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PM Narendra Modi can learn these lessons from Cairn on raising oil output.

Date: 18-10-2018
Subject: PM Narendra Modi can learn these lessons from Cairn on raising oil output
It is not clear if the global energy players prime minister Narendra Modi met earlier this week will pay much heed to his plea for a review of payment terms for oil—to allow more payment in rupees to stem the currency’s fall—but it is clear the matter is a serious one. At $48 billion in April to August this year—$87.3 billion for all of FY18—crude oil imports rose by 56% over that a year ago in the same period. The prime minister would, however, be better served if he concentrated on raising levels of domestic production of oil and gas instead; the lessons from Cairn Energy of the UK are important in this context.

In 2002, Cairn paid $12 million to Shell to buy its assets in Rajasthan, drilled 15 wells that were dry and then struck oil in the 16th. After extracting around 460 million barrels already, the estimate is that the Rajasthan assets will yield another one billion barrels over their lifetime. All told, Cairn—now owned by Vedanta Limited—produces over a fourth of India’s crude oil and, till date, it has given $17.1 billion to the Centre and Rajasthan in taxes/cesses/royalty and another $3.4 billion to ONGC as its share of profits in the joint venture; all told, that totals $20.5 billion or 85% of its revenues after paying for the opex and capex.

Despite this stellar contribution, however, using Pranab Mukherjee’s retrospective tax amendment, the UPA government slapped a $1.6 billion tax demand — the penalties were separate — on Cairn UK at the time it reorganised its global businesses in order to list the Indian operations. Till then, the Indian assets in Rajasthan were owned by Cairn Energy subsidiaries listed in, among others, various tax havens. Apart from the retrospective tax being a bad policy, Cairn argued that business reorganisation didn’t attract taxes, more so since not even one rupee had been repatriated. And while the NDA campaigned against the UPA’s tax terrorism, it did nothing to repeal the law. Indeed, under it, the taxman seized `440 crore of dividends from Vedanta due to Cairn UK on one occasion, then another `666 crore on another, and `1,594 crore of capital gains taxes that the company paid had to be refunded but were not; apart from this, the taxman also seized $1 billion worth of Cairn UK shares and has, since, sold most of these to recover its tax demand—all of this while Cairn UK’s arbitration case against the government is still going on!

So, instead of asking global oil producers for easier payment terms, the prime minister would be better served by trying to boost local output. While the prime minister’s plan was to reduce import dependence on oil/gas by 10% over the next five years, imports have risen—while India imported 77.3% of its crude oil in FY14, this rose to 82.8% in FY18 and, in the case of natural gas, this rose from 33.2% to 45.4%. Indeed, if the government were to agree to honour the Cairn aribitration verdict—due in December or January—it would go a long way in encouraging foreign investors as the signal would be that India honours its legal obligations. India is right now ranked 164th versus China’s 5th position when it comes to enforcement of contracts in the World Bank’s ease of doing business rankings.

Apart from this, it is also important to ensure India’s oil and gas policies are investor-friendly. Several global players have, in the past, exited India in the face of regulatory uncertainty, but that over the last few years has possibly increased. When Cairn-Vedanta found more oil and asked for an extension of its lease to allow extraction of the oil, instead of being happy about the lowered import dependence, the government told Cairn it had to pay 10 percentage points more of its profits to the government if it wanted the extension. And this is when the government already takes away, on average, around 70% of profits of oilcos by way of royalties, cesses and revenue-shares; after this, corporate taxes are to be paid. Two years ago, for instance, the cess on oil was hiked by 47%; last year, the government issued service tax notices on ‘cost petroleum’ (the share of oil/gas the companies get to compensate for their costs), cash calls (the amount a consortium leader asks others to pay for production costs) and even royalty paid to the government!

At one point, the government even put a de facto cap on the costs oilcos could recover by directing that, even if oilco investments rose, the investment multiple (IM)—the oilco’s net income divided by the capex—would not be allowed to change; as the IM falls, the government’s take falls. In other words, the government wanted the oilcos to increase their investment—this lowers the IM—but did not want its profit-share to fall. Some of these directions, like the one on IM, were withdrawn after being reported in the press, but the uncertainty hurts investment. Unless these are fixed, the prime minister and the oil minister will continue to go around asking for concessions since local oil/gas production will remain low.

Source: financialexpress.com

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