Resolve royalty row before approving Cairn-Vedanta deal: ONGC

ONGC holds a 30 per cent stake in Cairn India's mainstay Rajasthan oilfields, but is liable to pay royalty on all the crude oil produced from the fields, making the nation's largest onland field a losing proposition for the PSU.

Its board yesterday recommended to the government that the royalty it pays not only its share, but also on the 70 per cent share of Cairn India, should be deducted from the price realised on the sale of crude oil from Mangala and other oilfields in the Rajasthan block, sources in-the-know of the development said.

The ONGC board's resolution will be added to the preconditions that the Oil Ministry has imposed for approving the Cairn-Vedanta deal.

Sources said the preconditions, including resolution of ONGC's royalty liability, have been vetted by the law ministry and the same are being sent to the Prime Minister's Office.

ONGC's board yesterday noted that the Solicitor General of India has opined that the state-run firm's preemption rights will be triggered upon UK's Cairn Energy selling up to 51 per cent of its stake in Cairn India to Vedanta.

The stake sale will lead to a change in ownership in the 10 properties held by Cairn, the nation's second highest law officer opined. ONGC is a partner in seven of these blocks, including all three producing properties of Cairn.

While Cairn had reluctantly agreed to seek the government's consent for a change in ownership in all 10 properties, it has refused to recognise ONGC's preemption rights, a fact that the board noted. In contrast, the ONGC board  felt that in line with the SGI opinion, Cairn needs its prior approval for the stake sale, they said.

Sources said the ONGC board noted that the Rs 405 a share price Vedanta is paying was about 40 per cent more than its own internal valuation of Cairn India and so it would not like to match the offer or make a counter-bid.

The Oil Ministry and its regulatory arm, the DGH, are also in favour of adding the royalty paid by ONGC to the Rajasthan project cost.

In the case of fields awarded under the New Exploration Licensing Policy (NELP) -- like the gigantic KG-D6 gas fields of Reliance Industries -- royalty can be added to the capital and operating cost of the block, which as per law are deductible from revenues earned on the sale of oil and gas before calculating profits for all stakeholders.

The Production Sharing Contract (PSC) for the Rajasthan block is silent on the treatment of royalty and Cairn is opposed to its addition to the project cost as it would lower its profits.

The Oil Ministry, which was asked to take a decision on Vedanta buying most of Cairn Energy's 62.38 per cent stake in its Indian unit by the end of the month, had asked ONGC to give its response on the transaction by January 27.

The response of ONGC is being submitted to the Oil Ministry, which will incorporate it in a letter it will write to Cairn-Vedanta giving "in-principle" approval for the deal. The letter will list out a set of 11 preconditions that Cairn/Vedanta will have to meet for securing the government nod, they said.

Sources said ONGC wants the royalty it pays on the entire expected crude output of 12 million tonnes per annum from Cairn's Barmer oil fields to be added to the project cost and profits for stakeholders be calculated thereafter.

As per the Production Sharing Contract (PSC), the operator gets to first recover all project costs from the sale of oil or gas produced from a field before profits for itself and the government are calculated.

Treatment of statutory levies like royalty paid by ONGC are explicitly mentioned in the PSC for the Rajasthan block and Cairn is opposed to their inclusion in project cost, as it will not only lower its own profit, but also the profit that the government earns, they said.

The preconditions being set for the Cairn-Vedanta deal include the withdrawal of pending lawsuits and accepting the ministry's diktat on future petroleum operations in the Rajasthan block.

The preconditions also include Vedanta guaranteeing that Cairn's technical capability will be undisturbed by the share transfer agreement and the London-listed firm providing a fresh financial and performance guarantee.

Vedanta would not have factored in reduced profits because of the inclusion of royalty in the project cost and may be forced to call off the deal if ONGC takes the matter to arbitration.

Sources said the royalty liability on ONGC, wherein it has to pay 20 per cent of the price realised on the entire output of crude oil from fields like Rajasthan even though its share of production is only 30 per cent, is a historic legacy and the government had at several times considered reimbursing the part which the PSU pays on behalf of foreign operators like Cairn.

The government had in the 1990s put the liability of statutory levies on national oil companies to attract global players to the then-nascent oil and gas sector in India.
The royalty liability had made projects like Rajasthan economically unviable for ONGC. Royalty could be reimbursed from the government's profit share from the Rajasthan field, the Oil Ministry had opined earlier.

Sources said the ONGC board yesterday decided not to press for reimbursement if royalty is included in the project cost.

According to the Production Sharing Contracts and the government of India policy for pre-New Exploration Licensing Policy (NELP) blocks in the 1990s, 100 per cent of statutory levies (including royalty) were to be borne by the NOCs in order to provide a competitive fiscal and contractual regime.

During this period, the relationship between the government and NOCs was seen in a different perspective, because the NOCs were 100 per cent owned by the government. As such, the NOCs' rights and obligations in the pre-NELP blocks were to be borne by the government.

To attract investment in exploration and production in India during the pre-NELP regime, the government consciously placed the responsibility of royalty entirely on the licensee. In return, NOCs could take a 30 per cent stake upon a discovery in these blocks without incurring any risk capital or past cost.

In the Rajasthan block, Cairn invested USD 600 million of its own risk capital on exploration and once the oilfields were discovered, ONGC, as the government nominee, acquired a 30 per cent stake in these fields without paying anything.

In 1997, it was agreed by a Group of Ministers (subsequently discussed by Committee of Secretaries in February, 1998, and reviewed various in recent years) that NOCs could be reimbursed for actual liabilities out of profit petroleum accruing to the government, sources said.