One wonders what would have happened to the Indian natural gas sector had Dhirubhai Ambani fathered only one son or if his sons had not fallen out after his death. Available evidence suggests that a precious natural resource of the country would have become, for all practical purposes, the property of one business house as the undivided Reliance Industries Ltd. (RIL) would have been one of the largest producers, transporters, distributors and consumers of gas in the country.
Instead, the scions of Reliance had a falling out and therein lies a story. One of them got the production, transmission and distribution side of gas and the other got the power generation sector which was thirsty to consume the gas. Thus, what should have just been an unfortunate family dispute has had the fortunate side-effect of spilling a lot of smelly beans, grabbing media attention and hopefully catalysing some positive changes in the sector.
Various issues, such as the price of the gas, the utilization of the gas, justification for the investments made by RIL into the gas fields, the validity of a family MoU, the validity of a Government contract, and the impact of all this on Government revenue and subsidies, have been highlighted over the last few months by different commentators. Let us join these dots and see what emerges.
Before the split
It was way back in 2000 that the Government of India (GoI) signed a Production Sharing Contract with RIL for the KG-DWN/98-3 block in the Krishna Godavari basin. According to the contract, RIL (along with its junior partner Niko) would explore the block and, if it found any gas (ignoring oil for now though the contract also catered to oil finds), it would be free to sell the gas within the country subject to certain conditions.
The Government was also guilty of omission in not formulating a gas utilisation policy for over five years.
The important conditions were that a) the gas would be sold according to the utilisation policy of GoI, b) the price of the gas would be discovered through 'arms-length negotiations' based on a GoI approved formula prior to signing sale-purchase contracts and c) after it had recovered its costs in the block through sale of gas, it would share any profits with GoI. The profits were to be shared according to a formula where the Government's share of the profit went up from 10% to 85% over time, with the Government's share being a function of the cumulative revenue from the block divided by the total investment into the block.
So far, so good. In 2002-03 RIL discovered about 300 BCM (billion cubic metres) of gas in a few wells in the block - one of the largest discoveries in the world in that year. So, in 2003-04, when NTPC launched an international tender to buy 12 mmscmd (million cu m/day) of gas for 17 years, RIL won the bid to supply the gas with a fairly low quotation of $2.34/mbtu (million btu) since its primary competition was imported LNG which was costlier.
Cracks in the empire
But, by 2004-05, about 2-3 years after the death of the Ambani patriarch, the empire had begun to crack and the Ambani brothers had decided to split their business interests. Towards this end, they entered into a de-merger MoU, as part of which RIL (which was part of Mukesh Ambani's share) agreed to supply Reliance Natural Resources Ltd. (RNRL, an Anil Ambani group company) 28 mmscmd of gas at the same price as promised to NTPC, and additionally, any of the 12 mmscmd gas that NTPC was unable or unwilling to consume.
In other words, about 70 per cent of the gas then expected to flow from KG basin was to go from one side of the Reliance fence to the other. Needless to say, in the absence of the falling out, all this would have stayed within the undivided Reliance umbrella.
Around 2005-06, in the backdrop of increasing international gas prices and the growing feud with RNRL, RIL claimed that its contract with NTPC was never 'concluded'. This naturally rendered the MoU to supply gas to RNRL invalid since it had piggy-bagged on the NTPC one. This forced NTPC to go to court to try to secure its gas supply, while RNRL filed a case to force the implementation of the MoU. Incidentally, it is this latter case which has been hogging all the recent headlines and which resulted in an aggressive ad campaign by Anil Ambani's group against RIL after the Bombay High Court ruled in his favour.
Curious role of the government
Even as all these events unfolded, one party was conspicuous by its deafening silence in the matter, namely the GoI in general and the Ministry of Petroleum and Natural Gas (MoPNG) in particular. This, like the famously curious Sherlock Holmes incident of the guard-dog that didn't bark, was most peculiar, since the gas at the centre of the controversy belonged (and still belongs) to the nation, with the Government as its custodian. So, the Government had a duty to protect the public interest.
In addition, the Government was also guilty of omission in not formulating a gas utilization policy for over five years, and not stepping in to approve or disapprove the pricing formula that won the NTPC tender. Not surprisingly, both of these are now central in the hotly contested legal quagmire.
Things got worse in 2007. RIL 'discovered' a price of $4.5/mmbtu through a seriously flawed auction of its own, which involved inviting bids selectively from gas-starved consumers who had already sunk large amounts of money into assets that needed gas, and was based on a formula that anyway allowed very little leeway in terms of the final discovered price. In spite of all its weaknesses, which had been recognised by various parties including a Government-appointed Committee of Secretaries and the Economic Advisory Council, an empowered group of ministers constituted by GoI only tinkered with the formula a bit and 'authorized' a price of $4.2/mmbtu for gas from the KG basin.
Meanwhile, the investment figures (i.e. the costs incurred for exploration, development and production) also gradually increased from about $2.5 billion to $8.8 billion. Given that the profit from sale of the gas is to be shared with the Government after the contractor recovers all his costs, these greater costs naturally imply a lesser share of revenue to the Government. Some studies have shown that such an increase in investment levels would halve the net present value of Government revenues at the price of $4.2/mmbtu.
Whether this higher cost is justifiable is still a raging debate. On the one side, the Directorate General of Hydrocarbons (DGH) has defended its approval of RIL's expenditure levels, saying they have been verified by reputed international consultants and compare well with international costs. On the other side, RNRL has been leading a vigorous attack on non-transparency behind RIL's investment levels and conflict of interest in the audits conducted so far, obviously with an implication that the higher price of gas is not justified and that it should get the gas at a lower price.
Even the Comptroller and Auditor General of India has now joined in (after the DGH stated that it had approved the RIL investment levels) and said MoPNG and RIL have not been very co-operative in providing access to KG basin accounts for auditing.
A chance to clear the cobwebs
In the meantime, the Centre has been tying itself into knots, with MoPNG on the one hand trying to defend its actions in approving a price of $4.2/mmbtu and investment levels of $8.8bn, and MoP on the other hand trying to protect NTPC's interests and get gas at $2.34/mmbtu. Eventually, the Government has formed a committee of ministers that is attempting to hammer out a compromise, though its credibility has been badly damaged. The refusal of the watchdog to bark at the right time has come back to bite its credibility, and no less than the Prime Minister got involved and pleaded with the brothers to settle the dispute amicably even as the governance crisis threatened to spin out of control.
But thanks to these acrimonious battles between the brothers, it is now at least public knowledge that a) natural gas is a valuable national resource; b) the emerging market in the natural gas sector is highly concentrated; c) RIL is a massive vertically integrated player with significant presence in every segment of production, transmission and distribution; d) there is need for greater transparency in investment levels and indeed, in the entire block auctioning and contract awarding process and e) there is a need to re-look at the gas utilisation and pricing regime to maximise the public interest too, rather than private profit alone.
One hopes that all this attention will help to clear the cobwebs from the sector and help to pave the way towards completely revamping the natural gas sector, so that the concerned ministries and regulators not only act in the public interest, but are also seen to act in public interest, and promote the energy and food security of the country. At the least, it should lead to a clear articulation of a gas pricing and utilisation policy based on transparent and participative discussions, setting up effective and just regulatory systems, reducing concentration in gas markets and greater transparency in the functioning of the upstream regulator and management committees of the exploration blocks.
Imagine how hard it would have been to bring all this into public discourse if the brothers had not quarrelled, especially considering that the watchdog remained distressingly quiet. Perhaps we really have a lot to thank Dhirubhai Ambani for!
