Sticky issues in oil exploration

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The Hindu Business Line

by

Arpinder Singh
Partner and National Leader, Fraud Investigation and Dispute Services
EY

In the current fiscal year, private sector oil and gas companies witnessed significant challenges largely driven by the Comptroller and Auditor General's (CAG) audits and a large number of disputes between the contractors and the Government.

In the early 90s, when India faced an acute shortage of oil and gas resources, the Government decided to open the exploration and production (E&P) business to private companies. The overall business model under the New Exploration Licensing Policy (NELP) was to be controlled by way of a production sharing contract (PSC), to which the contractors are bound.

PSC is a detailed document which governs the entire business structure for the contractor and protects the interest of Government, the owner of natural resources. Key aspects of the exploration and production (E&P) business such as the contractor's role and responsibilities, procedural aspects, cost and revenue sharing, routine regulatory filings to be made by contractor, etc., are defined under the PSC.

It has been argued that PSCs signed in the early years were more loosely drafted and favoured private sector contractors, leading to several disputes between the Government and contractors. PSCs executed in later years, primarily after 2005, were redrafted by the Government to clear loopholes. However, these were seen as ‘highly regulated' by private and independent players, and impacted the response to the NELP-8 auctions held in 2009.

Areas of dispute

One of the critical aspects of the PSC, which also tends to be one of the most contentious, relates to cost recovery: the extent of cost recoverable by the operator from revenue generated in the oil and gas field. Another important area of dispute is the investment multiple (IM) that determines profit sharing between the Government and the contractor.

In the last two to three years, India has seen a large number of disputes between the private contractors and the Government, most of them around cost recovery claims of contractors and IM.

There are three critical issues that have caused disputes between the Government and private contractors. The first issue is cost recovery limits (CRL). Every PSC defines the limit for the contractor. This limit is the overall threshold for contractors to spend and recover costs from petroleum revenues.

This limit excludes certain specific cost categories and cost escalation scenarios. It has been argued that CRL has not been clearly defined, and, thus, often leads to a dispute.

The immediate need is to clearly define the costs recoverable and non-recoverable; also, the issue of limits and change scenarios need more clarity.

Additional development cost is another issue. The E&P business comes along with several uncertainties that occur during evaluating the projected output from fields and planning the development cost.

Historically, almost all PSCs have seen cases where contractors have submitted revised development plans for additional capex activities. According to the contractor, the additional cost is considered a logical increase to sustain or increase production volumes. These additional developmental costs lead to regular disputes between the contractor and the Government, since the latter tends to consider such cost as part of the original plan and subject to initial cost recovery limits, whereas the former perceives it as additional cost that is required and is recoverable from revenues.

A logical conclusion to such disputes would be relying on experts in the oil and gas industry to justify whether the additional cost is required or not.

CAG's scope

The last issue is that of audit rights. Private contractors have been regularly raising their voice against the Government auditor going beyond its scope during audits. Contractors insist that the role of auditors is limited to the financial aspects. Recently, the audit reports have seen issues of operational efficiency being raised strongly. The Government needs to clear terms on the scope of audit and to facilitate availability of petrochemical experts if audit needs to include operational and technical aspects.

It has been regularly commented that the disputed actions taken by contractors has led to revenue loss for the Government. On the other hand, contractors have been raising issues of delays in recovering billions of dollars they have invested in projects.

The future of E&P business in India and the investment by multinationals and Indian corporates would depend upon the extent to which the Government can simplify the NELP process and PSCs. The investment climate would be positive if the private sector feels that their investment would be safe and free of disputes on a long-term basis.

On the other side, the Government would feel comfortable in relaxing the rules and regulations, if corporates can demonstrate highest standards of efficiency in various deals. It would be beneficial for both the parties to arrive at a common point on PSC interpretation and managing the project cost.

This would need a strong effort from the Government by way of simplifying the rules and regulations around operations of private contractors — such as approving the additional development expenditures by way of the standard approach which would involve third-party techno-commercial experts.

Similarly, the corporates would have to ensure that they demonstrate strong project management skills at lowest possible cost.