No oil’s not well at all

No oil’s not well at all

The Economic Survey 2019-20 points out the fact that India’s dependence on oil imports increased to 85% in April-December 2019, against 78.3% in 2014-15. Domestic oil production is estimated at 32.6 million tonnes in the current year, against 34.2 million tonnes in 2018-19, making it the lowest in the last eight years. Oil production has reached a plateau, while gas production is showing a rising trend.

In the 1990s, GoI entered into production-sharing contracts (PSCs) with private sector players and handed over discovered small and medium fields to them, as they were too small for Oil and Natural Gas Corporation (ONGC) to deal with. Under the PSC arrangement, operators allotted these fields would invest their resources into drilling and development activities. GoI would buy the complete production at prices benchmarked to rates in the international markets. It took a share of the operating revenues in the forms of royalty, cess and profit petroleum, besides value-added tax (VAT) and income-tax (I-T) on the profits of the enterprise. Typically, the amounts payable as royalty and cess were fixed in rupee terms (per tonne), except gas, which was generally at 10% of the wellhead price, ad valorem.

The PSCs were valid for 25 years, and could be extended for another 5-10 years. Many private players entered the fray, but only a few were successful because of the plethora of problems — from regulatory to operational and infrastructural — that plagued the industry. GoI notified the policy for granting extensions to PSCs, and notified rules thereafter, operational from March 2016, thereby governing most of the producing private sector oil and gas fields.

Broadly, the fiscal changes were, one, that the share of profit petroleum would be 10% higher than as according to the old PSCs; two, royalty and cess would be payable at prevailing rates (ad valorem). These would aggregate to 36.67% on the value of oil produced/sold.

Assuming the price of oil to be, say, $60 a barrel, under the existing PSC, the payout on royalty and cess would be about $3 a barrel. After the PSC extension, it would be $22 a barrel. This is an increase of over 633% in direct cost to the operator.

Such drastic increases in royalty and cess rates would significantly raise the amount of production required from each new well drilled to be economically viable for the operator. Since most of these fields are over 40 years old, this is a very difficult task. It is very likely, therefore, that many of these fields may have to shut down, resulting in lower investments, lower production, lower employment and, ironically, lower royalty and cess collection for the government.

These factors will further cripple the industry and give future entrants second thoughts. Large corporates like Reliance Industries, and now Cairn, are also losing interest due to fiscal issues. ONGC, unlike private sector companies, does not pay profit petroleum to GoI, which in most cases amounts to 50% of the profits for private sector oil and gas fields. The private sector should be allowed a level playing field.

The oil sector is still under the VAT regime. As a result, it does not get a set-off for all the GST paid to service providers utilised in oil operations. A single onshore well could cost ₹14 crore ($2 million) in payments to service providers, and at 18% GST, the input credit loss (no set-off) is as high as ₹2.5 crore a well.

The authorities should revisit these drastic issues in the larger interest of increasing oil production and attracting private sector players. Controlling fiscal deficit, pressure on the rupee exchange rate and oil prices are also important goals for GoI, in which reduced oil imports could play a major role.

It may also be pertinent to point out that one of the clauses in the PSCs is the equalisation of economic benefits. This broadly states that if there are any changes in laws or rules, including taxes dependent upon the value of petroleum, which result in a material change to the economic benefits accruing to any of the parties to this contract, the parties shall consult promptly to make necessary revisions and adjustments to the contract to maintain such expected economic benefits to each of the parties.

To prevent a ‘telecom-style’ meltdown, the time has come for GoI to honour the PSC clause and roll back the arbitrary — and enormous — increases that have followed. It also needs to resolve long-pending arbitration disputes to prevent the private sector oil industry from going under.