Govt to share revenue in all future gas exploration contracts

The government proposes to dispense with the current cost recovery system for leasing out gas blocks and instead introduce a revenue sharing model, under which the government will share overall revenue with the contractor without setting of any costs.

The new gas pricing formula, suggested by a committee headed by C Rangarajan, chairman of the prime minister's economic advisory council, will rid the government of the problems experienced in assessing costs involved under the present dispensation, minister of state for petroleum and natural gas Panab Lakshmi said today.

The existing production sharing system (PSC) allows the contractor to recover his cost, before giving the government its share in the contractor's revenues, in case there is commercial discovery leading to production.

The government gets a certain proportion of the balance revenues of the contractor, based on the value of an investment multiple for each year. The investment multiple is the ratio of cumulative net cash income to cumulative exploration and development cost.

Government's share increases as the multiple increases, which happens when cumulative income increases at a rate higher than the rate of increase for cumulative cost.

This system will now be dispensed with in favour of sharing of the overall revenues of the contractor, without setting off any costs, the minister stated.

For future PSCs also, the share will be determined through a competitive bid process. The bids will be made in a matrix, in which the bidder will offer different percentage revenue shares for different levels of production and price levels.

The bids will have to be progressive with respect to both volume of production and price level. This will ensure that as the contractor earns more, government gets progressively higher revenue, and will also safeguard government interest in case of a windfall arising from a price surge or a surprise geological find, the panel recommended.

Further, this system will help eliminate the underlying cause of the joint management committee consisting of government and contractor representatives and audit related problems.

The management committee will no longer go into issues relating to approval of budget or procurement issues.

Investor interests will remain unaffected, since they would be free to bid the government share, and they will also have a more hassle-free operational environment.

The committee has also recommended an extension of tax holiday to 10 years, from 7 years already available for all blocks having a substantial portion involving drilling offshore at a depth of more than 1,500 metres, since cost of a single well can be as high as $150 million.

Further, the committee has recommended extending the timeframe for exploration in future PSCs for frontier, deep-water (offshore, at more than 400 m depth) and ultra-deep-water (offshore, at more than 1,500 m depth) blocks from eight years currently, to ten years.

Contract management
Apart from resolution of problems currently experienced in contract management through the proposed fiscal regime under new PSCs, the committee has suggested two mechanisms for improving progress of exploration and development under existing PSCs.

For policy related issues, it has suggested the setting up of a secretary-level inter-ministerial committee to suggest policy solutions.

For issues involving condonation of delay on the part of the contractor in preparing for and seeking approvals, and for minor technical issues, the mandate of the existing empowered committee of secretaries (ECS) can be expanded. The ECS has earlier been empowered, with CCEA approval, to condone delays in the exploration phase only.

CAG audit
Under the revenue sharing model, the CAG will conduct periodic audit of a list of blocks for selecting those that it would directly audit. CAG would select blocks on the basis of financial materiality, and would focus on blocks in the exploration and development phase, when costs incurred are higher. Other blocks would be ordinarily audited by CAG-empanelled auditors, although CAG would continue to have its statutory freedom to directly audit even these.

Further, it has been recommended that CAG perform the audit within two years of the financial year under audit, as prescribed under the PSC. Also, for PSCs beyond a high financial threshold, a concurrent audit mechanism may be considered.

Pricing mechanism
The committee has proposed a gas pricing formula for domestically produced gas under the PSE since there is no market-determined arm's length price and nor is this likely to happen for several more years.

The proposed policy would provide for estimation of an unbiased arm's length price based on an average of two prices.

The relevant price in this context would be the price producers receive in other gas-producing destinations. One price would be derived from the volume-weighted netback price to producers at the exporting country wellhead for Indian imports for the trailing 12 months.

The other would be the volume-weighted price of US's Henry Hub, UK's NBP and Japan Custom Cleared (on net-back basis, since it is an importer) prices for the trailing 12 months.

The arm's length price thus computed as the average of the two price estimates would apply equally to all sectors, regardless of their prioritisation for supply under the Gas Utilisation Policy.

The suggested formula will apply to pricing decisions made in future, and can be reviewed after five years when the possibility of pricing based on direct gas-on-gas competition may be assessed.