(De)regulation of oil pricing!

The Gulf war, which substantially increased the crude import bill of India, led to a severe balance of payment crisis in 1991. To overcome the financial calamity, the Government of India took resort to the International Monetary Fund (IMF) and the World Bank prescriptions to bail out its ailing economy. The national currency was devalued and the liberalisation process, which had been started earlier, was accelerated and extended to other sectors of the economy in the name of the structural adjustment process (SAP). The main features of SAP were (i) liberalisation, (ii) privatisation, and iii) globalisation of the economy. However, much before this exercise, the petroleum sector was opened to foreign companies.

Against this background, we shall discuss the effect of economic liberalisation on this vital industry. Our analysis will focus on (a) exploration and production (b) pricing

Exploration and production

i) To begin with, the government, in the early 1990s, had changed the legal status of the Oil and Natural Gas Commission (ONGC) by converting it into a corporation, thereby giving it more autonomy. Oil and Natural Gas Corporation Ltd (ONGCL) — a limited company governed by the Indian Company Act — was formed. Earlier, ONGC was governed by the Acts of the Parliament.

ii) The government also decided in favour of more involvement of the private sector in exploration and production. To manage this transition, it felt the need for establishing an independent regulatory body that could effectively supervise the activities of all the companies — private and public. Thus, the Directorate General of Hydrocarbon (DGH) was set up in April 1993. Since then, the privatisation process of the exploration and production activities has been augmented.

iii) The most noteworthy policy shift was the decision of the government to involve private and foreign companies in the development of already discovered fields. In the first offer of such fields in August 1992, contracts for five medium-sized and 13 small- sized fields had been awarded. Enron Oil and Gas Company, Reliance Industries Ltd, Command Petroleum, Videocon Petroleum Ltd. and Ravva Oil Pt. Ltd were a few such major foreign and Indian private companies. ONGCL and OIL's share in those joint ventures (JVs) were limited to 40 per cent only. The estimated oil and gas production from these fields was 360 billion barrels and 50 billion cubic meters respectively. The most promising fields of Panna, Mukta and Mid & South Tapti, which had been successfully explored earlier by ONGC, were offered to Enron-Reliance consortium without reimbursing the past exploration expenses to ONGC. Moreover, the government agreed to purchase the produced crude from the consortium at the international price plus a premium of USD 4 per barrel as the sulphur content was low.

iv) From 1991 to 1996, the government had held five rounds (fourth, fifth, sixth, seventh and eighth) of bidding for exploration acreages offering as many as 126 blocks, ranging in sizes from a few hundred square kilometres to over 50,000 square kilometres. Eleven contracts had been awarded. Some of the important companies which had been either awarded contracts or participated in the exploration round were: Shell, Occidental, Amoco, and Enron.

Nevertheless, all these efforts could not improve the crude and gas reserves of India. In 1990-91, the crude oil reserve was 739 MMT which declined to 658 MMT in 1999-2000. The corresponding natural gas reserve figures were 686 bcm and 628 bcm respectively. In that period, crude production also declined from 33.02 MMT to 31.95 MMT and, in 1999-2000, India had to import 44.99 MMT of crude. The above figures clearly indicate that the government's policy of involving the private parties — both Indian and foreign — offering liberal terms, did not help the upstream petroleum sector. On the contrary, reserves and production drastically fell in the post-liberalisation period.

v) Alarmed with this situation, the government decided to further liberalise its terms to lure Indian and foreign companies to exploration and production. A new Exploration Licensing Policy (NELP) was formulated by the government in 1997-98 to provide a 'level playing field' in which all parties (including national oil companies) would compete on equal terms for the award of exploration acreage. A Model Production Sharing Contract (MPSC) was framed for the finalisation of the contract.

Some of the incentives announced by the government were:

⁕No customs duty on imports was required for petroleum operations

⁕No minimum expenditure commitment during the exploration period

⁕No mandatory state participation

⁕No carried interest by national oil companies

⁕Freedom to sell crude oil and natural gas in the domestic market at market-related prices

⁕Biddable cost recovery limit up to 100 per cent

⁕No cess on crude oil production

⁕Royalty payment: 12.5 per cent for on-land areas, 10 per cent for offshore and five per cent for deep water areas

⁕Liberal depreciation provisions

⁕Seven years of tax holidays from the commencement of production

If we compare the fiscal incentives offered in the NELP with the incentives declared in earlier production-sharing contracts (the third round of bidding in 1986), these were not more liberal than those already offered. But in all the earlier contracts, participation of national oil companies in the JV was mandatory in the event of successful crude/gas find during exploration. This clause has been dropped in the new policy. Moreover, as per the new policy, ONGCL and OIL will have to compete at par with the private companies for the exploration and production of new acreage.

vi) The new exploration license policy (NELP-I) was finally launched in January 1999. Record number of blocks had been offered for exploration — including 10 in on-land, 26 offshore up to 400 meters depth and 12 deep offshore off the east coast. Out of these, 24 blocks were awarded to different parties. ONGCL on its own had bagged five blocks; and with GAIL and IOCL one and two more blocks respectively. Among the private parties, the RIL-NIKO consortium got the maximum 12 blocks.

In December 2000, the government announced NELP-II and invited proposals for 25 blocks. For the first time, eight deep-water blocks on the west coast and prolific blocks of Assam and Gujarat had been included under NELP. Twenty-three blocks have been awarded to different companies, of which ONGC consortia bagged 16 oil and gas blocks while Reliance-Hardy Oil combine won four blocks. ONGCL on its own managed to bag six blocks, and OIL one block.

vii) For the first time, in April 2001, the government offered seven blocks for competitive bidding for the exploration and production of Coal bed Methane (CBM). The incentives package had been framed in line with those already offered in NELP.

The liberalisation policies followed so far have not shown any positive result in the exploration and production sector. In FY20, crude oil production in India stood at 32.2 MMT (compared to 33.02 MMT in FY1990). In a desperate bid, the government has accelerated the pace of reform. How the national oil companies, ONGC and OIL, adjust to this rapidly changing situation is to be watched closely. Crude oil import rose sharply to USD 101.4 billion in 2019-20 from USD 70.72 billion in 2016-17. Now, nearly 80 per cent of India's crude oil requirement is imported.

viii) The government has also adopted several other policies to fulfill the increasing demand. It has allowed 100 per cent Foreign Direct Investment (FDI) in many segments of the sector, including natural gas, petroleum products and refineries among others. Today, it attracts both domestic and foreign investment, as attested by the presence of Reliance Industries Ltd (RIL) and Cairn India. According to the data released by the Department for Promotion of Industry and Internal Trade Policy (DPIIT), FDI inflows in India's petroleum and natural gas sector stood at USD 7.96 billion between April 2000 and June 2021.

Pricing

India's consumption of petroleum products grew by 4.5 per cent to 213.69 MMT during FY20 from 213.22 MMT in FY19. The total value of petroleum products exported from the country had increased to USD 35.8 billion in FY20 from USD 34.9 billion in FY19. Export of petroleum products from India increased from 60.54 MMT in FY16 to 65.7 MMT in FY20.

In the 1990s, the government had announced a few major policies to boost the marketing of petroleum products, with far-reaching implications. These policies have helped to make the western coast of India emerge as a major refining and marketing hub. The policies include:

i) To attract private investment in exploration, the government has announced that any company investing nearly USD 400 million (Rs 20 billion) in exploration and production or other specified avenues, would be eligible for marketing rights for petroleum products in India.

ii) In September 1997, the government had decided to dismantle the Administrative Pricing Mechanism (APM) in a phased manner. It was supposed to be implemented from the very second year of the new millennium, but it was delayed till 2010 due to various worries.

Apprehensions

It was argued that the refining and marketing PSUs with old refineries and decades of 'retention' culture might find it difficult to face competition in the post-APM phase. And if international crude price falls, as we saw during the late 1980s, ONGCL and OIL will also become uncompetitive unless they adjust themselves quickly to the changing situation.

The second major concern was about the economy of scale: Except for the one in Koyali (Gujarat), all other 14 public sector refineries were small in size (less than 8 MMTPA capacity). Their capacities ranged between 0.65 MMTPA at Digboi (Assam) and 12.5 MMTPA at Koyali (Gujarat). And, most of these refineries were built before the 1980s. Compared to this, the Reliance Refinery, built in 1999 with state-of-the-art technology, had a capacity of 27 MMTPA in FY2000.

In September 2001, the refining margins of IOCL refineries were only 30 cents per barrel compared to RPL's margin of USD 1 per barrel. In 2000-01, IOCL had to forgo over USD 400 million on account of lower refining margins compared to the earlier years. The effects of de-regulation on public sector oil refineries were clearly visible by then.

The third problem was the need for matching of crude oil. Under the deregulated market, the refineries will have to pay import parity prices for the crude and any fluctuations in the actual crude price will not be absorbed, as before, by the 'oil pool account' (a part of APM). Hence, selection of proper crude oil for a particular refinery will be of vital importance. In the emerging scenario of lower availability of sweet crude, dependence on heavy and sour crude oil is bound to increase. Selecting and sourcing matching crude for 15 different refineries for optimum production to meet stringent environmental regulations and international quality standards, will be a major challenge to public sector refineries.

The year 2008 saw an unprecedented rise in the oil prices in the world market. Oil price volatility had also increased. When the average monthly price of Indian basket of crude oil on the world market increased from USD 36 / barrel in May 2004 to USD 132.5 / barrel in July 2008, the government did not permit public sector Oil Marketing Companies (OMCs) to pass the full cost of imports on to domestic consumers of major oil products, i.e., petrol, diesel, domestic LPG and PDS kerosene. The consumers of these products thus received large subsidies. As a consequence, OMCs had large under-recoveries, which were financed partly by the government through issuing bonds, and partly by upstream public sector companies ONGC and OIL, and GAIL through price discounts. The OMCs also absorbed a part of the under-recoveries themselves. But this facility was not provided to the private refineries.

In this context, an expert group was set up by the Ministry of Petroleum & Natural Gas on August 31, 2009 to suggest 'a viable and sustainable system of pricing of petroleum products' in India. The expert group, under the chairmanship of Kirit Parikh, submitted its report on February 2, 2010. One of the major recommendations was to phase out APM and allow most of the oil products to be market-determined.

On the recommendation of the expert group, the Government of India decided, on June 25, 2010, to allow the pricing of a few major petroleum products on the basis of a free-market mechanism. After deregulation, on that very day, the price of petrol was increased by Rs 3.5 per litre, kerosene by Rs 3 per litre, diesel by Rs 2 per litre and LPG cylinder by Rs 35. Since then, prices are moving to the north.

However, it is reported that the Standing Committee on Petroleum wants to re-look the decontrol of market prices of petrol and diesel by the UPA government. Agreeing to the demand of Opposition parties, the Parliamentary Standing Committee on Petroleum and Natural Gas has decided, in October 2021, to examine the pricing, marketing, and supply of petroleum products, including natural gas. The panel will also review the Centre's policy on the import of crude oil. As per a Business Line report, the MPs argued that "decontrol" of the market prices have burdened the people as oil companies were unwilling to reduce the prices even though the international price of crude oil was low.

The petroleum sector is a 'cash cow' to the Indian state. It is very unlikely that the government would allow the free-market mechanism to determine the price of such an important product. To date, in practice, the government has not allowed market forces to determine oil prices. Only the mechanism of control has changed.

Views expressed are personal