an increase of royalties showing clearly that output in this period has physically increased. While CAG has given no explanation for this, it is clear that all is not well with the NELP and the Production Sharing Contracts with private parties.

In November 2009, preliminary investigations by the CBI had found evidence of “gross abuse and misuse of public office” by V K Sibal, the then Director General of DGH. This had been informed to the Petroleum Ministry and to CVC. Numerous links had been found between Sibal and Reliance. The CBI enquiry remains stalled, very much in the telecom 2G mode, showing that Reliance tentacles in the Government go far beyond Sibal.

Apart from the major scam of gold-plating of contracts, the other major issue is that DGH and Ministry connived with Reliance so that it could “hoard” the entire exploration area as discovery area. As per the Production Sharing Contract, Reliance was supposed to vacate 25% of the exploration area in the first phase, 50% in the second phase and all areas in which it had not sunk wells or developed oil wells in the third phase. Instead, Reliance never relinquished any of the areas and has been allowed to keep all 100% of the 7645 sq km of the exploration area in complete violation of the contract.

If any company takes a particular area for exploration, it must finish the exploration within a certain time period or release it back to Government for awarding it to others. It cannot sit on top of an exploration area and hoard it indefinitely for the future. That is why the clause of progressive release of exploration areas back to the Government.

Normally, when gas or oil is struck in an area, its nearby areas are also likely to have hydrocarbon deposits. The value of such areas would therefore go up for any subsequent auction. Hoarding such areas means that though the party considered has not spent the money it was required for exploration, it is still allowed to retain this area and explore it at leisure. The entire purpose of NELP of time bound and expeditious development of India's hydrocarbon resources gets defeated if private parties are allowed to retain exploration areas indefinitely without doing any development work.

The Panna Mukta oilfield and the one held by Cairn Energy shows similar features to the KG DWN 98/3 Block issues. This brings into question the entire New Exploration Policy and the way it is being implemented by MoPNG and DGH. CAG report has also brought how Reliance and other contractors have flouted various contract terms and conditions, how it has incurred expenditure without approvals, did not submit required plans and documents, etc. The major issues it has raised is the way that the Government has supervised the production sharing contracts. It has also suggested that a far simpler scheme would be to peg Government's take simply on the output – this way no complex mechanism needs to be put in place for monitoring the contracts and the purchases. For existing contracts, where a profit sharing arrangement is in place, the Government has to exercise far greater vigilance than it has shown till now to protects its revenues.

Both DGH and PoNG have clearly connived with Reliance and the private operators. CAG has also made an observation that DGH has to separate its two roles – one as a technical advisor to the MoPNG the other is its regulatory role. The key issue is however not that of separation of roles as much as playing the role it was designed to do – safeguard the interests of the people in the production sharing contracts. This, it has clearly failed to do.

Various other criticisms have been mounted against CAG – one by Congress MP's in Parliament and echoed by others outside – that CAG is going beyond its role of audit into policies. In this case, CAG has examined only those which pertain to GoI's revenues share being reduced. Unfortunately, today policies are being crafted in a way to suit private interests and against public good. Both 2G spectrum allocation and the NELP are policies which have benefited private parties to the detriment of public good.

There are two sets of issues that need to be addressed urgently. One is that immediate measures need to be taken to vis-a-vis Reliance and other private parties. These include:

• Taking back 95% of the exploration area retained by Reliance in gross violation of the Production Sharing Contract

• Imposing penalties on Reliance and other private parties for gold-plating contracts

• Ensuring that such increase is considered invalid expenditure such that GoI's share of the profit petroleum is not reduced

For the Government, the following steps need to be taken so that a repeat of this does not take place again:

• Immediate prosecution of Sibal and other concerned officials

• Investigation of the role of Ministry of Petroleum and the erstwhile Petroleum Minister in this

• Strengthening the role of the Government in the Management Committee for the existing contracts

• Change in Production Sharing Contracts to prevent such misuse

• Review of the NELP