beyondbrics

In July, when the Indian government approved BP’s $7.2bn purchase of a 30 per cent stake in big natural gas fields owned by Reliance Industries, it was thought that the British group’s deepwater expertise would help India build up production that had failed to live up to expectations.

But nearly six months later, output at the largest field – Krishna Godavari D-6 -  has hit an all-time low, with gas pumping out at a daily rate  of just over half of what Reliance originally envisaged. And BP’s technology has yet to be unleashed, as Reliance finds itself locked in a financial dispute with the government. That’s bad for India and bad for its reputation with foreign investors.

India’s largest private sector company is arguing with New Delhi over profit sharing and over allegations – which it denies – that it inflated capital expenditure.

The dispute could cost Reliance $1.2bn in the next two years in investments that it could not recoup from revenues.

RIL is seeking approval for further capital expenditure – which would further delay profit sharing payments to a government from a field originally discovered in 2002.

As billionaire chairman Mukesh Ambani has told the prime minister and the finance minister, Reliance also wants BP to be included in a revamped production agreement, otherwise the British company cannot begin working on the site. Reliance said it could not comment for this article.

Meanwhile, a government regulator has proposed penalising the company for failing to produce as much gas as it originally said it would.

“The government is trying to twist Reliance’s arm to drill more wells and Reliance is saying that will not help,” said one Mumbai-based analyst who did not wish to be named. Production, the analyst said, is flagging because of lower pressure and more water incursion than expected. So more investment was needed to boost output from existing wells, never mind new ones.

KG-D6 has had problems stretching back to when production began in April 2009.  Even before that, Reliance had anticipated difficulties and in 2006 increased its cumulative planned capex to $8.8bn from the $2.4bn proposed in 2004, as the FT reported. It said then it would double output to 80m cubic metres of gas per day, compared to an earlier target of 70.39m cubic metres. In fact, in the latest week for which numbers are available (early December), the output was 39.8m cubic metres daily.

That capex increase prompted the Comptroller and Auditor General in June to issue a draft report accusing the “Oil Ministry and [the Directorate General of Hydrocarbons] of turning a blind eye to the cost increase which would lower government’s profit take from the field” and Reliance of overstating its investments, according to the Business Standard.

The ministry, the DGH and Reliance all disputed the report, with RIL saying in a statement that: “There was no evidence identified suggesting that KG-D6 costs were overstated in purchases from third parties or purchases from related parties and affiliates and in respect of other costs including allocated costs and non-purchase order-based expenditure.”

But on November 22, GC Chaturvedi, secretary of petroleum, told reporters that his ministry was considering penalizing RIL for the drop in production by restricting the percentage of its investments that the company could recover.

Six days later, amid government discussions about restricting RIL’s recoupment in proportion to faltering production – despite no such linkage existing in the initial agreement – the company sent the government an arbitration notice, according to the Economic Times.

By December 10, the petroleum minister was pulling back on Chaturvedi’s statement, but only a little.  He told reporters in Delhi that if any changes to the agreement between the company and the government were to be made, they “would be with prospective effect and not retrospectively.”

On Tuesday, the government’s upstream regulator, the DGH, suggested that $1.2bn of RIL’s investment be disallowed when calculating profit sharing over the next two years, according to the Business Standard.

While the field’s output has indeed been low, another Mumbai-based analyst told beyondbrics the government would have a hard time making the case for punitive action, not only because no such clause existed in the initial agreement, but because “it’s very difficult for the operator to 100 per cent correctly assess what the production of a field will be in the future.”

“And [any such government action] will also hamper the sentiments for foreign investors and impact any further [exploration and production] in general,” he added. “It has happened in [the] past that a company is not able to match the target level that they had proposed, but there was no penalty then, so I don’t see why there would be one now.”

Indian officials should watch out. With foreign investors already wary of the country’s patchy track record in dealing efficiently with business, India can hardly afford more knocks to its reputation. Keeping a company like BP waiting in the wings when it has know-how that India needs, sends a poor signal.

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Cairn-Vedanta: in limbo in India, beyondbrics
Vedanta / Cairn India: no game changer, FT