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Updated: August 6, 2013 04:31 IST

Crude and not sweet at all

Sudha Mahalingam
Comment (10)   ·   print   ·   T  T  
The Hindu

Far from being automatic, the energy security from India’s overseas oil assets is only as good as the contracts and joint ventures that govern them

For some years now, energy insecurity has come to dominate the collective national psyche. Every pundit and observer has her own set of nostrums and homilies to deal with the country’s energy vulnerability. A range of solutions is being touted and tried. None, however, has captured the public imagination as the acquisition of overseas oil equity in pursuit of energy security. That China has embarked on an aggressive acquisition spree of hydrocarbon assets in every corner of our planet seems to have convinced us that this is indeed the way to go and that we must ‘catch up’ with China if we are to be energy secure.

Misplaced perception

In the public perception, it is almost axiomatic that overseas oil assets constitute energy security. It assumes that ownership confers rights of unqualified access. There is a belief that if you own hydrocarbon assets in any corner of the world, it automatically and ineluctably entitles you to physically access those resources as and when you need them; in fact, especially when you need them in the event of a sudden disruption in global oil supply arising from natural disasters, terror strikes or political disturbances.

That may not be true, except under specific conditions and circumstances. It is instructive to note that neither ONGC Videsh Limited (OVL) nor its Chinese counterpart actually brings any significant quantities of oil from any of its overseas assets. Most of OVL’s overseas oil production is sold in the local or international markets and the company is compensated in cash payments. As for gas, OVL does not bring to India even a molecule of gas produced in its own fields in Sakhalin, Vietnam or Myanmar although China fares better in this regard, primarily because it has had the foresight to build transnational gas pipelines.

While India does not have a single transnational gas pipeline yet and therefore cannot access its own equity gas, what about oil which is fungible and can be brought in tankers from anywhere? Why are we not bringing our own oil from our overseas acreages? Does mere ownership confer any degree of energy security on the country?

Many necessary and sufficient conditions must be satisfied before equity oil of our national oil companies translates into energy security. Firstly, not all assets in which OVL has invested are producing assets. Exploratory acreages can contribute to India’s energy security only if and when there is an exploitable, viable discovery of hydrocarbons.

Secondly, even in the case of producing fields, equity participation is subject to certain contractual terms with the host government. Additionally, if you share your equity with other partners as in a consortium or joint venture, you would also be subject to the terms of the consortium or joint venture agreement or the operating agreement between parties. Both these must contain provisions that allow you to take your share of production in kind.

Types of participation

Let me explain this point further. There are many types of participation in overseas oil fields: production sharing agreements, service contracts, production leases, concessions and so on. Not every type of contract envisages equity oil to be taken in kind. Service contracts, for instance, envisage only a pre-determined fee, not a share in production. Only production sharing contracts usually have an express provision with the host government wherein the foreign investor can take his share of production in kind. Even so, ownership of the mineral — in this case oil or gas —vests with the host government, except in the U.S. What this implies is that the host government can, and often does, in its national interest, impose Domestic Market Obligations where the operator is required to sell part or all the production to the local market. Sometimes, the domestic market has prior claim and only surpluses can be exported.

We in India know little about the type of overseas engagement of our oil companies. Even the company websites are vague in disclosing the exact type of engagement. Except for one or two assets, our companies are partners in a consortia of international oil companies or in a Joint Venture with the host country national oil company. Yet, we know absolutely nothing about their terms of engagement with other consortium or JV partners anywhere in the world.

Even assuming that our oil companies have Production Sharing Agreements (PSAs) that allow profit share in kind, equity oil can be lifted only after the operator of the field has recovered its costs of exploration and development from the sale of the mineral. When exploration and production costs go up, profit take gets thinner and that has been happening in consortia-operated fields almost everywhere.

The partners in a JV or a consortium can elect to cede their profit oil to the operator who in turn sells the oil and shares the revenues thereof with the former. It is customary for major oilfield operators to enter into long-term contracts with buyers, prior to actual production and as such, the option to take equity oil in kind has to be exercised ex ante. Since most disruptions occur suddenly and unexpectedly, the freedom to divert one’s own share of equity production to one’s domestic market to take care of the disruption is severely constrained by prior contracts. Violation of oil/gas sale contract terms invites serious penalties and ends in litigation. Where, then, is the scope for physically ensuring energy security in the event of supply disruption?

Certainly OVL can exercise its option to take its profit share ex ante and bring the oil or gas to India wherever it is able to do so. For any oil importing country, and even more so for a country like India that imports almost four out of every five barrels it needs, the economics of transporting equity crude from distant sources like Venezuela or Sakhalin (in Russia) will have to be weighed against buying from our own neighbourhood, namely the Middle East/ Persian Gulf region. Until recently, our refineries were geared only to certain kind of crudes available in our neighbourhood. Now, that constraint has vanished with the advent of new refinery capacities in both private and public sector. Even so, since heavy sour crudes entail high refining costs, most refineries prefer familiar crudes unless the former is available at a substantial discount.

There are many other ifs and buts before overseas oil equity becomes an energy security measure, such as political risks, risks of expropriation or outright nationalisation. The host country can strengthen its control over production of oil and gas by foreign oil companies without even violating the terms of PSA. For instance, in Russia, foreign investors have been slapped with tax claims and penalties for environmental violations that seriously impact the viability of the investments. During Vladimir Putin’s presidency, Gazprom was nominated the sole export agency for gas exports from Sakhalin. This puts a question mark over the ability of foreign investors to claim their own share of gas production for export to their home markets without going through the agency of Gazprom. If, as reports claim, Gazprom will buy gas at discounted domestic prices and resell at international prices, that would rob international investors of any advantage of ownership over the mineral. How does this scenario enhance our energy security?

If the circumstances allow it, OVL can swap its equity oil with other buyers. For example, it can swap Sakhalin oil with Japan and divert oil bound for Japan from the Persian Gulf region to our ports. We have no information in the public realm about whether such swaps have been effected and if so, the extent and scope of such swaps to be able to judge the energy security impact. However, swaps are possible, inter alia, only when the swapping country’s refinery configuration matches the quality of our equity crude.

Illusion

All things considered, reserve accretion through overseas oil equity seems to give only a notional sense of energy security. This illusion is emphasised by the lack of transparency in overseas petroleum contracts. We need greater transparency in contract types and terms to be able to judge the energy security quotient of an overseas oil asset.

This is not to minimise the investment benefit of a good quality asset. When international prices of crude/gas reign high, a risk-free asset whose production/development costs are reasonable can make an excellent investment option, provided we have not paid a higher-than-competitive price for acquiring the asset . That does not seem to be the case in some of our overseas oil assets.

A diplomatic thrust with emphasis on assets that can be connected to our borders through pipelines could ensure better energy security for India since pipeline supply is dedicated to the destination. It is not impossible to tweak our engagement overseas to subserve our energy security, but that would require a visionary approach and a great power mindset backed by matching strategies.

(The author is an independent energy analyst and former Member, Petroleum and Natural Gas Regulatory Board)

More In: Lead | Opinion

Eye Opening indeed.

from:  Deepak
Posted on: Aug 7, 2013 at 01:03 IST

This is a well thought ought commentary by the author, for which we
should be thankful. It is in India's best interests to own overseas
assets, as a way of maximising its sovereign wealth, and also assuring
supply of critical materials. However, this wealth will work for the
country only if it is properly audited, and stringent safeguards are
put in place to avoid misuse. Given the state of administration (mal-
administration would be more appropriate), it is not at all clear
whether the benefits will actually be forthcoming to the nation,
instead of whichever political party that happens to be in power. This
is a clear danger that must be addressed now.

from:  CS Venkat
Posted on: Aug 6, 2013 at 22:11 IST

India look forward to what China is doing. India waited more than 30 years to open foreign direct investment in the name of protectionism, socialism and non alignment ideologies. By that time China tripled its GDP when compared to India. Even now the foreign investors are running away from India because of bureaucracy, politics, bribes, delays, difficulty in land acquisition and politically motivated labor problems. The foreign investment in China is about 8 times that of India. Now India wants to emulate the acquisition of oil assets overseas, after China acquired most of the available oil assets around the world. India is too slow to adopt progressive financial and trade policies that India will remain a very distant runner up after China.

from:  Davis K. Thanjan
Posted on: Aug 6, 2013 at 19:27 IST

I totally disagree with author, the point is, in most of countries (even if the contract is
PSA/Concession/JV/Service contract), the contractor (it comprises of operator co., as well as other
partner companies) is generally entitled to lift the product (of course one can not lift gas until it is
liquified) [the good example is of Iraq, where most of the contract is service contract, but contracting
companies lift the oil (as remuneration)]. Although there can be long debate on this.

from:  birendra mishra
Posted on: Aug 6, 2013 at 17:55 IST

The article was an eye opener and helped in demystifying a lot of things about India's Energy Security in light of its operations abroad.Indeed it is appropriate and convincing when we hear it from the horse's mouth on what to look for when we enter into operations abroad.

from:  Gautham
Posted on: Aug 6, 2013 at 17:17 IST

I thank the author to provide the insider's views about energy security.
This article was an eye-opener for me and it destroyed many myths what I
had in mind after reading plentitude of articles on this subject.

The oil and gas, its pricing, the geopolitical impact, environment
concerns, growing population and its necessity fascinate me because I
guess all complexities of world culminate in pricing and distribution of
crude oil.

from:  Santosh Singh
Posted on: Aug 6, 2013 at 13:29 IST

On a very basic note,a very legitimate and self beneficiary agreement is supposed to be honestly made by the Indian govt irrespective of the country having the source.This solely is going to secure us for the needful energy.
Most of that matters is the kind of sharing that ensues

from:  Arunabh
Posted on: Aug 6, 2013 at 12:05 IST

Sudha,

You WILL have energy security for ever and ever, without your beloved
and dirty OIL and GAS!
New technology will be shown very SOON which make both these sources
AND nuclear completely UNECESSARY!
That's why Germany is CLOSING down permanently all its nuclear
reactors!
Just wait with a little patience. Your childrens and grandchildrens
futures are assured!

from:  gamini samarasinghe
Posted on: Aug 6, 2013 at 07:10 IST

Crude being fungible , equivalent dollars are a perfect hedge against crude price inflation,
enhancing energy security.

from:  Giridhar
Posted on: Aug 6, 2013 at 06:48 IST

Even countries like the United States, which would probably be the
prime example of a country securing foreign oil assets, do not really
own oil. The oil which comes into any country, including India, is not
bought directly from a host country, but rather traded through
markets. It is true that individual countries can and do exercise some
control over the traded prices, however, there is no country besides
Saudi Arabia which can influence oil prices to a very large extent on
its own. As such, it doesn't really matter where the oil is produced,
since most of it goes into the global market.

So, Indian PSUs engaging in production in foreign oil fields is an
excellent step, as it boosts technical knowhow of Indian companies,
and eventually, adds to the oil production of the world as a whole,
which is always good, even if the oil doesn't come to India finally.
What only matters is the global oil price.

from:  Rahul
Posted on: Aug 6, 2013 at 05:32 IST
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