Chawla panel critical of Reliance's KG-D6 PSC

However, the Oil Ministry rejected the criticism saying the New Exploration Licencing Policy under which Reliance bagged the KG-D6 block was designed by the BJP-led NDA government in 1999 and the terms being deplored now are ones vetted and signed by the then Atal Bihari Vajpayee government.

Reliance bagged the KG-DWN-98/3 block in the first round of NELP, which was pioneered by the NDA government, and signed the PSC for the block in 2000. "The Congress-led UPA government first came into power in May, 2004. You don't expect contracts signed by sovereign governments to be reneged just because a different party has come into power," an official said.

The PSCs provides for the operator to recover all capital and operating expenditure become the government's share of profit from a field rises to as high as 85 per cent.
This system gives "incentive to (an operator to) increase his investment, or front-end his work plan" in order to see that the threshold where government's profit take rises rapidly is not reached, the Chawla panel said in its report.

Oil Minister S Jaipal Reddy had yesterday indicated that the government will be open to accepting suggestions that can improve PSCs, but there are doubts if any chances in policy can be implemented with retrospective effect.

At the heart of the PSC lies the 'investment multiple', the ratio of net cash income to exploration and development costs. The investment multiple defines the share of profits that go to the government. The higher the expenditure, the lower the IM and hence, the government's share of profit.

Citing the example of KG-D6, the Chawla panel said, "The relationship between the pre-tax investment multiple (PTIM) and the share of contractor profit petroleum changes dramatically once the PTIM crosses 2.5, with the government's share increasing from 28 per cent to 85 per cent."

"It is useful to remember that this schedule is bid by the operator and not determined by the government," it said.

"A high share of some PTIM will help to win the bid, depending on the financial model of evaluation used, but it does raise concerns that such a radical change would provide very strong incentives for any operator to adopt all investment and strategies possible to ensure that the PTIM stays within the 2.5 limit," the panel report said.

The CAG, in a draft report on its audit of the KG-D6 accounts, had also criticised the current PSC structure saying it was "unsuitable for protecting the government of India's financial interests."

The Chawla panel said the NELP model is not an outright upfront bid model (often called a bonus model).

"Neither is it a standard royalty model as seen in mining systems, where revenue is shared regardless of profitability. Rather, it is a model that allows the operator to substantially recover his costs before the sharing of revenue," it said.

However, once these costs are recovered, the sharing with the government is often large.

"Private contractors have virtually no incentive to minimise capital expenditure and a substantial incentive to increase capital expenditure so as to retain the PTIM in the lower slabs, which would result in low/lowest share of profit petroleum for the government of India," the draft CAG report said.

The auditor said the Oil Ministry and its technical arm, the Directorate General of Hydrocarbons, "did not pay adequate attention to protecting the government's financial interest."

The report has been sent to the ministry for its comments.
The CAG was asked to audit KG-D6 after allegations of "gold-plating", or artificially inflating costs, were levelled against Reliance, which increased the development cost of the Dhirubhai-1 and 3 gas fields in the KG-D6 block from USD 2.39 billion proposed in May, 2004, to USD 8.8 billion in 2006.

The Comptroller and Auditor General has recommended a sliding scale of royalty payment linked to different oil and gas production quantities or values.

"In our opinion, this is the best formula, given the current context, for harmonising the financial interests of both the government and private contractors."

However, it said if the Oil Ministry wished to retain the current PTIM model, it should allow prospectors to bid as per a fixed profit-sharing formula with a specified band.

"This will at least minimise the incentive for skewed capital expenditure resulting in very low government share of profit petroleum, although it will still require enormous efforts by the government to control cost recovery," the CAG said.