If ‘first come, first served' was the structural flaw which led to the 2G spectrum scam in the telecom sector, the Comptroller and Auditor-General has identified the production-sharing contract (PSC) structure for oil and gas as the original sin which allowed private companies such as Reliance Industries Ltd. to gain “undue benefit” at the government's expense.

Hitting out at the Petroleum Ministry and the Directorate-General of Hydrocarbons (DGH) for having “failed to protect” the government's financial interests, CAG has called for complete structural changes in the present PSCs for the management of hydrocarbon exploration and production involving the private sector.

The Indian PSC today is based on a scaled formula for profit-sharing between the government and private contractors. The slabs for profit-sharing are so designed that the more capital-intensive the project — or the lower the ‘Investment Multiple' (IM), in industry parlance — the lower the government's share of profit petroleum, even as low as 5 to 10 per cent.

The CAG notes that private contractors thus have virtually no incentive to minimise capital expenditure — and substantial incentive to increase capital expenditure, so as to retain the IM in the lower slabs (which would result in low/the lowest share of profit petroleum for the government).

Since the control of E&P operations largely rests with the private operators, the government's oversight role is restricted essentially to its representation (through the Petroleum Ministry or the DGH) in the Management Committee. But what happens if, as in the case of the Krishna Godavari basin operations, the government's representatives fail to bat for the public interest? This is the question the nation's auditors have zeroed in on.

“Given the realities in the Indian context, we are, thus, forced to conclude that the profit-sharing mechanism (linked to investment multiple) incorporated in the current PSC structure is unsuitable for protecting the government's financial interests,” the CAG's latest draft report on oil and gas PSCs says. “In the vast majority of cases, there is virtually no chance of government's profit-sharing ratio reaching the highest slab, except in few cases at the fag end of the contract period when production is likely to show a declining trend.”

Talking specifically of the role of the Management Committee in RIL's KG basin operations, the report states: “Our audit has revealed that, by and large, the Ministry and DGH (both through the Management Committee and otherwise) did not pay adequate attention to protecting government's financial interests, specifically in terms of exercising adequate control on recoverable costs and monitoring with a hawk's eye.”

It recommends that in future government's representatives on the Management Committee will have to be held accountable for protecting government's financial interests just as the principle shareholders of the private contracts will hold their representatives on the committee similarly accountable.

Making a comparison of the procurement procedures provided under the present PSCs with that of Bangladesh, the CAG states: “In fact, a comparison of the procurement procedure under PSCs in Bangladesh and India reveals that the clauses are similar; expect that the Bangladesh PSCs require approval by the Management Committee for high value procurements (typically greater than $500,000). This clause is, however, strangely missing from the Indian PSCs in almost all its versions.”

Radical changes

Seeking radical changes in the PSC mechanism, CAG recommends replacement of the profit-sharing formula based on IM with a royalty formula based on either quantity or ad valorem with a sliding scale linked to different slabs of production of hydrocarbons. “In our opinion, this is the best formula, given the current context, for harmonising the financial interests of both government and the private contractors. In such a situation, the PSC could be considerably simplified as the requirement for control by the Management Committee at different stages of the E&P process could be considerably reduced.”

Further, the draft report states: “If the government still feels it necessary to continue with a profit-sharing formula, we strongly recommend that the contractor should not be allowed to bid for profit percentages for different IM slabs.” Instead, while the contractor could bid a target profit-sharing formula, a relatively small range linked to IM slabs could be pre-determined. This will, at least, minimise the incentive for skewed capital expenditure resulting in a very low government share of PP, although it will still require enormous efforts by government to control cost recovery, CAG adds.

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