A fact check on gas

How the recent gas price hike got it right.

ONGC, Reliance and Cairn, the three major oil and gas producers in the country, should make an earnest effort to bring politicians, bureaucrats and other opinion-makers to their producing fields in the offshore basins of Krishna Godavari, the desert of the Barmer district in Rajasthan, and the remote hill terrain of Tripura, Assam and Meghalaya. The purpose should be to “educate” through visualisation. It should be to show them the welter of well-heads, pipes, compressors, valves, chemicals, etc that have to be constructed and deployed, both on surface and below ground, more often under high pressure and temperature, and at great cost, to locate and then produce hydrocarbons. It should be to convince them that this business does not lend itself to conspiracy theories.

I make this suggestion because ever since the government decided to raise the price of gas to around $8 per million British thermal unit (mmbtu), there has been a spate of ill-informed commentary. I can understand opposition politicians taking a potshot at the government, but what I find troubling are the number of non-politicos who believe that this decision has been taken to benefit the private sector. There are many otherwise balanced individuals who are convinced that the discoveries of oil and gas by the private sector has happened only because these companies had privileged access to data because of their “contacts” within ONGC, that the government was “persuaded” to accept a contract structure that “legitimised” over-invoicing and gold plating, and that the recent price hike has no basis in economics and will disproportionately benefit the private companies. It is troubling because it reflects ignorance and a lack of understanding. It is particularly troubling because it deters fresh investment, and that at a time when nearly 50 per cent of the country’s trade deficit is because of oil and gas imports.I am not suggesting that the private sector is without clout. Our private energy companies are amongst the most powerful groups in the country. I am also not suggesting that these companies are pure as driven snow. On the contrary, they are driven by the profit motive and, given an opening, they will unhesitatingly exploit it to their advantage. But what I am suggesting is that these conspiracy theories are not built on solid ground, and that petroleum exploration is so complex that it cannot be “de-risked” through influence or access.

Oil and gas molecules do not accumulate in lake-like reservoirs. It is not as if one can punch a hole and drain the accumulation. These molecules exist within rock pores. The hole might locate the molecules, but if the rock faces are impermeable, there will be no flow. The well will be declared a no-show “dry”. Another well, drilled within the same geological structure may, however, encounter permeability, and there will be production. This is of course a gross simplification of reality, but the essential point is that geophysical data cannot assure a commercial discovery. Wells have to be drilled and then too, there is serendipity. My first commercial job was with Phillips Petroleum. It had been a small, Oklahoma-based, US-centric entity, but it grew into an international behemoth after it discovered the giant Ekofisk oil field in the North Sea. It made this in a licence area relinquished by the super majors. The latter had drilled a number of wells, but without success. Similarly, Reliance was not the first company to drill in the KG basin. ONGC had been active in the area for years before Reliance acquired the block. Data is no doubt important, but it is only the first step in a long, technologically arduous, risky, serendipitous and expensive trudge towards a commercial discovery. It is not a journey that can be undertaken by all. And it is not one that allows for a straight line, procedurally encumbered, L1 (lowest bidder) constrained mindset. There are four types of exploration and production (EP) contracts. The “concession agreement” grants the company the concession to explore and the government receives royalty income and taxes. The government is minimally involved with management and operations. The “service contract” pays the company a service fee, which is usually a margin over costs and/ or a fixed dollar per barrel. The government does not “lease” out the resources. Then there is the “joint venture” structure, wherein the government and the company share everything in proportion to their equity interest. And there is the “production sharing” contract (PSC), where the government, as the sovereign, takes a share of the production based on a sliding scale weighted in its favour. Typically, once the earnings of the company pass a threshold of profit and/ or rate of return on investment, the government’s “profit oil” ratchets up sharply to, in the highest tranche, as much as 90 per cent of incremental earnings.

Most Indian EP contracts are PSCs. This means that the government is the principal beneficiary of any decision, like a hike in the price of gas that pushes a company towards a higher earnings threshold. The private companies benefit but not disproportionately. The twist in the tail has been the concept of “cost oil”. The PSC gives the companies first call on production to recover their costs. This has led to the allegation that companies are incentivised to gold plate. This may be true in principle but in practice it is difficult to fudge the accounts especially if, as is the norm, the accounts are scrutinised by independent third-party auditors. This is because the market for oil equipment and services is narrow, specialised and transparent and their market price is well known.

The conspiracy theorists fail to appreciate three fundamental facts. One that, at $8/ mmbtu, the price of domestic gas is still at a substantial discount to the LNG import parity price of around $12-14/ mmbtu. And that the LNG import parity price is at a discount to the diesel import parity price of around $20/ mmbtu. Thus, taking a holistic view, it is clear that

India must vigorously develop its indigenous gas reserves. Second, other than the government, the biggest beneficiary of the price hike will be ONGC. For it will now be able to bring into production discoveries that were uneconomic to produce at $4.20/ mmbtu and three, while consumers will no doubt be hit by the price hike, the answer is not to kill exploration by insisting on an uneconomic price. That would be tantamount to cutting off one’s nose to spite one’s face. The answer is to find other means of safeguarding the consumer’s interest.

My opening suggestion has been made to give people an insight into the technological, engineering, construction, project management and human resource marvel of petroleum exploration and production. I believe this insight will help them better appreciate the facts, and if nothing else, persuade them to give credit where credit is due.