The time has come for the government to get off the oil industry's back The runaway rise in international oil prices, which recently crossed $100 a barrel, has put Indian oil companies in a spot. Even as their costs rise, they are unable to raise prices to get the resources needed for acquiring oil assets or otherwise build the infrastructure needed for oil security. And, we are in the strange situation that, while we need to import over two-thirds of our oil and gas consumption, Indian refineries are for the first time exporting petroleum products like petrol or diesel. Our refining capacity is more than enough for internal consumption. In the next couple of years, refining capacity would expand further and Indian companies would increasingly cater to the export market. At the same time, our dwindling crude oil reserves and production within the country is making it imperative to find new hydrocarbon resources outside the country. This search for energy security will lead to India having a more proactive foreign policy, moulding it to meet our energy needs. Whether in the neighbourhood (from Iran to Myanmar to the states of central Asia) or further afield (in Sudan, Russia, West Asia or even South America), Indian foreign policy is increasingly likely to be dominated by our need for oil and gas. Already, the overseas oil and gas fields have begun to yield results. ongc Videsh Limited (ovl) today has a presence in 15 countries, including Russia, Sudan, Vietnam, Iran, Libya, Syria, Myanmar, Nigeria, Colombia and Brazil. Last year, ovl produced nearly 8 million tonnes per annum (mtpa) of oil and equivalent gas from its assets abroad in Sudan, Vietnam, Russia, Syria and Colombia. "We got a target to acquire 20 mtpa production by 2020, but efforts are on to achieve it even earlier," says R.S. Muthola, md, ongc videsh. Some oil assets still have to start production. "We have already acquired one block with ovl in Iran and we have another block in Libya. We also have a presence in Libya, where we have two blocks," says M.R. Pasrija, chairman and managing director, Oil India Limited (oil). "Even in Yemen, we have a long ocean block. Our partner here is Indian Oil. We are 50:50 partners. We have recently won two blocks in Yemen, where we have 15 per cent stake. We have also taken one discovered block in Nigeria in partnership with Indian Oil. Apart from that, our presence is also there in a pipeline in Sudan," adds Pasrija. On the home front, the search for hydrocarbons has not yielded many successes. After the major oil discovery at Bombay High in the 1970s, and smaller fields like Mukta and Panna subsequently, the only significant new oil discovery as been by Cairn India in the Mangala field in Rajasthan. This, along with Cairn's other finds, is expected to yield around 7.5 mtpa when it starts production in 2009, adding to the present oil production of 35 mtpa. This is still a small part of the over 120 mtpa of oil needed in the country, most of which is imported. To cover the gap between domestic supply and demand, the government initiated the new exploration and licensing policy (nelp) nine years ago, to make a push to discover oil and gas in India's land and territorial waters. There have been seven rounds of nelp so far, when prospective hydrocarbon bearing blocks are put up for bidding by the government. The bids are evaluated both on the amount of exploratory drilling work the bidders would do, and the production sharing contract between the bidder and the government that lays out how much of the oil or gas will go to the government. Significant finds In the first six rounds, drilling began in many exploration blocks and many small fields have been discovered. There have been significant finds, such as the oil fields in Rajasthan by Cairn India, with a potential of around 7.5 mtpa. In the most recent round of bids, the government offered 57 blocks under nelp vii to exploration and production companies. Says Murli Deora, Union minister for petroleum and natural gas, "nelp vit is being offered in the backdrop of 49 oil and gas discoveries, which have already been made in 15 exploration blocks by addition of hydrocarbon reserves of more than 600 million tonnes of oil equivalent." The biggest find is the discovery of gas by Reliance Industries in the offshore Krishna-Godavari basin. The company is at the moment finalising the laying out of infrastructure to transport the gas from the deep water wells and hopes this process will be completed within a few months. When operational, the gas field will more than double India's production of gas by adding another 80 million cubic metres a day (mcmd) to the present 74 mcmd of indigenous gas production. This is roughly equivalent to around 25 mtpa of oil, almost as large as Bombay High, the largest hydrocarbon find in the country so far. "Other discoveries of ongc and gspc are also likely to come into production, establishing the deepwater expertise of the Indian companies," says Deora. Much more oil and gas has to be found if the country is not to slip into further dependence on imported oil, which could go up to as much as 90 per cent within a few decades. There are massive exploration plans that need enormous resources, ongc, India's premier exploration and production (e&p) company, has aggressive ideas of expansion for the XI Plan (2007-2012), during which time, it plans to invest over Rs 121,000 crore in exploration and production. Of this, almost Rs76,000 crore would be invested in domestic projects and over Rs45,300 crore overseas. The overseas business is seen as the growth driver in times to come. A major stumbling block in implementing these plans is the oil subsidies. Until 2002, the prices of petrol, diesel, lpg and kerosene were regulated under the administrative price mechanism (apm), created through the complex oil pool account system. Under the apm, petrol was priced far higher than the actual cost, to subsidise products such as kerosene and lpg. It was a complex system of cross-subsidisation and ensured that the general budget was not burdened with subsidies for the petroleum sector. With the dismantling of the apm, petrol and diesel were priced at rates that were revised every two weeks, in keeping with the market rate for petroleum. This situation continued till 2005, when international oil prices began shooting up. The government then buckled down to public pressure and fixed petrol and diesel prices, based not on international oil prices but on a fixed price for crude. As the gap between international oil prices and the fixed price increased, it became necessary to subsidise not only kerosene and lpg but petrol and diesel as well. Initially, this was done by dividing up the subsidy equally between the e&p companies like ongc and oil, the refining and marketing companies like Indian Oil, hpcl and bpcl, and the government. The government bore its part of the subsidy by issuing oil bonds, which were then sold by the oil companies to banks. In effect, the government was postponing the effect of the subsidy on the fiscal deficit by five to seven years by issuing the bonds. The government issued oil bonds worth Rsl 1,500 crore in 2005-06 and this doubled to Rs24,121 crore in 2006-07. As the gap between the market price of crude and the fixed price grew, so did the subsidy. So, while crude prices are ruling at around $95 per barrel, even after the hike in petrol and diesel prices in February, the prices are fixed for crude at $65-66 per barrel. "While subsidy initially was to be shared equally - one-third each by government, upstream and downstream oil companies - in practice, the proportion has been roughly 55 per cent by way of oil bonds, 40 per cent by the upstream oil companies and 5 per cent by the downstream oil marketing companies, last year and this year," says Nagarajan Narasimhan, head of research at rating agency Crisil. Oil bonds The oil bonds, while not being reflected in the current budget deficit, only postpones the deficit till the time they mature. Besides this, the government pays interest on them as on all borrowings. The burden of the deficit on the oil companies is substantial. The burden on the marketing companies can be assessed by taking the case of Indian Oil, the largest company in India. During the release of Indian Oil's third quarter 2007-08 results last month, its chairman Sarthak Behuria revealed that the net under-recovery on the four sensitive products -petrol, diesel, pds kerosene and domestic lpg - for the three quarters of the current fiscal was Rs6,515 crore, while the amount due to it from the oil bonds was nearly Rsl 1,500 crore. The total subsidy is much larger than its net profit of Rs7,377 crore for the nine months ending December 2007, while the subsidy paid by Indian Oil cut its available profit almost by half. The situation is much worse for the e&p companies like ongc. In conversation with Business India, its finance director D.K. Sarraf said, "Subsidy does not work at all" and that ongc paid all its taxes and the subsidy was not transparent. While the average international price of crude was $91.19 during October-December 2007, the average realisation to ongc was just $54.52. "We would not mind if the government had some more transparent way of collecting resources, like a windfall tax or higher royalty payments. If the subsidy mechanism is made more transparent, the current ad-hocism in subsidy sharing by upstream companies would end, which will in turn improve valuations of upstream companies like ongc," said Sarraf. He added that ongc had paid a subsidy of Rsl 7,024 crore in 2006-07 while, in the nine months of this fiscal, the subsidy was Rsl3,528 crore. The subsidy paid by ongc almost equals its net profit of Rsl4,075 crore. "This subsidy of Rs30,000 crore has seri