The key to controlling oil and gas imports is to offer prices that are on par with international prices. Since the oil and gas trade deficit contributes to more than 3/5ths of the trade deficit, our economic health depends on how quickly we can close this wound...

1. Gas Pricing: Extracting Reason from the Depths.
India, the world's fourth-largest energy consumer, uses coal for
nearly 56 percent of its energy needs, while oil accounts for another
26 percent. It aims to double the proportion of gas in its energy mix
to 20 percent by 2020. Demand for gas in India's economy far
outstrips production, as India's desire to keep prices cheap for the
power and fertilizer industries deters investment in costly
producing areas and in pipelines and terminals for more expensive
LNG. There is a simple lesson to be learnt about oil and gas pricing.
The higher the prices the greater the reserves as more become
economically viable. The key to controlling oil and gas imports is to
offer prices that are on par with international prices. Since the oil
and gas trade deficit contributes to more than 3/5ths of the trade
deficit, our economic health depends on how quickly we can close
this wound.
The Narendra Modi government has postponed taking a decision
on domestic gas prices as proposed by the Rangarajan Committee
by another three months. The Rangarajan formula calls for pricing
at an average cost of importing liquefied natural gas (LNG) into
India and rates prevailing at international hubs in the US and UK
as well as the price of gas imported into Japan, indicating a price of
$8.4 per mmBtu. As ONGC and Oil India produce more than 70%
of the gas, it is they who benefit most by any price increase. ONGC
expects to add about Rs 8000 crore in profits annually and Oil
India another Rs.1000 crores thanks to the increase in gas prices.
Standard & Poor’s anticipates that the increase in gas prices will
significantly improve ONGC's operating profit by about 20 per
cent, compared with 5-7 per cent for RIL.

2. But anything to do with Reliance automatically becomes
problematic. Its baggage of perceived wrongdoing, corporate
skullduggery and the much-celebrated regime insensitive influence
in the halls of government often precludes an objective analysis of
any policy issue that concerns it. Consequently the issue relating to
the pricing of the gas production from D1 and D3 fields in block
KG-D6, India’s first ever deep-water field has become an extremely
contentious one.
Quite simply the issue is thus. RIL was given the contract to extract
gas from the D-6 block from depths of about 3.5 kilometers in the
high seas. The extractable reserves were initially estimated to be
11.3 trillion cubic feet (Tcf) of 2P reserves. In the oil terminology 1P
means proven reserves, 2P is for proven plus probable, and 3P is
for proven, probable and even possible reserves. This was
downscaled by the DGH to 10.3 Tcf.
Last RIL restated these 2P reserves by 10-15% suggesting they
could be 8.5-9 Tcf. Deep depth drilling is a tricky business.
Historically, 2P reserves have a strike rate of 50%. The 1P reserves
in KG D1 and D3 are just 1.4 Tcf. RIL was expected to drill 50
development wells, but so far has drilled only 18. RIL indicates that
it has hit a slew of unforeseen problems with water and sand
ingress into the fields, making further drilling commercially
unviable and technologically impossible.
RIL partners, the oil majors BP and NIKO, too have downgraded
the reserves in D-6 by as much as 70% to a mere 2.9 Tcf from the
original 10.03 Tcf. It is not exactly uncommon for a producer to
downgrade its estimated reserves after drilling a few wells.

3. ONGC/OIL have done it several times. But they are never held
responsible for the so-called under-recovery.
Some in the Ministry for Petroleum and Natural Gas (PNG, then
dug their heels and insisted on 50 wells. RIL says if the 1P reserves
are extremely limited and 2P is tending towards 3P, it would be
pointless drilling more wells. It’s akin to drinking from a bottle of
juice with more than one straw. In other words, the extractable oil
will remain the same despite more wells. Their argument is that if
India needs more oil it should discover more fields. And India
needs more oil, as of yesterday.
In 2007 the PNG ministry appointed Dr. P. Gopalakrishnan, a
reservoir management and optimization consultant to look into the
reasons for the rise of phase I capital expenditure from $2.47
billion to $5.2 billion. But Dr. Gopalakrishnan too has a past
baggage problem. He was responsible for a previous study for
upgrading the reserves. That is, according to him, there are more
1P reserves. In his report to the PNG ministry he recommended
that RIL be asked to drill more wells. Some of the PNG bureaucrats
and others are now holding this report as the gospel. The conflict
of interest should be apparent to anyone willing to open his or her
eyes. RIL is essentially saying that the initial diagnosis is wrong;
the biopsy proves it and so don’t expect us to follow his line of
treatment, and at our cost.
Now let us look at the macro-economic realities. India had a trade
deficit of $191 billion in 2013. Of this $109 billion was due to oil.
India imports 82% of its oil needs. Last month the price of the
Indian basket of imported oil peaked to $114 a barrel when it was
assumed that it would be $104. Every additional dollar adds $1

4. billion to the oil bill. India is the world’s fourth largest consumer of
energy with an oil equivalent of 563.5 million tonnes of oil a year.
Its oil demand is growing by 5.1% every year. Clearly there is an
urgency to produce more oil and gas domestically. The road to our
national salvation means closing in this trade deficit, which means
reducing our energy import dependency quite significantly.
There are plenty of 2P and 3P reserves in and around India. We
have to make those fields viable by higher producer prices. Last
year the Government subsidized oil consumption (under-
recoveries of petroleum marketing PSU’s) to the extent of Rs.190,
000 crores or close to $30 billion at today’s exchange rates.
Fertilizer subsidies and electricity subsidies further ramp up the
subsidy bill. The argument many make is that higher indigenous
PNG producer prices will mean higher government outflows
towards subsidies are nonsensical. For a start they are unmerited
subsidies. Then the Government needs to make a call between
stimulating higher oil and gas production in India and the sundry
desires of citizen consumers for lower prices.
Now if the government were to take D6 gas at $4.32/MMBTU and
sold it at say $13.60/MMBTU it will gain 85% of the extra
$9.28/MMBTU which would mean a yearly gain of over Rs.50, 000
crores to the government. The question is why should the
government give this away to big industry when it could do well to
use this money to help uplift tens of millions more each year out of
their miserable BPL existence? RIL has a point. Why should it be
penalized to make other tycoons happy? And we must not also
forget that every rupee given as a subsidy on fertilizers, electricity
and domestic gas is actually snatched from the poor who benefit
little from the State, and ironically enough even less after the so-
called reforms.

5. RIL antagonists on the other hand harp on the sanctity of
Production Sharing Contract (PSC). The PSC is a standard oil and
gas industry contract and explicitly acknowledges that that reserves
and production figures are governed by probability and not
certainty. An expectation is very different from a certainty. The KG
D6 field was mostly about 8.5-9 Tcf of 2P reserves of which 1P
reserves are just 1.3 Tcf. Clearly it is a business of chance. When an
estimate is given it cannot be clung to as if it was a guarantee. Only
the very naive will give or expect guarantees in the oil business.
The Government of India too is not without its credibility
problems. It is now increasingly perceived to have become
discriminatory and arbitrary. By its pricing policies it clearly
discriminates between imported and domestic production. This
discrimination has resulted in waning interest for India’s NELP
over the last few years with fewer and fewer substantial companies
coming to bid for blocks. Oil majors, repeatedly seeing expediency
overtake policy, have stayed away as they have become extremely
skeptical of the sanctity of contracts signed with the Government.
The Modi government needs to set its course and not allow old
prejudices and corporate rivalries cloud its judgment of crucial
national issues. It has to sustain a policy to increase indigenous
PNG production and reduce import dependency. But first it must
extract reason from the depths it has been buried into.
Mohan Guruswamy
Email: mohanguru@gmail.com
2 July 14