Gokul Chaudhri, Partner, Deloitte Touche Tohmatsu India LLP
E&P of hydrocarbons: The evolving landscape in India
During its 20-year journey, Indian Infrastructure has been witness to several milestones that define the evolution of the upstream industry in India. In 1999, just a year after the magazine was launched, the government formulated the New Exploration Licensing Policy (NELP) with the aim of encouraging private participation and increasing investment in exploration and production (E&P). The government permitted 100 per cent FDI (through the automatic route) in E&P activities, under the NELP regime. Till the 1990s, E&P activities in India were dominated by two state-owned companies, the Oil and Natural Gas Corporation and Oil India Limited, while the three rounds of exploration by private players yielded no success.
Did the policy deliver?
When the government announced the NELP in the 1997-98 budget, the need to reduce India’s dependence on crude oil imports was stated as the key reason for the introduction of the policy. The production sharing contract (PSC) regime had been the basis for the nine NELP bid rounds that the country saw over the better part of the past two decades. The bid rounds under the NELP resulted in over 250 PSCs, attracted investments worth over $20 billion and led to 130 discoveries, with three of them being categorised as major. However, the NELP had limited success in the monetisation of the commercial discoveries. Of the 254 blocks auctioned in the nine NELP rounds, 148 blocks are active, 106 have been relinquished and commercial production has commenced in only three blocks with a total output of 0.4 million tonnes of crude oil and 26.11 million standard cubic metres of gas per day. There has been no investment in actual development after NELP-IV in 2003.
Over time, the PSC system stirred controversy and became a challenge for both contractors and the government. The NELP mechanism of profit sharing, wherein explorers first recovered their costs and then shared profits with the government, was severely criticised by the Comptroller and Auditor General during an audit of a giant gas discovery at the KG-D6 block. The government had to verify the cost in all cases to ensure that the contractors did not gold-plate. The goal of finding and producing oil and gas was lost in the mire of bureaucratic procedures and disputes regarding discovered fields among other issues.
Trouble also brewed in gas pricing issues, with allocations at stipulated rates to fertiliser and power companies. Three gas pricing formulas were introduced in over seven years, while 167 out of the 254 NELP licence holders relinquished the blocks after sinking nearly $8 billion in surveys and exploration drilling, or after paying for unfinished jobs under the committed minimum work programme. New investments thus sputtered to a halt.
Over the past couple of years, the 28 oil and gas blocks that were given out during the pre-NELP era have started to come up for renewal. A policy for renewals was announced in March 2016, which provided for an extension beyond the initial 25-year contract period only if there is a raise in the government’s stake, by way of increased percentage of profit petroleum proceeds from the sale of hydrocarbon that companies share with the government; and royalty and cess to be paid at the prevailing rates by contractors in proportion to the participating interest. Recently, the Delhi High Court allowed the writ petition of one of the explorers, directing the government to extend the PSC for its producing block till 2030, on the same terms and conditions as entered into 1995.
Tax policy for upstream also came up for scrutiny. Take the instance of tax holiday under the provisions of the Income-tax Act (ITA), 1961 (section 80 IB), which allows a seven-year tax holiday to an undertaking on the commercial production of mineral oil. The government, vide the Finance (No. 2) Act, 2009, inserted a retroactive explanation to provide that all blocks licensed through a single contract under NELP-I shall be treated as a single undertaking. Consequently, the availability of tax holiday was restricted per contract, instead of a tax holiday for each well or a cluster of wells. Further, the Indian Revenue Authorities contested the applicability of tax holiday to the commercial production of “natural gas”, instead of only for “oil”.
A similar rigid stance was taken by the taxman on the applicability of section 42 of the ITA, which allows for deduction in the case of E&P contractors. In both cases, contractors had to approach the judiciary in order to clarify the intent. The presumptive tax regime under the ITA for non-resident oilfield service providers (section 44BB) was disputed by the IRA for almost a decade with millions of dollars stuck in tax demand. Ultimately, in July 2015, the apex court clarified the scope of the presumptive tax regime in favour of the taxpayers.
Broad contours of the new regime for the E&P sector
The new government, on arrival in 2014, set out to review the erstwhile policy. By March 2016, the government approved the Hydrocarbon Exploration Licensing Policy (HELP) and the revenue sharing contract regime along with the Open Acreages Licensing Policy (OALP). Four main facets of HELP are:
- Single licence for all hydrocarbons (unlike the NELP regime)
- Open acreages
- Revenue sharing model
- Marketing and pricing freedom
The question is whether the new policy can by itself solve the problems discussed above. In the first round of auction under HELP for 55 oil blocks, which took place earlier this year, no foreign oil company submitted expressions of interest, possibly impacted by the low oil prices globally that have lowered global exploration capital outlays.
Opportunities in the E&P sector
India has 42 billion tonnes of oil equivalent reserves, according to a report by the Directorate General of Hydrocarbons. This represents a jump of almost 50 per cent from the previous estimate in 1996. With India offering 85 per cent of its total sedimentary area under the OALP and HELP, several investment opportunities are available in the upstream sector.
The Discovered Small Field (DSF) policy was launched with the aim of extracting oil and natural gas from the unmonetised small oil/gas discoveries available in the country. In the first round of the DSF policy, 30 companies were awarded 23 onshore and seven offshore blocks. The DSF policy is expected to offer around 60 discoveries across 26 new contract areas (under bid round II on August 8, 2018 released by the Ministry of Petroleum and Natural Gas [MoPNG]).
The new contracts covered under HELP also provide various benefits to contractors. The contractors get the full right to explore and produce oil and gas, and all other types of hydrocarbons during the entire contract period along with certain fiscal incentives such as low graded royalty rates, exemption of oil cess and customs duty. Another paradigm shift is replacement of the complex cost revenue model with a simple revenue sharing with the government. It is likely to ensure faster decision-making and speedy project implementation. This reform of reduced government intervention should encourage foreign investment considering that global oil prices are recovering.
The government has also introduced production enhancement contracts, which offer stake in some producing fields to private players for enhancing the existing productivity of the field. Private investors will be encouraged to infuse best-in-class management practices and world- class technologies into the declining fields.
On India’s energy agenda, securing sufficient supplies is the most crucial order of the business and is expected to be paramount in the foreseeable future. While there have been significant advances in exploration on land and in shallow basins across the country, the largely unexplored domains of deep-water and ultra-deep-water oil and gas resources hold the solutions to India’s concerns over substantially declining domestic production. This opens up avenues for strategic investors with the requisite technical expertise and financial muscle. Given the significant opportunities in E&P, investments worth $102 billion are likely to be made in upstream equipment and services over the next 10 years. Drilling and drilling-related services are likely to account for 35-40 per cent of the total spend followed by oilfield equipment for 18-20 per cent, and completion and stimulation equipment and services for 18-20 per cent as per “The Evolving Energy Landscape in India: Opportunities for investment” report by Deloitte.
On the natural gas front, demand is expected to grow owing to the expansion of the core consuming sectors. As per the “Working Group on Enhancing Refining Capacity by 2040” report by the MoPNG, the refining capacity is expected to reach 438.65 million tonnes (mt) by 2030 through several brownfield and greenfield expansion projects. Considering this potential, many industry players are looking to establish LNG terminals in the country. About 13 such projects have already been announced.
Key learnings; looking ahead
India imports more than 80 per cent of its crude oil requirements to meet its energy needs. In 2016-17, the country imported 213.93 mt of crude oil at a cost of $70.196 billion (Rs 4.7 trillion) as per the Ministry of Commerce and Industry’s Annual Report 2017-18. In 2017-18, the crude oil bill amounted to $88 billion (Rs 5.65 trillion) according to the Petroleum Planning and Analysis Cell, representing 18 per cent of India’s total imports during the year.
Domestic production of crude oil has witnessed a reverse trend. Crude oil output in 2017-18 dropped to 35.7 mt, as against 36 mt in 2016-17. The International Energy Agency has projected that India’s oil import dependence will increase to above 90 per cent in another two and a half decades. In order to realise the current government’s stated goal of reducing dependence on oil imports by 10 per cent, India needs to enhance its domestic oil exploration activities.
The wisdom gained from the two-decade- long policy life cycle for the upstream segment needs to be carefully reflected upon by policymakers. These learnings need to be applied in such a manner as to create not just a policy framework but also a broader ecosystem, which will reduce or, better, eliminate state discretion and allow domestic and foreign investment to return to the sector.