The existing policy framework which governs the exploration and production (E&P) activities in the hydrocarbons sector is stymied by a number of flaws. This has resulted in implementation issues, legal challenges and overintervention by the government, leading to an unfavorable business environment for E&P players.
In a long-awaited move, the government has finally addressed the problem by approving the Hydrocarbon Exploration and Licensing Policy (HELP) which will replace the New Exploration and Licensing Policy (NELP) introduced in 1997. Under the reformed framework, key improvements have been made in problem areas such as the production sharing regime, pricing and licensing. While these issues have been long discussed, HELP was approved only in March 2016, following proposals announced during the Union Budget 2016-17. With this move, the government expects to revive investments in the oil and gas sector so as to boost domestic output in keeping with the vision of reducing import dependence. The policy is also aimed at enhancing transparency and reducing administrative discretion in the sector.
Another noteworthy policy that has been approved is the Marketing and Pricing Freedom for New Gas Production from Deepwater, Ultra Deep Water and High Pressure-High Temperature Areas, which is expected to provide a boost to production activity in difficult areas. These areas have been lying idle for a while as it made little economic sense to produce from them. With better pricing of the output, as proposed by this policy, companies will shore up their investments in this space.
NELP and its problems
The NELP, with its host of problems, is understood to be a major contributor towards the lower-than- potential investment in India’s oil and gas sector. Production sharing contracts (PSCs) under the NELP, for instance, have been a bone of contention. The PSC regime calls for sharing of profits (by the explorer) with the government after recovering the costs incurred in the development of the block. This often leads to ”gold-plating” (over-stating) of costs by the exploring company and results in disputes with the government. Besides, the company is also required to secure requisite approvals from the government before moving ahead with capital expenditure plans, leading to delays and cost overruns.
Pricing has been another area of concern. At present, gas prices in India are determined by a formula based on average gas prices in gas-surplus areas. With gas prices reaching new lows in recent times, it has made little economic sense (and companies have thus frozen their investment plans) to produce gas domestically, given the high costs of production and limited pricing freedom. This has been especially true for deep-sea/high-tide areas where the costs of production are significantly higher, and has resulted in a number of players not bringing such assets online.
The absence of a “unified licence” has been another vexing issue. E&P players are required to seek a separate licence to tap each type of hydrocarbon from the same block. In other words, separate licences are required for producing shale, coal bed methane (CBM) and conventional oil and gas from the same block.
HELP: Key features
Though there have been discussions on the issues addressed by the reformed policy for a long time, no decision was taken on these owing to disagreements among the various stakeholders. In March 2016, HELP was approved by the Cabinet Committee on Economic Affairs (CCEA). This policy is applicable to new discoveries and areas which are yet to commence production as of January 1, 2016. It would thus include fields where exploration is under way and commercial production has not yet commenced. The key features of the new policy are:
- Revenue-sharing regime: HELP proposes a shift from the PSC to a revenue-sharing regime. The new regime is a kind of “pay-as-you-go” model where the operator will have to part with a percentage of the gross revenues generated from the block. The government’s share of revenue will move in accordance with the total earnings of the developer from the block. The government will not be concerned with the cost incurred and will receive a share of the gross revenue from the sale of the output (oil, gas, etc.). This is also a step towards ensuring the government’s agenda of facilitating the “Ease of Doing Business” initiative.
- Marketing and pricing freedom: Under HELP, the company will have freedom in pricing and marketing the gas produced in the domestic market on an “arm’s length” basis. To safeguard the government’s share of revenue, the share will be calculated based on the higher of the prevailing international crude price or the actual price.
- Single licence for exploring all types of hydrocarbons: HELP requires companies to get just one licence to manage all hydrocarbon reserves such as oil, gas, shale, and CBM. A single licence for the exploration and production of all forms of hydrocarbons in a block would be given to the firm offering the maximum revenue to the government.
Blocks would be allocated under the “open acreage policy”, wherein companies can submit bids for areas of their choice. Under the policy, a bidder may apply to the government seeking permission for the exploration of a new (unexplored) block. The government will then examine the expression of interest for awarding the block for further activity. If the block is found suitable, competitive bids will be called for. This will enable faster coverage of the available geographical area for exploration.
Other changes under the HELP regime call for lower royalty rates as compared to those in the NELP. A graded system has also been introduced in which the royalty decreases from shallow water to deep water and ultra-deep water. Royalty for on-land areas has been kept intact so that revenues of state governments are not shaved off. Besides, cess and import duty exemptions have been retained from the NELP framework.
Policy for Marketing and Pricing Freedom for New Gas Production from Deepwater, Ultra-Deep Water and High Pressure-High Temperature Areas
At present, gas prices in India are determined by a formula based on average gas prices in gas-surplus areas. Under the new policy, producers will be allowed marketing freedom including pricing freedom for all the discoveries in deep water/ultra-deep water/high temperature-high pressure areas which are yet to commence commercial production as on January 1, 2016 and for all future discoveries in such areas.
However, in order to protect user industries from sharp increases, this freedom would be accompanied by a price ceiling based on the opportunity cost of imported fuels. The ceiling price would be lowest of:
- Landed price of imported fuel oil
- Weighted average import landed price of substitute fuels (coal, fuel oil and naphtha)
- Landed price of liquefied natural gas (LNG).
These prices will be reset biannually. This price cap, at current prices of the fuels that form part of the equation, works out to $6-$7 per million British thermal units (mmBtu) of gas. This is significantly higher than $3.8 per mmBtu, which is the current price of natural gas as fixed by the government using a dynamic pricing formula which takes into account prices in gas-surplus countries such as the US, Canada and Russia.
Another policy approved by the cabinet is for the grant of extension to the PSCs for 28 small- and medium-sized fields where the recoverable reserves are unlikely to be produced within the remaining duration of the contract periods. During the extended period of contracts for these blocks, the government’s share of profit will be 10 per cent higher but royalty and cess will be applicable at the prevailing rates of the current regime.
Expected impact of HELP
The various policies announced for the sector certainly come as good news for E&P players. HELP, for instance, has addressed some key problem areas that have thus far deterred investments in the sector, from both domestic and foreign players. The shift towards a unified licence and lower royalty rates are likely to incentivise domestic production of hydrocarbons, especially from deep water and ultra-deep water blocks, which are currently lying untapped. Besides, this will also bring greater transparency to the auction process.
Meanwhile, the shift to a revenue-sharing system could prove to be a disincentive as the investment recovery period for producers gets prolonged. However, the reform pertaining to reduced government intervention should lure foreign investment when global oil prices recover. The regime will also ensure transparency in awarding blocks as well as speedy implementation of projects. According to India Ratings, nearly 190 billion cubic metres or around 35 million metric standard cubic metres per day of gas reserves (15-year production profile) can benefit from the changed policy. Also, unlike in the existing contracts where 100 per cent of the gas allocation is decided by the government on the basis of the gas priority allocation policy, the new regime provides more flexibility to developers to choose the end-consumers as well as the price at which the gas is sold to them.
The new pricing formula for output from difficult areas also comes as a huge relief. However, E&P players will have to revisit their costs as there are blocks that have both deep- and shallow-water discoveries. Averaging the price will be difficult if the same infrastructure is used. Over time, it would pave the way for a level playing field between domestic and imported gas and create a competitive gas market. However, prices of alternative fuels, to which India’s gas prices are indexed, should stay healthy for the derived gas prices to remain attractive and support new investments in the sector. According to industry experts, the new policy will increase investments in the difficult fields but prices of gas from normal fields will still stay subdued, discouraging investments in that segment.
Meanwhile, it is pertinent to note that some of the difficult fields are greenfield projects and many discoveries will need approvals for capital outlays and some time to implement. Hence, it will take at least three years for these fields to start production. Still, the attractive pricing is a big positive going forward. The Indian government estimates that the new pricing could help monetise about 38 field reserves valued at over $25 billion that are still to be put up for production. In the long run, when crude prices (and thus gas prices) harden, the effect of the resulting investments will definitely be visible.
Going forward, there is further scope for policy easing. For instance, after these policy changes, the gas pricing framework in India still remains somewhat complex with at least four different pricing mechanisms – gas prices for normal fields; gas prices for marginal fields; new price formula for gas from difficult fields; and prices for imported gas. Steps towards simplifying such regulatory structures, if taken, would further attract investments in the E&P space.