Shocking decline of gas production in Krishna-Godavari Basin

At that time the prognosis was to reach 80 mmcmd by April 2012. The reality turned out to be different. By November 30, 2010, the gas production had started to decline. The current production is under 50 mmcmd and is likely to go down even more. As a result, chances of Karnataka securing any gas supplies from KG basin is likely to remain a pipe dream.

As late as March 2011, the Directorate General of Hydrocarbon (DGH) issued a report stating that Reliance gas production from KG basin would go up to 67 mmcmd by April 2011. How can an autonomous and independent agency like DGH give such misleading information? DGH is charged with the responsibility of managing the production sharing agreement on behalf of the government.

Experts of DGH should be as knowledgeable as that of Reliance on technical data concerning KG-D6 block. They should be closely monitoring the operations of Reliance and be up to date on any problems faced by PSA contractors. How and why were they in the dark till Reliance informed them formally on the problems faced by Reliance in KG-D6?

All over the world, when new oil and gas fields are discovered, predicting the rate of production has not been easy. Geological complexity especially in new territories usually turns out to be difficult during the early phase of the production even to the experts. The same seems to be happening in the KG basin.

According to Reliance, because of water ingress there has been pressure drop in the wells leading to lower production. According to them drilling more wells is not a solution. However the consultant hired by DGH has been recommending that by drilling more wells in newer areas production can be increased. Under the PSA, DGH cannot force Reliance to make an investment. It can only question the gold plating to disallow the cost recovery.

Reliance must have realised that it will not be able to manage the complexity of the gas reservoir and sought to form a joint venture with a multinational like BP with greater expertise in deepwater technology. Usually oil companies do not seek partnership after a discovery unless they are short of capital or they want to manage any potential political risk. In the case of Reliance these do not apply.

Another factor which is preventing aggressive development of gas reserves in Krishna Godavari basin not only by Reliance but also by others like the government owned ONGC and Gujarat State Petroleum Corporation is the irrational gas price control by the government.

Faulty pricing formula

In 2007, the empowered group of ministers recommended a price based on the pricing formula submitted by Reliance with some tweaking. Based on that formula the landed gas price for KG-D6 was fixed at $4.20/mmbtu for five years. Even in 2007, the gas price for KG-D6 was considerably below the market price.

It is such irrational prices which are fixed though not for a long time period and do not have any relation to market reality disincentivise the development of gas discoveries. Part of the blame lies with Reliance since it was Reliance which had developed the pricing formula.

Today when crude oil price is around $110 per barrel, on fuel oil equivalent basis, LNG landed price would have been around $14/mmbtu. It is surprising that Reliance had suggested a pricing formula which had no relationship to competing fuels. When LNG is the incremental fuel which meets the marginal demand of gas in India, it can be argued that LNG pricing formula should have been the basis for arriving at KG -D6 gas pricing formula.

The situation has been made even more complex with the interference of petroleum ministry in forcing Reliance to sell gas to the so called priority sectors like power generation, fertiliser companies, residential consumers and LPG extraction plants and cutting off supplies to steel companies, petrochemical plants and refineries.

Steel companies have gone to the court complaining about their huge losses. Is the government capable of figuring out the optimum gas allocation to maximise the overall economic output? Has the government considered the capability of companies to switch from gas to alternates, cost of switching, lost revenues of the companies as a result of losing gas supplies, etc? It is because of such complexity, such an allocation should be left to the market which can do a far superior job through price setting mechanism.

Instead the government having made the mistake of setting the price in an irrational manner is making another blunder by taking up an equally difficult task of allocation. Or is such a task preferred by political leaders or bureaucrats? Does such discretion give them an opportunity to show favouritism like in the case of 2G scam?