Oil and gas: Hurdles to domestic production

Prime Minister Modi wants India to reduce its oil and gas imports by 10 per cent by 2022. This seems a tough ask given the many challenges in increasing domestic production.

The ongoing protest in Neduvasal village in Tamil Nadu’s Pudukottai district is symptomatic of a key risk — that of getting local consent for hydrocarbon projects in onshore areas. Worried that drilling for oil would pollute their lands, farmers in Neduvasal have been protesting against work in a block allotted under the Discovered Small Fields bidding.

For years, protests by farmers in Tamil Nadu and Kerala have held up the Kochi- Bengaluru-Mangalore gas pipelines being laid by GAIL. With land becoming a premium resource, such protests can increase in the future.

The HELP (Hydrocarbon Exploration Licensing Policy) regime brought in last year seeks to address pain points in the older NELP (New Exploration Licensing Policy). It is an extension of the liberal rules for the auction of the discovered blocks surrendered by ONGC and Oil India.

The HELP has progressive provisions — easy-to-implement revenue-sharing contracts, unified licensing policy that lets exploration of all hydrocarbons in a block, open acreage licensing that allows on-tap bidding, and pricing and marketing freedom for new gas production from difficult terrains. But the fly in the ointment could be the revenue sharing mechanism replacing the erstwhile production sharing contracts (PSC).

In PSCs, contractors could recover costs before sharing profits with the government. This reduced their risk significantly. But in the revenue sharing mechanism under HELP, contractors have to share revenue with the government from the start of production; costs cannot be recovered first. Whether industry players will be game for this in high-risk exploration ventures needs to be seen.

Market-linked gas pricing

Then, there is the problem of formulae-based gas pricing. Unlike crude oil, domestic gas price in India is not market-linked. From November 2014, it is being determined every six months as a weighted average of four international benchmarks — US-based Henry Hub, Canada-based Alberta gas, UK-based NBP and Russian gas. Given the prolonged weakness in international gas markets, domestic gas price has gone downhill.

From $5.05 per mmbtu during November 2014 to March 2015, the price has crashed to $2.5 a unit during October 2016 to March 2017. Gas imported into India costs $6-$7 a unit currently. There is no incentive for contractors to scout for domestic gas.

Market-linked pricing is imperative to encourage gas production in the country. Under the HELP, the pricing and marketing freedom for domestic gas is restricted to new gas production from deepwater, ultra deepwater, and high-pressure, high-temperature areas. Here too, the price is subject to a ceiling, based on a formula, involving the import price of alternative fuels. The current gas price notified for such blocks is $5.3 a unit, not exactly commensurate with the risks involved.

There is also the danger of the government nudging PSU companies to make sub-optimal investments. In December, ONGC acquired the Gujarat-government controlled GSPC’s 80 per cent stake in the not-so-successful Deen Dayal asset for $1.2 billion.

There are apprehensions in many quarters that this is a bailout deal for GSPC that is straining under high debt, though ONGC denies this. Sub-optimal capital allocation, if any, will impede the ability of the PSU companies to invest in the future.

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