2/24/13

[Economy] Rangarajan Gas Pricing, Production Sharing Contract (PSC), APM, Non-APM, issues, recommendations Mrunal

[Economy] Rangarajan Gas Pricing, Production Sharing Contract (PSC), APM, Non-APM, issues,
recommendations
1.
2.
3.
4.
5.
6.

7.
8.

Introduction
What is Production Sharing Contract(PSCs) ?
Royalty-tax regime
Problems faced by Oil/Gas exploration companies
CAG-Audit
Gas Pricing Mechanism
1. Administered Pricing Mechanism (APM)
2. Non-APM
Criticism on Rangas gas pricing
Summary points

+30

Introduction

Rangarajan is a noted economist, ex-Governer of RBI, ex-MP, Chairman of 12th Finance Commission and Chairman of Economic
Advisory Council to the PM.
Mohan had appointed Rangarajan Committee to look into following matters
1. Production sharing contracts with oil n gas exploration companies
2. Contentious issues between those companies vs Government.
3. How to decide the Price of domestically produced natural gas?
Rangarajan submitted report in December, 2012. It mainly revolves around following issues
1.
2.
3.
4.

Production sharing contracts

Problems faced companies
CAG auditing
Gas pricing mechanism

#1: Production Sharing Contract(PSCs) ?

The PSCs work in the following fashion.
This contract made between the government and a contractor (oil/gas exploration company).
Contracts bids for specific oil block.
If he wins the bid, hell start oil exploration in that block.
Oil exploration =lot of investment and risk taking involved. This is borne by contractor. (lets say 150 million dollars were
invested).
Once the oil is discovered, contractor will start commercial production and sells it.
Lets say he makes profit of 1 million dollar per month. According to contract, he has the right to first recover the
investment.
So for the first 150 months, he doesnt need to share profit with Government. (because 1 million x 150 = 150 million.)
Once contractor has recovered his the cost of exploration, then hell have to share part of his profit with the Government (as
per the terms and conditions in production sharing contract.)
Sounds well and good, right? But CAG and Rangarajan Committee found some flows in ^this Production sharing contract.
(PSC)
1. This system encourages Contractor to inflate costs. (I would rather show cost of exploration as 2 billion dollars, even if it
took me only 1 billion dollar.)
2. Difficult for Government to check the accuracy of contractors account and get the correct share. (I may be making 1.5
million per month but I would doctor my accounts to show profit of only 1 million.)
3. I intentionally dont run my plant on full capacity. Ill just wait till the oil prices in international market to sky rocket, and only
during those days/ months, Ill run plant on full capacity to make lot of profit.
For more on this, recall Reliance KG Basic article click me
To solve ^these problems, Rangarajan made some recommendations. He proposed a

Royalty-tax regime
Under this system:
1. From the total profit from selling the oil, a fixed royalty is to be paid to the govt.
2. After royalty is paid, the rest of revenue is shared by the govt and contractor.
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2. After royalty is paid, the rest of revenue is shared by the govt and contractor.
3. Government should allocate block to a company that offers maximum share from profit.
Advantages of the system are:
1. Encourages the contractor to reduce costs.
2. In case of price rise, the contractor doesnt get windfall gains.
3. Government gets more money = more money for MNREGA, food security.

#2: Problems faced by Oil/Gas exploration companies

They can be classified into three types

1. Policy Issues

1. Environment ministry cancelled the NOCs given to areas under the oil blocks.
2. Contractors have difficulty in oil-exploration in North East and Naxal affected regions.
3. Once oil is found, contract would want to dig more wells but he wont be allowed under the license
granted.

2.Management
Issues

1. If there are merger/acquisitions of companies, the Production sharing contract doesnt recognize
them.
2. In the difficult terrain, it takes many years to complete survey, research, exploration. But
production sharing contracts allow only 8 years to finish this.

3. Contractual
Issues

1. Concerns of inflation of costs. (from Governments side

2. Procurement of goods and services has to be done according to the PSC. (e.g. Government would
say buy xyz machinery only from Government controlled PSU, even if a foreign company is
providing better equipment at cheaper cost.)
Ranga recommends:

For Policy Related Issues Make an Inter-Ministerial Committee to iron out the issues.
To solve other issues, there is already an Empowered Committee of Secretaries(ECS). Give them more powers to resolve
these issues.
For companies exploring oil / gas in difficult terrains, should be given following extensions:
Currently Rangarajan wants
Tax holiday

7 years

10 years

Timeframe for exploration 8 years

10 years.

#3:CAG-Audit
Another controversial issue is : CAG auditing. Oil/ Gas exploration companies like Reliance, want following things:
1. CAG should only check our financial accounts, he should not do performance auditing. (because Production sharing
contract doesnt mention performance auditing).
2. CAG should not reveal details of audit to public( not even in Parliament) because that leads to bad publicity for our
company.
3. Audit should be within 2 years. If later, then under permission of the contractor.
Ranga on CAG
The CAG is bound by the constitution to share all its audit with the Parliament. Just because some private company doesnt
want it, we cant change that!
CAG is fully empowered to carry out audits. (including performance audits)
If a block has high value, then CAG himself should audit it.
If the block has low value, then CAG should outsource this auditing work to others. (reputed private audit firms selected by
CAG)

#4: Gas Pricing Mechanism

India has 2 types of gas pricing mechanism

1. Administered Pricing Mechanism

(APM)
Government fixes this price for National Oil

2. Non-APM
This is applied to:

Companies .
Imported LNG. (because Imported gas comes at a price agreed
This is the price at which gas is provided to
upon by the 2 countries in agreement.)
fertilizer, power companies, etc. (so if National
Gas obtained from National Exploration and Licensing Policy
company
makes
losses,
then
Government
pay
(NELP) era and pre-NELP era gas fields. (because Pre-NELP era
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company makes losses, then Government pay

money = subsidy).
This system is already regulated under Gas
Utilization Policy(GUP).

(NELP) era and pre-NELP era gas fields. (because Pre-NELP era
licenses sell gas according to the Production Sharing Contracts
signed.)
Not yet regulated.

Since there are ^two mechanisms, the price of gas is neither constant nor predictable in Indian market.
Ranga on GAS
Rangarajan says, first you gather two values.
Value #1

price of imported liquefied natural gas

(LNG).

Value #2

Weighted average price of gas in Global

markets (US, UK and Japan)

Then, take average of values #1 + #2. Thatll be the final pricing for gas in the country.

Criticism on Rangas gas pricing

1. There are two types of gases: Wet gas vs. dry gas. The wet gas contains crude oil too. So obviously wet gas is more useful.
But Committee has not considered it in in the pricing mechanism.
2. Countries that export LNG, donot openly declare the price. Because it depends on many variables. (e.g. Iran may sell us
gas cheap, if we support their nuclear program.) So it is hard to determine value #1 objectively.
3. While calculating Value #2 (weighted avg in global market), Rangarajan has included Japan in the list, but Japan doesnt have
its own gas production/suppliers. (counter: Japan is a big buyer so whatever gas prices go in Japan, they reflect
benchmark for Asia-Pacific region.)
4. Rangarajan says take average of Value #1 + #2. This Average logic is unheard of in International markets. No country is
doing this!
Ranga Defends
In free market, price of a commodity is determined by Supply demand, but Indian market is not yet ready to introduce direct
market based gas pricing. Because
1. there is huge gap in supply-demand of gas. And our sea-ports donot have sufficient capacity to handle lot of imported gas.
2. Gas is essential for fertilizer, power industries and these sectors are essential for overall performance of economy and
controlling inflation. So we cant let the gas prices to be determined by free market.
So, use ^above pricing mechanism be used until such provision can be made.
Rangas implication?
If Rangas pricing mechanism is implemented, we (public) will have to pay higher price for gas, just like we do for petrol right
now.
On the other hand, itll reduce the subsidy burden on Government = fiscal consolidation.

Summary points
Feature

What was there earlier

Recommendation of Rangarajan

1. PSC

Cost Recovery by contractor first, then profits

shared between govt and contractor.

Move to a royalty-tax regime after which the

balance revenue is shared by govt and contractor.

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2. Issues

North east, naxal area, company mergers, # of

wells etc.

1. Create an Inter-Ministerial Committee to solve

policy related issues.
2. Give more powers Secretaries(ECS)
3. tax holiday, more time to explore

3. Audit

Lot of issues between the contractor and CAG

over what type of audit can be performed.

1. CAG has the right to perform audit over oil/gas

blocks and publish report.
2. CAG to directly audit big blocks.
3. CAG to outsource auditing for small blocks.

4. Pricing for
domestically
produced Gas

Two models: APM, Non-APM

Average of (imported LNG + wt.avg of prices in

US, UK and Japan)

For more articles on economy, visit Mrunal.org/economy

ref
1.
2.
3.
4.

Major Inputs from Mr.Shiva Ram

http://eac.gov.in/reports/rep_psc0201.pdf
http://www.thehindu.com/opinion/lead/making-a-mockery-of-domestic-gas-pricing/article4316958.ece
http://www.livemint.com/Politics/P6M3Mcn7LIjC4cMhdGfMqL/Rangarajan-committee-seeks-freeing-gas-prices.html

31 comments to [Economy] Rangarajan Gas Pricing, Production Sharing Contract (PSC), APM,
Non-APM, issues, recommendations

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SABYASACHI MUKHARJEE
Reply to this comment
MRUNAL SIR,
I HAVE A MINOR DOUBT RELATED TO THE ISSUE OF COMPULSORY ENGLISH QUESTION IN THE PRELIMS,IS IT MANDATORY
TO QUALIFY IN THE 8 COMPULSORY QUESTIONS WHICH IS SAME FOR BOTH HINDI AND ENGLISH MEDIUM STUDENTS MANY
OF THE PEOPLE ARE SAYING THAT IF U R GETTING MORE THAN THE QUALIFYING MARKS BUT FAILED TO GET THE MINIMUM
QUALIFYING MARKS IN THOSE 8 QUESTIONS U WILL BE DISQUALIFIED .
SIR ,KINDLY CLEARIFY MY DOUBT

Rakesh
Reply to this comment
I too have same doubt, have heard from some so called Pandits of UPSC. Let us see what is Mrunals Opinion.

Mrunal
Reply to this comment
not necessary. It was nowhere mentioned in the UPSC 2012 notification.

TRA
Reply to this comment
Thanks a lot Sir.
had been following every article in editorial and op-ed of hindu about rangarajan committee report but have comprehended it actually
today after reading your article.

Praghu
Reply to this comment
thank u sir. was waiting 4 this article.

aaditya singh
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Sir in non-APMthis applies to both NELP era and pre NELP erahow??

dr .ramesh krishnan
Reply to this comment
thanks sir.ur not just good but best

csl80
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csl80
Reply to this comment
look at the press conference pic has has k haalat kharab ho gayi hahahaha keep the good work going mrunal

Dhananjay
Reply to this comment
it was quite helpful, easy to understand..but missed the question section

SIDHARTHA
Reply to this comment
http://www.hindustantimes.com/India-news/NewDelhi/Civil-services-exam-pattern-may-be-changed/Article1-1014097.aspx
plz friends view this
this article is v informative
plz Mrunal Sir xplain the special majority in polity with examples

vishnu
Reply to this comment
As usual mrunal bhaiyya has written a master piece

vishnu
Reply to this comment
Sir can u explain how supreme court is handling inter state water dispute. Isnt is beyond its jurisdiction???

GURMEET
Reply to this comment
PLZ TELL ME WHETHER OPTIONALS WUD BE REMOVED FROM THIS YEAR OR NOT.WHEN WUD B NOTIF. OUT.

Himanshu Srivastava
Reply to this comment
Hi Mrunal,
Thanks a lot for the great article.
I have a doubt in some points. Request you to check/correct the following points:1. NELP is New Exploration and Licensing Policy (not National)
2. Policy issues It is not true that if oil is found the contractor wont be allowed to dig more wells. If the volume of the oil/gas discovery
is good enough to allow the techno economic drilling of further wells, the contractor is allowed to do so (in fact encouraged).
3. Management issues PSC does recognise the merger/acquisition of companies. eg:- PSC recognised the acquisition of 30% of
RILs share by BP in KG-D6 block.

sandeep
Reply to this comment
csat paper 2 good books list..

MANI
Reply to this comment
hi,
anyone help me.
If LINGER is written as 123456 and FORCE is written as 56789. Then how to write FIERCE?
A. 345667
B. 456678
C. 345677
D. 556789

hapo
Reply to this comment
may be (b) er=56(as er and 56 are common); ling=1234; foc=789
fierce=er+fc+e+i={56+78+6+4} shuffled=456678
a and c have 3 and 4 but only one letter i comes form ling
d doesnt have any as it should contain atleast one for 1234
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mANI
Reply to this comment
how could you split FIERCE like this?

vips
Reply to this comment
defintely b. er means 56 or 65 1from foc so 3 and 2 from ling so 78, only option b matches

vips
Reply to this comment
1 from foc so 4 not 3

mANI
sorry.. cant get u!

Raam.K
Reply to this comment
Dude, the answer is D.check for the common letters in the word FORCE and FIERCE.its pretty obvious.

manukoleth
Reply to this comment
Come on! how can it be D. Other than R&E the other letters in FORCE & FIERCE is FOC and FIC respectively so 789
together can never come as it is evident that the letter I is not in 789 and it is in 1234 and hence D can never be the option.
As you can R & E are 56 [or 65] and hence C too cannot be the option because E repeats 2 times in FIERCE and hence an
option of 55 or 66 must be present.
Both A & B option qualify on this ground but. Now only one letter from the word LINGER [other that E & R] is taken in FIERCE
ie I so only one digit from 1234 must be present in the option. In Option A both 3 & 4 is present but B has just one digit that is
4 and Hence option B is the right option. Final Result-Option B

amritpal
Reply to this comment
Thx mrunal. been waiting for this..

Brijesh
Reply to this comment
Thanks a lot for your lucid explanation as always. One small clarification req. few points under the head royalty-tax regime. Point No.1
stated From the total profit from selling the oil, a fixed royalty is to be paid to the govt. Is it total revenue from selling the oil, right? and
Point No.3 has stated Government should allocate block to a company that offers maximum share from profit is it maximum share from
revenue?

Abhinav Kumar Singh

Reply to this comment
NELP it should be New Exploration and licensing Policy, rather than National
Anyways Great article as usual..with bit Edutainment.

Shakti Swami
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Again an applaudable work Sir..keep postingkudos

Pradeep Kar
Reply to this comment
Such a complicated subject, Gas Pricing formula, the contentions between govt and exploration companies, and to translate the details
of it in a lucid, explicit manner can be done only by Mrunal. Thank You so much for this article. I have been gathering pieces of
information on this topic, as newspaper do not cover the basics. Your article is comprehensive.

Jaan
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Jaan
Reply to this comment
I am not able to LOGIN DISCUSSIONS MRUNAL.. KINDLY HELP ME OUT. It says wrong password..

Jaan
Reply to this comment
UPSC MAINS EXPECTED PATTERN FROM 2013
OLD PATTERN MAINS NEW PATTERN MAINS STATUS
PAPERS PAPERS
GENERAL STUDIES I CURRENT EVENTS OF NATIONAL Changed
IMPORTANCE
GENERAL STUDIES II INDIAN CULTURE & HISTORY Changed
FIRST OPTIONAL I GEOGRAPHY OF INDIA Changed
FIRST SUBJECT II INDIAN ECONOMY Changed
SECOND OPTIONAL I GENERAL SCIENCE Changed
SECOND OPTIONAL II INDIAN POLITY AND Changed
INTERNATIONAL RELATIONS Changed

Rahul
Reply to this comment
what to read from frontline and kurkshetra sir?

[Result] UPSC CSE Mains 2012 result is out, interviews start from
4th March

[Diplomacy] Pakistan: Kishanganga Hydroproject Judgement,

Gwadar Port given to China

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