A primer on issues involved and what do they mean
Alam Srinivas | November 15, 2012
Wednesday, October 31, 2012, started with a buzz in social media circuits as to who would be the next target of Arvind Kejriwal. During the day, several names were speculated upon – Anil Ambani of the ADAG Group, a mining conglomerate in Madhya Pradesh, and Gujarat-based Adani Group. Finally, by 2 PM, it became clear that the man in Kejriwal’s crosswire was Mukesh Ambani, the promoter of Reliance Industries Ltd (RIL), India’s largest private sector firm.
Ironically, when the stock markets closed a couple of hours later, the RIL scrip was up while many of the ADAG Group’s were down. The investors, it seemed, were not interested in Kejriwal’s press conference, which started just after 4 PM that day. However, the next day (Thursday), RIL was down and ADAG stocks were up in early morning trades. But the charges hurled by India Against Corruption (IAC) against RIL and the government, although old, were serious. It said that the oil & natural gas major had manipulated government decisions to get undue benefits.
Favorable petroleum ministers (Murli Deora and Veerappa Moily) were appointed at the behest of RIL, and some of them went out of their way to help the company. Essentially, RIL was allowed to hike its investment costs to explore gas at Krishna-Godavari (KG) basin, off the coast of Andhra Pradesh, increase the price of the gas it sold to fertilizer and power units, and sell a 30 per cent stake in the gas business to global major, British Petroleum (BP), at a whopping $7.2 billion last year.
As Kejriwal said at the press conference, “Sarkar toh Mukesh Ambani chalate hain (the government is run by Mukesh Ambani).” But what is the veracity of these charges? Is there a smoking gun lurking around, or is it all smoke without any fire? Is the government really in the pocket of Mukesh Ambani? Can the KG basin events be labeled as the worst form of crony capitalism? We provide a primer to understand the issues involved and what do they mean.
Allegation # 1: RIL sold India’s natural resources, which belonged to the people, at a huge profit to BP
In its press release, IAC compared the RIL-BP deal to a driver hired to “drive my car and that driver sells off my car after a few days.” The Supreme Court, in its various orders, has stated that natural resources like minerals, oil & gas, and telecom spectrum belongs to the citizens and, hence, they can be used only for public interest, and not private profits. So, the price paid by BP should have gone to the government, and not RIL, which was “just a contractor hired by GoI (government of India) to extract gas.”
However, a distinction has to be made between the sale of various natural resources, say spectrum and natural gas. In telecom, the spectrum can be used from Day 1 (technically) by the private buyer to offer mobile and other services, and earn profits. Yes, the operator does have to set up towers and invest in infrastructure to provide efficient services, but the main business risk is finding enough customers willing to pay viable tariffs. This is not so in the case of gas.
The risks attached with the gas business are higher. For example, there is no guarantee that gas will be found if a well is drilled in a specific area. Most global companies are saddled with hundreds of empty wells. Thus, the investments, which run into billions of dollars, have to be made before the exploration firm knows whether it will find gas in the region. Sure, there is seismic data on the gas trapped underneath, but it only increases the chances of finding gas without any certainty.
If the increase in valuation of a gas business is because of financial and other commitments by the operator (RIL) then, logically, the private entity can be allowed to reap its benefits through a part or complete sale. Why should the money go to the government, and not RIL? By this logic, the $11 billion that Vodafone paid to buy Hutch in the telecom space should also go to the government, which owns the spectrum on behalf of the Indian people!
Allegation # 2: Oil ministers were appointed and sacked at RIL’s behest
IAC contends that the government is run, not by ministers and the bureaucracy, but by business houses. “It appears that telecom companies select their own nominees as Telecom Minister and RIL selects its own person as Petroleum Minister,” stated its release. For instance, Kejriwal said that two ministers, who were anti-RIL – Mani Shankar Aiyar and Jaipal Reddy – were divested of the petroleum portfolio in 2006 and 2012, respectively, because of pressures from Mukesh Ambani.
There appears to be some truth here since Murli Deora, who replaced Aiyar in 2006 and remained in the ministry until 2011, was pro-RIL. In July 2009, at a shareholders’ meeting of one of his firms, Anil Ambani, Mukesh’s younger brother who had separated in 2005, said that the petroleum ministry under Deora was abetting “the plain and simple greed of RIL”. It is also known that Reddy (2011-12) had initiated several actions and taken decisions that went against RIL’s business interests.
Does such an account fully explain the lobbies and vested interests at work to select and shunt out key ministers? If one agrees that Deora came in because he was Mukesh’s friend, then why did the government replace him with a more honest and anti-RIL person, Reddy, in 2011? Was it that the government was against Mukesh in 2011 and most part of 2012, and not between 2006 and 2011, and then changed its mind again during the last cabinet reshuffle by getting rid of Reddy?
Allegation # 3: Government deliberately allowed RIL to raise gas prices
In 2005, after a protracted public battle between Mukesh and Anil, the two siblings decided to split the Reliance’s empire built by their father. The duo agreed that Mukesh would supply huge quantities of gas from the KG basin, which he now owned, to Anil’s power projects. The price fixed was $2.34 per unit (measured in mmscmd, or million metric standard cubic meter per day), which was the same as what Mukesh had promised earlier to sell to the state-owned power producer, NTPC.
Throughout 2006, Anil wrote several letters to the Prime Minister’s Office (PMO) and petroleum ministry (when Deora was in-charge of the portfolio) to approve the price. In July 2006, the ministry rejected the price of $2.34, and asked RIL to discover a new market-related price by inviting bids from potential customers. An empowered group of ministers (eGoM), headed by the then the external affairs minister, was formed and, in September 2007, it approved a much higher price of $4.2.
Since this decision was not taken by Deora alone, but by an eGoM, one can argue that the former was not solely responsible for this windfall gains to RIL; it was a collective government decision. The blame would lie with the entire cabinet, or most of its members. More importantly, the Supreme Court (May 2010) upheld the higher price as it said the government had the right to fix gas prices. But the fact remains that the government allowed Mukesh Ambani to earn higher profits.
Unfortunately, the story did not end here. The price of $4.2 was fixed for seven years (2007-14). During Reddy’s tenure as the oil minister (2011-12), RIL asked for another substantial increase to $14.2. Reddy said no as the company was under a contractual obligation to sell at $4.2 for seven years. The matter went to the Attorney General, who advised that this was a policy decision, and not a matter of law. The issue will now be discussed by another eGoM, as was the case earlier.
IAC said this was the primary reason why Reddy had to go. He could not be in the petroleum ministry when RIL wanted such a huge hike and which, according to Reddy’s note to the new eGoM, “would mean an additional profit of Rs 43,000 crore to RIL (in two years) at current levels of… production.” The IAC release added that the increase in gas prices would translate into “higher electricity and fertilizer prices in the country or a higher subsidy burden” for the government.
Now we get into tricky moral issues. Isn’t it the right of a business entity to maximize profits, and ask for a higher price, wherever possible? As Kejriwal himself said, the current international price of natural gas is $13. So, why should a company sell the gas at a huge discount, and not demand $13-14? It is the government’s decision to agree to a price increase, or reject it, and it has not accepted $14 as the new price. The company cannot really be faulted for it, especially since all contracts have several provisions for price escalations in case of justifiable circumstances.
Finally, why is it that IAC wants the government to charge higher prices for other natural resources such as spectrum (2G scam) and coal (CoalGate scandal), which would also increase prices for consumers in terms of higher tariffs, but not for gas? We will answer the last question a little later.
Allegation # 4: RIL gold plated its investment in KG basin
Mukesh Ambani signed the gas exploration agreement with GoI in 2000, when the BJP-led NDA was in power. Kejriwal maintained that the “contract was meant to favor RIL right from the beginning.” He added that he NDA “signed a contract dictated by RIL wherein an increase in cost (investments in exploration) by one rupee meant additional profits of RIL by almost Rs 2.2. Isn’t it strange?”
The facts are that RIL stated in 2004 that it would produce 40 mmscmd of gas a year at a proposed investment of $2.39 billion. By 2006, the company told the hydrocarbon regulator that it could double the production to 80 mmscmd but its overall capital expenses on exploration would go up to $8.8 billion. “Doesn’t that sound strange? To double production, you increase your investments by four times? Having put the initial infrastructure in place, it should have cost lesser…,” said the IAC release.
It is true that higher investments translated into higher profits for RIL, given the nature of its contract with the government. The reason for this is that whatever gas is found is divided into two components – cost petroleum (or gas) and profit petroleum. Since the exploration business is risky, companies are allowed to initially recover most of their capital costs by selling the gas (cost petroleum). Once that is done, the revenues from the remaining portion of gas (profit petroleum) are shared between the private operator and the government as per a specific formula.
So, if an operator can unduly hike the investments, its share of cost petroleum is higher. This reflects on its balance sheet and the government has little or no claim on it. Logically, since gas reserves are generally limited, this exercise leaves lesser volume of gas that can be shared with the government thereby reducing its profits from the gas basin. This is also concluded by a report on performance audit of hydrocarbon contracts by the Comptroller and Auditor General.
For the same reason, the government should logically ask the operator to sell gas at higher and not lower prices. If the price is high, the volume of gas that needs to be sold to recover capital costs or to be deemed cost petroleum will be lower. This will leave a larger volume to be shared between the operator and government as profit petroleum, which will lead to more profits for the latter.
Consider this hypothetical case, where the gas reserves in KG basin are 100 units, RIL’s capital costs are Rs 100, and the price is Rs 5 a unit. For the company to recover its costs, 20 units are required as cost petroleum, which leaves 80 units to be shared with the government. But if the price is Rs 1, the entire reserves will become cost petroleum and the government will not earn a single penny. Therefore, higher gas prices maximize the revenues for the government, as also the private operator.
The choice for the government is twofold. Does it lower its gas profits through lower gas prices, benefit the final consumers of fertilizers and power, and reduce its subsidies? Or does it maximize its revenues from gas sales and pay higher subsidies in the interim period till the gas operator has recovered his costs? In both cases, the net impact on the exchequer will remain similar, though not the same. Should the government rob Peter to pay Paul, or Paul to pay Peter?
However, doubts about RIL’s gold-plating of its investments remain. This is the reason why Reddy, the former petroleum minister, had asked RIL to slash its investments by over $3 billion, an important figure that is missing from Kejriwal’s list of facts and charges. This is possibly a stronger reason why RIL may have lobbied against Reddy during the cabinet reshuffle. Also, don’t forget that the contract signed between the government and RIL wasn’t unique; it was the same that the previous governments have signed with all the oil majors, including the state-owned ONGC. And these contracts subscribe to global practices as similar contracts are signed the world over.
(This article appears in our latest, November 16-30, issue.)
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