India’s New Hydrocarbon Exploration And Licensing Policy A Spectacular Failure

On January 18, Indian government launched the auction for 55 blocks covering 59,282 sq.km after examining the Expression of Interest (EOIs) submitted last year by oil companies. After a gap of eight years this was the first auction inviting bids for petroleum exploration. The Petroleum Minister Dharmendra Pradhan expressed his satisfaction with the outcomes during the launch.

By any standard, India’s New Hydrocarbon Exploration and Licensing Policy (HELP) is a spectacular failure based on the number of bids submitted. Unfortunately no one in the government had the courage to tell the Petroleum Minister that the goal of reducing oil import by 10% in 2022 will remain a pipe dream.

On the other hand, the US has been able to move towards a far more difficult task of achieving energy independence, a goal set by each President since Nixon. This is the result of the US shale revolution thanks to the sound policies implemented by successive presidents to promote energy security. Unfortunately our planners, bureaucrats and leaders have failed to learn from the stunning success of the US shale revolution.

In July, 2017 India opened 2.8 million sq. km of sedimentary basins for oil and gas exploration under HELP inviting submission of EOIs. Oil companies could select blocks of their choice under this Open Area Licensing (OAL) regime. Earlier it was the government which selected the blocks where oil exploration can be carried out. Oil companies under HELP has marketing and pricing freedom. Before HELP, contracts were based on production sharing where there was always the possibility of gold plating the investment and short changing the government by ‘manipulating profit’. To reduce the complexity of handling contracts, It was changed to revenue sharing.

Not one foreign oil company has submitted any EOI. There were only six domestic companies. Besides ONGC which has bid for 41 blocks and Vedanta’s Cairn India for 15 blocks, only four smaller oil companies had submitted EOIs. Absence of Reliance, BP, Niko in the initial bidding round must have surprised the government. Even though foreign oil companies did not submit EOIs, will they participate in the auction? Chances are slim. There are far more attractive areas like the US with far less bureaucratic hassle and political cronyism (discussed later) than in India.

US succeeded, but India failed to develop its petroleum reserves

No oil expert could have predicted that the US oil production would increase after it reached its peak as predicted by geologist Marion King Hubbert in 1970. Peak demand became a cult in some circle. US Gas supply situation was equally grim. As a result of gas price control, US gas production was declining. To ensure gas supplies for essential needs like residential heating, new gas power plants were banned during that time. Gas was to be used only for ‘noble purposes’.

However, once the gas prices were deregulated in 1978, gas production increased and prices came down. But this did not last for a long time. Gas production started to stabilize in late 1990s, and US started to invest in large LNG import terminals expecting gas deficit. However thanks to the shale revolution, gas production started to increase in later part of 2000. Soon afterwards, the US started to convert LNG importing terminals into LNG exporting terminals to export gas. Today India is beneficiary of such gas exports.

What a contrast from the US when we compare India’s oil and gas production during the last 50 years. India’s oil dependence has steadily increased to 81%. In the case of gas scenario it is even more dismal. After reaching a high of 50 billion cubic meters (cbm) gas production fell below 30 BCM. One obvious question though not raised by our political leaders and planners is why did India fail when the US succeeded?

Often the argument given is that the US has huge petroleum reserves while India is not endowed with them. While it is true, such an easy reasoning is erroneous. India still has a large area (78% of India’s sedimentary basin has yet to be explored) which has still not been explored to find petroleum reserves. Till extensive exploration has been carried out, it is wrong to write off India.

Failure to attract any bid from from foreign oil companies during the recent auction of oil blocks should be taken seriously by India. Again let us contrast this with the US. Even an oil rich country like Saudi Arabia has shown interest to explore for shale reserves in the US. This is because the US offers attractive terms to explorers. Regulations though stringent (environmental regulations of the US are stricter than the ones in India) are transparent and not left to the discretion of the officials and certainly not to the influence of politicians. In India, there is the perception that even if the oil companies comply with all the rules and regulations, unless politicians and officials are taken care of (in other words bribed) it is difficult to operate.

Examples of perceived crony capitalism

There was a disagreement between Reliance and ONGC in Krishna Godavari basin regarding the possible production of gas by Reliance from the adjoining gas discovery belonging to ONGC. Such situations are quite common in most of the oil producing countries and reserves are developed by joint ownership. There was even the perception that it was a case of crony capitalism to favor a private company.

T he controversy was settled , but not based on geological facts in routine manner as happens all over the world. They are settled by technical people and not by judges and definitely not by political intervention. Justice Shah who looked into the controversy was fair in finding fault with ONGC and Reliance for not bringing the possibility of gas migration to the attention of Director General of Hydrocarbon (DGH) soon after the discovery. However he erred by concluding that gas in ONGC leases belonged to the nation. Since ONGC had leased the area, any reserves in that area belonged to it. ONGC or its minority shareholders should have taken this up with the government or appealed against such a ruling.

When London stock exchange listed Cairn Energy wanted to sell its company to Vedanta, thanks to the intervention of the petroleum ministry, it took enormous time and political intervention to resolve a reasonably straight forward commercial transaction. Again such transactions should have been easy to implement without hassle and also without involving political leadership. Once the transaction was consumed, there was the perception of crony capitalism. The deal was delayed because of a dispute over royalty payments. ONGC had 30% holding in Cairn’s oil fields

in Rajasthan , but was obliged to pay 100% royalty which it felt was not fair. How could such irrational dispute even arise unless the government while signing the original Production Sharing Agreement (PSA) with Cairn might have agreed to such ambiguous terms.

The poster child example for crony capitalism and bureaucratic intervention is KG basin D6 oil exploration play by Reliance. Dispute arose because of the gas price. Only because of the dispute involved the Ambani brothers, the government was forced to intervene to ensure that the government was not taken for a ride. Finally it was the Supreme Court which resolved the pricing issue. Attracted by the early assessment of huge gas reserves in Reliance's KG block and also with the confidence of leveraging its technical ability to find even more reserves, BP bought into the block. To everyone's great disappointment, BP’s gamble did not pay off. This was made even worse by the disagreement between the government and oil companies over the PSA terms like recovery of costs, pricing, minimum drilling programs, profit sharing etc. BP’s unpleasant experience of dealing with the government in KG basin must have sent wrong signals to the potential international investors.

US is not free of oil lobby either

Not that politics has no role or influence on petroleum industry in the US. In fact oil companies have a huge lobby in Washington DC to influence the US Congress. What is different from India is that if any specific company is favored by tweaking the law by any influential politicians, chances are that such corrupt practices will be exposed and there will be heavy penalty.

There are also instances when US Congress voted for a legislation which harmed the economy because of special interest groups. Ethanol subsidy is one such example. Corn lobby has been successful in passing a law which is not in the interest of the overall economy.

However there are also several examples of how Congress is able to quickly change the rules which are detrimental to the economy. Soon after the first oil shock in 1973, US congress adapted a law to support small refineries by imposing oil price control. It resulted in mind boggling numbers of crude oil classification. However when it found that such price controls were counter productive (hundreds of many inefficient small refineries were built in a short time), the US Congress removed the oil price control.

When the US Congress realized that gas price control is not helping the industry and has resulted in reducing gas production, it finally dismantled the large edifice of gas price control.

But India is driven more by political security and not by energy security

Let us now contrast with India. Every political party wants to control oil and gas price. They also want to control who should get these controlled gas and oil. Argument advanced all the time is that by controlling price and preventing the Indian economy from external price shocks, we help the poor consumers and also economy. Often energy security is also advanced to support irrational policies in petroleum sector though the real driving force is political security. We have still not realized that the price control has killed the gas sector in India.

Only after a long time, India decided to liberalize oil price for producers by dismantling the Administered Pricing Mechanism in 2002. However soon after when oil prices went up from 2004, India “punished” public sector companies ONGC and OIL India by forcing them to sell oil at below the market price. They compounded the problem by forcing public sector marketing companies to sell gasoline and diesel (residential LPG and PDS kerosene have been subsidized always) below the market price. Private companies like Reliance, Essar, and Shell which were far more efficient than the public sector oil companies had to close down their service stations. One cannot think of a more Tughlakian strategy of subsidizing gasoline and diesel to help the poor.

Strategic need for liberalizing India’s gas market

Of all the wrong policies, it is the irrational pricing policy of natural gas which has caused maximum harm to petroleum sector. For example, in 2012 Administrative price for public sector oil companies was about $2/mmbtu, and for new gas reserves it was around $4 to $5/mmbtu while India paid about $13/mmbtu for LNG imports. Various expert committees recommended to liberalize the gas market. But neither the NDA nor the UPA government had the political will to implement such a policy. It was further compounded by a complicated pricing formula based on four international benchmarks (US, Canada, UK and Russia) which had no relevance to the Indian gas market.

Need for less bureaucracy and more rule of law

In the US when exploration areas are leased there are no special contracts for natural gas and shale gas. India’s bureaucracy in their wisdom used to have separate agreements for shale gas. Only recently they finally decided to drop such restrictive practices. All over the world, production sharing agreements use the concept of profit sharing. As discussed earlier this model has been replaced by revenue sharing. Since the oil companies are not familiar with revenue sharing model, that might have also worked against India. Highest regulatory bodies for petroleum sector in the US are autonomous and free from political control. However in India, Directorate General of Hydrocarbon is under the control of petroleum ministry.

Exploration is close to gambling

Another interesting aspect of shale revolution is that it was not because of the pioneering efforts of large oil companies. The chief architect of shale revolution is a wildcatter George Mitchell whose persistence in use of hydraulic fracturing and horizontal drilling resulted in the biggest gas plays in the US. India should encourage entrepreneurs like Mitchell to enter petroleum sector. In a way NDA’s strategy of developing “Discovered Small Fields” partly meets this criterion. It succeeded in creating 15 new entrants.

Unless Indian bureaucracy and political leadership appreciates the importance of investors earning attractive rate of return commensurate with the risk, India will not succeed in developing its petroleum reserves. Petroleum investing is an extremely risky business. It is close to gambling. Can India work to create a rule based environment for the petroleum sector without the hassle of winning the “goodwill” of the officials or politicians?