Deep controversy bogs down Reliance

If you look north from a helicopter hovering 19 miles off India’s east coast, the Bay of Bengal looks as it must have done centuries ago. Tiny fishing boats with white sails pitch and yaw across the ocean. 

Look down, though, and you will see the new India. 

A landing pad says ''Dhirubhai’' in big letters, the name of the founder of Reliance Industries. 

The helipad sits on a vast processing ship. Oil and gas rise from the seabed 3,000 feet down.

 The vessel siphons off the oil while the gas is piped ashore. 

It is one part of an $11 billion project by Reliance and British Petroleum, the British oil giant, which originally was hailed as the answer to India’s energy problems but is now embroiled in controversy. 

 

When Reliance found gas in 2002 in a block called KGD6, it was the world’s biggest gas discovery that year and India’s largest since the 1970s. 

For the country it was wonderful news. 

The discovery showcased the power of India’s private sector. What was good for India was good for Reliance. 

As excitement built, analysts began to speculate that the firm might eventually evolve into the next ''major’' energy firm, rivalling the likes of Exxon Mobil, Shell and Total. 

 

As late as December 2009, Dhirubhai’s dream seemed on track. That month tests at KGD6 yielded production of 80 million standard cubic meters per day. 

Huge capital investments had been made onshore in anticipation of a flood of gas, including at least $15 billion in gas-fired electricity plants built by a variety of power firms. 

The Ambanis spent between $2 billion and $3 billion on a new cross-country gas pipeline, owned by them rather than by Reliance at regulators’ insistence, they say. 

 

That euphoria is long gone. Production started falling in late 2010 and today stands 80 percent below the peak. 

When KGD6 was first being developed, Reliance reckoned that it might contain 10 trillion cubic feet of gas. 

Proven and probable reserves today are only 3 trillion. 

 

What went wrong? 

 

An old saying about India is that whatever you say about the country is true, as is its opposite. In this case two violently different views exist. 

 

The first is conspiratorial. 

It accuses Reliance of ''gold-plating.'' Under the production-sharing contract that governs the block, it can recoup its costs before any profits are split with the state. 

India’s national auditor has implied that Reliance deliberately inflated its costs, and hinted that it thinks some of the contractors used were secretly related to Reliance. 

 

Worse still, Reliance is accused by some of holding India for ransom, deliberately suppressing production of gas until it could get a higher price for it.

Under the original contract Reliance receives a ''market-based’' price, which in reality is set by the government. Until March this was fixed at $4.20 per million British Thermal Units (BTUs), about a quarter of the price India pays for imports of liquefied natural gas. 

As of April, a new formula will apply, based partly on global benchmarks, which should see the price rise to about $8. 

 

It’s a disgraceful scam, anti-graft campaigners insist. 

They argue that Reliance, with its cash-rich balance sheet and its legacy of political influence, had every incentive to suppress production until it could bully the government into raising prices. 

In support of this view, they point to the presence of BP. 

The British firm bought into the project in 2011, as production was falling, at a valuation – it paid $7 billion for a 30-percent stake – that implied that it still was a raging success. 

By this account BP knew that there would be a short-term ''crisis’' in output, but also that, once gas prices in India rose to more attractive levels, the field’s production would miraculously ''recover.'' 

 

It is hard for outsiders to evaluate the geology of KGD6. 

Reliance and its partners say that water had flooded parts of the field, giving a misleading initial impression of its potential, and that some gas pockets are isolated and hard to get to. 

 

The conspiracy theory does, in totality, look implausible. 

On the charge of gold-plating, most analysts concede that there are some scenarios in which the small print of the production-sharing contract could give Reliance an incentive to over-invest. 

However, most also think it almost impossible to fine-tune a big project to exploit these theoretical gains. 

Costs shot up because there was a global boom, inflating the price of hiring drilling rigs and equipment. 

 

Marketing gas

What about the charge that production was deliberately suppressed, with BP as supposed partner in crime? 

Past and present executives at the British firm say that it knew, when it signed the deal, that the geology in KGD6 was tricky. Indeed, it was brought in partly because of its expertise in sub-sea fields. 

It paid top dollar partly for the exploration potential in the five other blocks that Reliance and its partners still control today and partly for the potential of a ''downstream’' joint venture for marketing gas. 

 

The financial incentives of the main players do not support the idea of a scam. Ambani has lost a great deal on the gas pipeline he owns personally, which is thought barely to break even.

His foreign partners were under pressure to maximize short-term profits, not to feign a production slump. 

After the Deepwater Horizon accident in April 2010, BP faced a liquidity squeeze, a huge cash drain from litigation payments and the threat of a takeover. 

The smallest partner in the field is Niko Resources, a Canadian firm with a 10 per cent stake. Its shares have fallen by 98 per cent since 2010 and it has suffered financing problems. 

 

It is not clear that the project will make an acceptable return on capital, even at the higher gas price. 

Total cumulative capital investments will amount to $15 billion to $20 billion, the bulk of them made before 2013.

Estimates vary wildly, but total gross profits might amount to $20 billion to $30 billion, most of them generated after 2016. 

Taking into account income tax and the time value of money, the project could well be an example of value-destruction, not profiteering. 

ONGC, for now Reliance is trying to raise the output of existing fields and bring new ones online. 

In May it announced a ''significant’' discovery two miles below sea level, underneath the main field in the KGD6 block. 

BP expects the production of their joint venture to recover to 40 to 50 mscmd by 2018.