“Fishing in Troubled Waters” – feature article on TEI Energy Outlook Magazine (Aug 2014)
An additional $578 million tax slap, low outputs, and controversies surrounding the Krishna-Godavari basin Dhirubhai-6 block – things are not looking too good for the Indian oil and gas industry giant Reliance Industries Limited (RIL).
RIL, a materials value chain, and energy business conglomerate led by India’s richest business tycoon Mukesh Ambani, has three major operating segments:
| SEGMENTS | SCOPE |
| Petrochemicals | Poly-ethylene, polypropylene, PVC or poly-vinyl chloride, rubber-like poly-butadiene, terephthalic acid (purified), paraxylene, ethylene glycol, olefins, aromatic hydrocarbons, linear alkyl benzene, yarn, and fibre procured from polyester, butadiene, acrylonitrile, caustic soda, or sodium hydroxide (NaOH), polyethylene terephthalate et cetera. |
| Refineries | Production operations and marketing follow up of directly and indirectly procured petroleum by-products. |
| Oil and Gas | Exploring fresh reserves, developing process technology, and production operations of natural gas and crude oil. |
Apart from its main three segments, Reliance Industries has also made its footmark in the telecom/broadband sector, textiles, retail chains, development of Special Economic Zones (SEZs) et cetera. Reliance Jio, a subsidiary arm of the company, reportedly acquired the 1800 MHz spectrum bandwidth in the month of February 2014.
RIL & The Ownership History of KG-D6
Image Source: 1) National Data Registry, 2) ResearchGate
Reliance Industries was issued a New Exploration and Licensing Policy (NELP) for the D6 Block in the Krishna-Godavari Basin off the Andhra coast in 1991 when the Indian Government started allowing private and foreign parties to participate in hydrocarbon exploration, development, and production business.
It figured that Reliance discovered one of India’s largest gas reserves there spread over a thumping 7,645 sq kilometers. The block is officially recorded as KG-DWN-98/1. Initial reports from RIL’s Revised Field Development Plan (RFDP) to the Directorate General of Hydrocarbons (DGH) suggested that potential reserves under D1 and D3 blocks in the region were also ready for procurement.
Production in D1-D3 fields (KG-DWN-98/3) started in the year 2009 with an earlier estimated 40 Metric Million Standard Cubic Meters per Day (MMSCMD) capacity. Reliance, together with British partners BP Plc, has drilled 22 wells in and around the main channel periphery for the exploration and development project.
Reliance has altogether 18 finds in the offshore eastern KG-D6 Block to date.
4 Clear Impediments in the KG-D6 Project
On the exploration front, controversies have shrouded Reliance regarding the KG-D6 gas reserves since the project’s inception. The first obstacle came in the form of the ambiguous “Investment Multiplier” pricing method placed by the Indian Government.
Investment Multiplier Pricing:
While awarding the NELP for the region, clauses within the method allowed the company to acquire larger profit shares through higher initial investments. Capital costs could be recovered with a larger proportion of profits. Till completion of the process, 90% of production would be sold as “cost” petroleum. This 90% would include Government’s 5% royalty, operation costs, exploration costs, developmental costs et cetera.
The rest 10% would be the so-called “profit” production and Reliance’s share from the profit will lessen as the initial investment costs are consequently reduced. But with dwindling production capacity in both D1-D3 blocks and the D6 block as a whole, Government is still to realize its profits while Reliance is capturing the major proportion of the “profit” production in the name of capital cost recovery. The Comptroller & Auditor General of India has criticized Reliance’s upfront cost recovery process in his recent reports on the newer discovered blocks of the KG Basin.
Natural Gas Reserve & Production Estimates:
Unclear reserve and pricing estimates and internal collisions have also worsened the case for the future of the Eastern offshore find.
- As per 2004 estimates, the D1 and D3 blocks were to hold jointly 3.81 Tcf of natural gas.
- As per 2006 estimates, the reserve in the D6 Block was estimated to be 10.03 Trillion Cubic Feet (Tcf).
Later studies by RIL again showed a decrease in reserves at 3.10 Tcf for the D6 block. According to the RFDP signed to DGH, Reliance needed to have produced a cumulated amount of 1.584 Tcf of natural gas till the 2011-12 fiscal year-end, as was informed to the Andhra Rajya Sabha.
An addendum released in 2006 updated Reliance’s initial developmental cost estimates of $2.4 billion for facilities constructed in the area to a two-phase investment plan: 1st phase – $5.2 billion and 2nd phase – $3.3 billion, a total of $8.5 billion. The increment was based on a revised production study carried out by RIL which placed the D6 capacity to rise to 80 MMSCMD from the initially projected 40 MMSCMD.
Impact of the Ambani Family Feud:
Before production could take place, Reliance Industries was divided between two brothers – Anil and Mukesh Ambani. Anonymous sources revealed that Anil Ambani-led Reliance Natural Resources Limited (RNRL) had a family pact with Mukesh Ambani’s RIL to split the gas reserves between themselves.
RNRL was authorized to sell gas from the facilities at $2.34 per metric million British Thermal Units (mmBtu) for the upcoming 17 years from 2005 when the pact was signed. It is interesting to note that natural gas resources, like all other natural elements, are state-property which makes the so-called pact an aversion to the Government agreement.
The abstract $2.34 per mmBtu gas price was revised using Reliance’s so-called ‘Pricing Discovery Mechanism’ in the year 2007 to project an estimate of $4.20 per mmBtu. The new pricing formula was supported by an Empowered Group of Ministers (EGoM) headed by the then Finance Minister Mr. Pranab Mukherjee.
Interestingly, no production whatsoever had taken place from the KG-D6 block during all this time. By April 2014, the new pricing was to be implemented which was stalled due to general elections. The current government plans to increase gas prices even further to $8.40 per mmBtu using the formula prescribed by the Economic Advisor to the previous Prime Minister, Chakravarthy Rangarajan.
Interfering Government Policies:
Natural gas price increments were stalled for the third time in recent months when Indian Oil and Gas Minister Mr. Dharmendra Pradhan postponed the price hike for three consecutive months. The delay hit Indian crude oil and natural gas markets very badly with big industry names like RIL, ONGC bearing heavy losses with preceding low gas charges. Stockbroking firms tend to disagree on this point.
Amar Ambani, Research and Analyst head at IIFL, commented: “There won’t be any reaction on RIL shares, but ONGC shares may marginally get impacted from gas price hike deferment. Investors are hopeful that gas price hike will come for sure at a later date as the government wants to be sure about its policies”. Problems intensified for Reliance when crude oil prices from Iraq shot up due to on and off insurgencies in the country.
Gaurav Dua, Head of Research Wing at Sharekhan, remains optimistic about the ongoing events. He believes there is more to Reliance’s stocks than just a policy deferment. “The gas pricing is a key trigger for RIL but it is not the only trigger. Any fall in share prices of RIL can be an opportunity to buy,” he said while answering a query.
Declining output based on unwarranted production estimates cost Reliance excess penalties for four consecutive years. The government disallowed costs incurred in the field amounting approximately to $578 million to receive penalty charges for missing production targets promised for 2013-14 from the offshore KG-D6 basin. The disallowing takes Reliance’s total penalty tally for KG-D6 block to $2.375 billion, including production shortages for the fiscal years 2010-11 ($457 million), 2011-12 ($548 million), and 2012-13 ($792 million). Real production from the region stands at nearly 8 MMSCMD – about one-tenth of the original estimate.
The Final Word
Eluding controversies and mishaps from the company’s side, Reliance Industries Limited continues to be one of the main petroleum and natural gas suppliers of the country. The Mukesh Ambani-led conglomerate is busy creating footsteps in and out of India to delve into new fields within the energy sector and otherwise.
It is also to mention that Reliance Industries is also a big private player in the alternative fuels field and heads the second position in India in terms of Coal Bed Methane (CBM) production.
In plainer terms, bigger fishes don’t drown so easily. There may still be hope for the lucrative Kaveri-Godavari Basin yet.
