New Exploration Licensing Policy (NELP)

Under this policy, government auctioned potential oil and gas field areas to private players such as Reliance, Cairn etc.

These companies would take all risk of discovering the oil/gas, drilling it out and sell to to make profit.

Conventional Mining and Royalty

if you are involved in Iron-ore mining, the Indian Bureau of Mines ( IBM) will determine its present market value and you have to pay 10% royalty of that, to the Government.

For example you digged 1 kilo (!) iron ore, its present market-value is Rs.100, you’ve to give Rs.10 as royalty

It does not matter how much profit you make out of this, you’ve to pay 10% right from the day one of your mining activity.

But for the gas-exploration, the system of royality is different, it is called:

Production Sharing Contract (PSC)

But here in case of gas, first you’ve to do “Exploration”. It may happen that you drill in a potential area but still donot find any gas, and yet you’ve to purchase expensive drilling instruments, vehicles, hire engineers and monthly salary to staff etc.

So there is a “ gestation ” period involved, before you actually discover the gas, start selling it, recover your costs and then see the profits.

” period involved, before you actually discover the gas, start selling it, recover your costs and then see the profits. If there is a direct “royalty” sharing formulas like conventional iron-ore mining, then private players will not be interested in taking the risk in this gas exploration activity.

Hence government came up with a concept called “Production Sharing Contract (PSC)”

Under this scheme, the company will have to share royalty, according to the profit made.

Initially company makes low profit, government gets extremely low share, later company discovers more and more gas fields, its production increases and costs go down, then it has to share more profit to the government.

This is not the standard royalty model as seen in mining systems, where revenue is shared regardless of profitability. This PSC model allows the operator (RIL) to substantially recover his costs before the sharing of revenue.

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

But As you can understand Private contractors (RIL) have virtually no incentive to minimise capital expenditure and a substantial incentive to increase capital expenditure (they’ll buy more and more vehicles, machines etc) to keep their operation-cost high, which would result in low/lowest share of profit for the government of India

The crux of Reliance KG Basin controversy

It is alleged that Reliance used false accounting-methods to show huge-costs and operating expenses to keep the profit low so that they have to pay less money to the Government.

CAG found this out after auditing, media started reporting, right now matter in PAC (Public accounts committee) of parliament.

Also, RIL had to take permission of government before raising the sale price of Gas.

So citing the heavy cost and low-profit, Reliance also increased the sale price of gas with Government’s permission.

And then this (expensive) gas was sold ot fertiliser companies, power plants and thus snow-balling effect: price of fertilisers, electricity also increased = inflation .

. Director-general of hydrocarbons (DGH) was responsible for looking after this exploration-activity, how much gas is generated, what is the operating cost, is there any real loss etc. (but as the common sense suggests) he might have taken “suitcases” to turn a blind eye to all this.

Dateline of Reliance KG Basin Controversy

1999 Vajpayee Government introduced NELP (NEw exploration licensing policy)

2000 Reliance got the licence to explore gas in Krishna Godavari Basin

2002 Reliance Industries discovered huge reserves of natural gas – and some small reserves of crude oil – in a block called D6.

2007 CAG starts auditing

2011 CAG submits audit report and media starts reporting this controversy.

War of Words

CAG

Oil Ministry and its technical arm, the Directorate General of Hydrocarbons, “did not pay adequate attention to protecting the government’s financial interest.

Reliance Industry’s response

CAG has not found any false inflation of the cost or any dishonesty in developing the nation’s largest gas fields.

Corporate rivalry motivated a few people with vested interests to indulge in a vicious smear campaign against us

CAG neither had any expertise in hydrocarbon exploration

Ashok Chawla Committee on “Pricing of Natural Resources”

Production Sharing Contracts like the one Reliance Industries signed for the gas-rich KG-D6 are designed to benefit private players at the government’s expense.

Tapan Sen, a Rajya Sabha MP