IHS Global Insight Perspective | |
Significance | The three-member bench ruled two-to-one in favour of Reliance Industries (RIL), stating that the memorandum of understanding for supplying gas at US$2.34/mmBtu to Reliance Natural Resources (RNRL) was not binding on both corporate parties and that the government has the right to help fix the price and influence gas marketing. |
Implications | The ruling confirms the government's sovereign rights over India's gas reserves. However, continuing ambiguities in the model 2009 production sharing contract over gas utilisation and valuation means the verdict will ultimately bring little clarity to prospective investors. |
Outlook | The court has directed RIL and RNRL to renegotiate their contract within six weeks to safeguard the interests of RNRL's shareholders; some sort of compromise now appears likely under which RNRL could receive gas for its Dadri plant, albeit at the US$4.2/mmBtu price and for a shorter tenure than the previously agreed 17 years. |
Judgement Day
India's Supreme Court has issued a long-awaited verdict on the five-year legal battle between Reliance Industries (RIL) and Reliance Natural Resources Ltd. (RNRL) over natural gas from the D6 Block in the Krishna-Godavari Basin, offshore India. A three-member bench consisting of Chief Justice K.G. Balakrishnan, Justice B. Sudershan Reddy, and Justice P. Sathasivam heard the case. Justice Sathasivam ruled in favour of Mukesh Ambani and RIL, saying that the Ambani memorandum of understanding (MoU) was not binding on both the corporate entities and stating that the government has the right to help fix the price of natural gas because it is the owner of gas resources until they reach the consumer. Justice Sudershan Reddy’s verdict conflicted with that of the first judge, although Chief Justice Balakrishnan found in favour of RIL. The ruling suggests that the MoU for RIL to supply 28 mmcm/d of gas to RNRL at a price of US$2.34/mmBtu for 17 years was not legally binding, indicating that RIL does not have absolute marketing rights with regards to gas, which are subject to government approvals. The ruling indicates that India's production sharing contract (PSC) has overridden the MoU.
For RIL the court's ruling is an apparent victory, following the shock ruling by the Mumbai High Court to uphold the MoU in 2009 while stating that the two companies must enter into a gas supply contract within one month. For the Ministry of Petroleum and Natural Gas supplies from D6 are just too important to India's gas supply security to be distributed via an MoU agreed between two of the country's leading oligarchs and the Ministry has rather controversially got involved in the case to contest the validity of the memorandum. Nevertheless, it seems that the ruling was eased by changes made to India's model PSC of 2009. For example, under Article 21.3.1 of the New Exploration and Licensing Policy (NELP) VIII model PSC, a regulation has been included stating that from time-to-time the government may frame policy for utilisation of natural gas among different sectors, both for associated and non-associated gas, which would cover issues relating to the supply of gas to different consumers. However, because the model PSC remains vague on contractor's rights for marketing gas, the ruling is unlikely to provide that much clarity for investors; the model PSC does not state under what circumstances or conditions the government may frame policy for utilisation of natural gas. Regulation 21.3 also seems to contain contradictory sentiments, stipulating that the contractor shall have the freedom to market gas and sell its entitlement in the domestic market but only in line with government policy for utilisation of gas among different sectors.
The ruling has also upheld the sales price of US$4.2/mmBtu on gas sold from the D6 Block. This is good news for RIL, which otherwise would have had to sell a significant chunk of gas at US$2.34/mmBtu, which given the costs of extracting gas from the deepwater fields could have resulted in losses on sales. In its ruling the court seems to be upholding the model 2009 PSC, in which the government inserted additional regulations on gas pricing. The PSC states that gas should be valued on the basis of competitive arms-length sales in the region for similar sales under similar conditions. However, when an arms-length price is impossible to arrive at—which might be the case with D6—the formula or basis on which prices are determined needs to be approved by the government prior to invitations of price bids or other steps by the contractor to sell gas to consumers. It is possible that these additional regulations only recently came into force, which, if the case, would raise concerns about a shifting of terms to influence ongoing legal proceedings. The ambiguities exposed by the case have already raised questions over India's fiscal terms and fears that the government is trying to reassert control over marketing and pricing. As per the PSC, the government does appear to have the legal option to influence pricing and marketing, although in most cases it would likely refrain from doing so given the need to attract private and foreign investment into the sector. It is the national significance of gas production from KG-D6—which the government wants to provide to the fertiliser sector to ensure products to help millions of farmers, and as a feedstock for power generation—that has led the government to get involved.
Outlook and Implications
For RNRL the court ruling is a blow to its ambitions of establishing a huge 7,800-MW gas-fired power plant at Dadri in India. Nevertheless, there may be some room for compromise. The court has directed RIL and RNRL to renegotiate their contract within six weeks to safeguard the interests of RNRL's shareholders and the interests of India's economy as a whole given the importance of Ambani-owned assets, which together make up an estimated 5% of the Indian economy. Following the ruling RIL indicated that it might be willing to sell gas to RNRL, albeit for a shorter tenure than 17 years and at a price of US$4.2/mmBtu, providing the government approves. Undoubtedly this will raise supply costs for the Dadri power plant, which may need to be scaled down or hunt out alternative supply sources over the longer term. For RIL the US$4.20/mmBtu price will ensure margins on gas sales from KG-D6 over the long term and, by nullifying the MoU, appears to disallow RNRL from having right-of-first-refusal over 40% of future discoveries from Block D6, which still remains largely unexplored.
The case has been damaging to India's upstream sector, exposing ambiguities in the PSC while also leading to revelations by RNRL of corruption against India's oil regulator, the Directorate General of Hydrocarbons (DGH—see India: 29 October 2009: Directorate of Hydrocarbons in India Resigns After Corruption Investigation). The furore over gas prices thrown up by the case has also led the government to investigate alternative pricing systems, most notably a common pooled pricing mechanism to help standardise the array of gas prices in India. The government is currently carrying out studies on various mechanisms, although there are concerns that the system could lead to more government intervention in pricing while obscuring contractors’ ability to work out market prices for various consumers. While continuing supplies of gas sold by Oil & Natural Gas Corp. (ONGC) under the administered pricing mechanism (APM) threaten to undercut gas produced from private contractors, which is usually sold at higher rates, APM gas will ultimately decline as the low prices means that state-run companies do not have the capital to invest in fields to sustain output. Establishing a gas pricing system under which contractors are guaranteed to make margins on sales of gas in the domestic market will be crucial to attracting new companies into the upstream sector, particularly as exploration is increasingly focused on the deepwater areas of the KG Basin, where investment and extraction costs are higher. Allowing investors profits on gas sales will help meet future gas demand increases while reducing the percentage share of coal in India's energy mix, of which supplies could also come under pressure.
Attracting the private-sector investment needed to meet these demand increases requires regulatory clarity more than anything, as well as the broader streamlining of bureaucratic processes, and an improvement in sector management in order to accelerate exploration.