And the giants come marching in

The oil and gas industry is still recovering from the greatest global economic shock in more than 75 years. As we begin 2011, economic uncertainty remains, but a mood of cautious optimism has emerged. The current surge in commodity prices suggests that an average oil price of $90 or more per barrel over the year is seen as increasingly achievable. As a result, oil and gas exploration companies are beginning to look again at new frontiers of exploration and unconventional fuel resources in a bid to regain momentum. So where does India fit into this trend?

India is and will remain energy hungry. The country is currently the fifth largest energy consumer in the world and given its targeted GDP growth, fuel needs are likely to expand at a significant rate – up to 40% over the next decade according to some estimates. India’s per capita consumption of energy and electricity is well below that of industrialized nations and the world average, meaning that there is scope for rapid expansion. These facts perhaps explain two distinct initiatives from the Indian government. The first is an ongoing pressure for India to compete in the strategic race for global energy resources with other developing economies such as China and Brazil; late last year India’s Ministry for Petroleum and Natural Gas again publicly issued a call for Indian companies to flex their muscles overseas and contribute to the country’s energy security.

The second initiative, which is the focus of this article, is a clear requirement to maximize India’s own domestic natural resources. India already imports over 70 per cent of its crude oil requirements and around 15 per cent of its natural gas. It is with this context in mind that the Indian government launched its New Exploration Licensing Policy (NELP) in 1999, part of its Hydrocarbon Vision 2025 master plan, with a related goal of attracting $40 billion in oil and gas investment by 2012.

With some recent major discoveries hitting the headlines, a range of tax and investment incentives announced by the Indian government, and an estimated 22% of India’s prospective territory remaining so far unexplored, India seems on paper at least to be an attractive market. Yet the most recent sale of exploration rights (NELP 8) drew a less than overwhelming response from foreign bidders, and the ninth round, launched in October last year, is unlikely to fare much better. And although a number of European companies such as BG Group, BP and ENI have established businesses in India, other majors – particularly from the US – have so far stayed away. What are the risks that they perceive which are currently holding them back from exploring India as a new frontier?

 
Domestic production on the rise

The two major discoveries in India in recent times, namely Reliance Industries’ natural gas find in the offshore Krishna Godavari (KG) fields, and Cairn India’s heavy crude find in the deserts of Rajasthan, have provided a major boost to the domestic oil and gas sector in India. Indeed India’s fuel import bill in 2009-10 was around US$82 billion – significantly lower than expected due to the commencement of production from these two projects. The timing was also fortuitous given that several existing oil and gas fields experienced a decline in production in the same period as they near maturity.

Increased levels of exploration activity have also meant good business for oilfield services companies. Providers of seismic surveys, drilling rigs and ships, well-logging and so on have witnessed robust growth and this is likely to continue, particularly given the focus on deep-water blocks and frontier basins. Nonetheless, many of these blocks come with significant ‘below ground’ risks, a fact tacitly acknowledged by the Petroleum & Natural Gas ministry in the terms offered in the , and the major players are likely to stay away until reserves are proven and production has started.

Policy uncertainty

In terms of ‘above ground’ risks, the extent of State involvement and uncertainties in the direction of energy policy are important considerations. Foreign bidders will no doubt have concerns at the levels of participation in the rounds by State-owned companies such as the Oil & Natural Gas Corporation (ONGC) and Oil India, both of whom receive subsidies from the Indian government and may be perceived as being at an unfair advantage. The extent to which ONGC dominates the Indian oil & gas landscape should not be underestimated, with many existing operators and services companies citing the organization’s cumbersome bureaucracy and slow decision-making as a major negative factor of operating in the market. Its influence as an instrument of government policy is also clear, particularly in its recent moves to block London-listed Vedanta Resources from buying Cairn India.

Nowhere is this issue more clearly illustrated than in the dispute between the brothers Mukesh and Anil Ambani, who control Reliance Industries and Reliance Natural Resources respectively, following an acrimonious split of the family empire. The long dispute centers on the price of natural gas that Mukesh’s RIL had agreed to sell in 2005 to RNR. In 2007, the Indian government decreed that the price should be increased by some 80% in line with the Administered Pricing Mechanism (APM), the government’s price-setting tool for natural gas, a decision that was eventually upheld by the Supreme Court in 2010. The idea that the government has the power to set prices for natural resources is naturally off-putting for oil and gas companies. The ruling is also likely to worry investors across the board in that it appears to undermine the sanctity of contracts in general.

Furthermore, and in line with many other developing countries facing a sharp decline in tax revenues due to the economic slowdown, India is likely to target oil and gas companies with increased tax rates and other fiscal measures. The latest round, for example, will be governed by the proposed new Indian Direct Tax Code which has suggested that business income be computed for each E&P block separately. This could result in the block-wise ring-fencing of expenses and as a result companies being obliged to pay tax on the profits of each block, without the ability to offset against losses in other blocks.

Infrastructure and technology constraints

As in many other parts of the world, hydrocarbon reserves are not always found in the easiest of operating environments and India with its concentrations in remote areas in the north-east of the country and offshore, sometimes in deep-water blocks, is no exception. Ensuring sufficient access (with supporting infrastructure) to oil and gas reserves at a reasonable cost will remain a significant challenge. Infrastructure remains a key business limitation in India for many industries, in terms of transport and communication networks, but particularly for the oil and gas industry. The expansion of the natural gas industry in India will inevitably be constrained by India’s relative lack of pipeline network, especially in the south and east of the country.

For onshore blocks, dealing with land acquisition and the kind of communal issues that have recently dogged other natural resources companies such as Vedanta and POSCO in the east of India, will also require careful thought and long-term planning. For some foreign companies, this is reason enough to leave operatorship to a local partner or to avoid the onshore market altogether.

The shortage of human capital and availability of equipment affecting the entire oil and gas industry also applies in India. Indian companies themselves are starved of technology, particularly in the unconventional technologies space, and this will continue to drive cross-border deals by Indian players looking to buy in that expertise from overseas. The most notable deal last year in this field was RIL’s purchase of a stake in Atlas Energy’s Marcellus project, which gives them exposure to the North American market as well as access to shale gas technology.

 
An unconventional future

Despite the poor showing in recent rounds, the government is pinning its hopes on unconventional fuel resources as a bright spot on the horizon. India is known to hold huge potential shale gas reserves in the east of the country, as well as in the north-east and offshore, and a number of pilot shale gas projects have already begun. A framework for the new shale gas policy is currently under preparation by the Indian upstream regulator, with a first round of auctions due by the end of 2011.

At the same time government policies are becoming noticeably more investor-friendly. Recent moves towards more transparency in gas pricing have led some experts to predict that the Administered Pricing Mechanism will be dismantled in the near future. Caps on visas for expatriate employees in the oil and gas industry have also been removed after lobbying by the industry in the past 12 months. The sum of which may prove enough to tempt the major foreign players to India’s new gas frontier after all - so will the giants come marching in?

(Author’s note: This article was published in “Asia-Pacific Risk Watch” – the quarterly newsletter of Control Risks Pvt Ltd in January 2011; subsequent to my writing this (and not because of!), the Reliance-BP deal was cleared on 21^st July).