IF YOU look north from a helicopter hovering 30km (19 miles) off India’s east coast, the Bay of Bengal looks just as it must have done centuries ago. Tiny fishing boats with white sails pitch and yaw across the ocean. But look down and you will see the new India. A landing pad says “Dhirubhai” in big letters—the name of the founder of Reliance Industries. His son, Mukesh Ambani, now runs the firm (which is India’s second-most-valuable), and is India’s richest man.
The helipad sits on a vast processing ship. Oil and gas rise from the seabed 1km down. The vessel siphons off the oil while the gas is piped onshore. It is one part of an $11 billion project by Reliance and BP, a British oil giant, which was hailed as the answer to India’s energy problems—and is now embroiled in controversy.
When Reliance found gas in 2002 in a block called KGD6, it was the world’s biggest gas discovery that year and India’s largest since the 1970s. For the country it was wonderful news. Rather than import oil from the Middle East, blowing a hole in the balance of payments, or burn more filthy local coal, India could, it seemed, turn to a cheap and clean source of energy.
The discovery also showcased the power of India’s private sector. For decades Soviet-style state-run oil firms had searched for offshore energy. Only one big field, off the coast of Mumbai, had ever entered production, in the 1970s. After sporadic exploration efforts over the years, the big global energy firms had dismissed India as a barren place.
Dhirubhai Ambani, who had started his working life in a lowly job with Shell in Yemen, disagreed. He asked the experts, “How come God made India with no oil or gas?” When a new licensing regime came into place in 1999-2000, he piled in. Reliance bought 16 exploration blocks in two auctions, even as the global firms shied away, deterred by a low oil price and India’s patchy record. Dhirubhai died in July 2002. Four months later his company struck gold.
What was good for India was good for Reliance. As excitement built, analysts began to speculate that the firm might eventually evolve into the next “major” energy firm, rivalling the likes of Shell, Total and Exxon Mobil. As late as December 2009 Dhirubhai’s dream seemed on track. That month tests at KGD6 yielded production of 80 million standard cubic metres per day (mscmd). Huge capital investments had been made onshore in anticipation of a flood of gas, including at least $15 billion in gas-fired electricity plants built by a variety of power firms. The Ambanis spent $2 billion-3 billion on a new cross-country gas pipeline (owned by them rather than by Reliance at regulators’ insistence, they say).
That euphoria is long gone. Production started falling in late 2010 and today stands 80% below the peak. When KGD6 was first being developed Reliance reckoned it might contain 10 trillion cubic feet of gas. Proven and probable reserves today are just 3 trillion. Power plants lie idle. And Reliance is under fierce attack from some officials and politicians. Arvind Kejriwal is the leader of Aam Aadmi, an anti-corruption party that is contesting the national elections due in April and May. He thinks the gasfields are a giant scam.
What went wrong? An old saying about India is that whatever you say about the country is true—and its opposite. In this case two violently different views exist. The first is conspiratorial. It accuses Reliance of “gold-plating”. Under the production-sharing contract that governs the block, it can recoup its costs before any profits are split with the state. India’s national auditor has implied that Reliance deliberately inflated its costs, and hinted that it thinks some of the contractors used were secretly related to Reliance.
Worse still, Reliance is accused by some of holding India to ransom, deliberately suppressing production of gas until it could get a higher price for it. Under the original contract Reliance receives a “market-based” price, which in reality is set by the government. Until March this was fixed at $4.20 per million British Thermal Units (BTU), about a quarter of the price India pays for imports of liquefied natural gas. From April a new formula will apply, partly based on global benchmarks, which should see the price rise to about $8.
A disgraceful stitch-up, say anti-graft campaigners. They argue that Reliance, with its cash-rich balance-sheet and legacy of political influence, had every incentive to suppress production until it could bully the government to raise prices. In support of this view they point to the presence of BP. It bought into the project in 2011, as production was falling, at a valuation (it paid $7 billion for a 30% stake) that implied it was still a raging success. By this account the British firm knew that there would be a short-term “crisis” in output—and that once gas prices in India rose to more attractive levels the field’s production would miraculously “recover”.
It is hard for outsiders to evaluate the geology of KGD6; Reliance and its partners say that water had flooded parts of the field, giving a misleading initial impression of its potential, and that some gas pockets are isolated and hard to get to. But the conspiracy theory does, in totality, look implausible. On the charge of gold-plating, most analysts concede that there are some scenarios in which the small print of the production-sharing contract could give Reliance an incentive to overinvest. But most also think it almost impossible to fine-tune a big project to exploit these theoretical gains. Costs shot up because there was a global boom, inflating the price of hiring drilling rigs and equipment.
Besides denying all other wrongdoing, Reliance’s exasperated executives say it is ridiculous to suggest that contracts were handed to related parties. One of the contractors in question is Aker, a listed Norwegian firm no more related to Reliance than Roald Amundsen was to Gandhi.
What about the charge that production was deliberately suppressed, with BP as supposed partner in crime? Past and present executives at the British firm say that it knew when it signed the deal that the geology in KGD6 was tricky—it was brought in partly because of its expertise in subsea fields. It paid top dollar partly for the exploration potential in the five other blocks that Reliance and its partners still control today and partly for the potential of a “downstream” joint venture for marketing gas.
The financial incentives of the main players do not support the idea of a stitch-up. Mr Ambani has lost out on the gas pipeline he owns personally, which is thought barely to break even. His foreign partners were under pressure to maximise short-term profits, not feign a production slump. After the Deepwater Horizon accident in April 2010, BP faced a liquidity squeeze, a huge cash drain from litigation payments and the threat of a takeover. The smallest partner in the field is Niko Resources, a Canadian firm with a 10% stake. Its shares have fallen by 98% since 2010 and it has suffered financing problems.
Underwater in more ways than one
It is not clear that the project will make an acceptable return on capital, even at the higher gas price. Total cumulative capital investments will amount to $15 billion-20 billion, the bulk of them made before 2013. Estimates vary wildly, but total gross profits might amount to $20 billion-30 billion, most of them generated after 2016. Taking into account the time value of money, and income tax, the project could well be an example of value-destruction, not profiteering. ONGC, India’s largest state-owned energy firm, says some offshore discoveries are only viable at a gas price of $11 per BTU, well above the new price that Reliance will be receiving. (Since their gas production exceeds that of Reliance, ONGC and other state-run energy firms will be the main beneficiaries of the planned price rise.)
For now Reliance is trying to raise the output of existing fields and bring new ones online. In May it announced a “significant” discovery 4.5km below sea level, underneath the main field in the KGD6 block. BP expects the production of their joint venture to recover to 40-50mscmd by 2018. But the political and regulatory risks are acute. The consortium may be asked to provide bank guarantees to the government, so that any extra revenue from the gas-price rise can be clawed back if Reliance is found to have suppressed production or inflated costs. Campaigners are asking the courts to intervene. The government may yet abandon the price rise, or rip up the production-sharing contracts.
There are two lessons from the episode. The first is for India, an energy-hungry country whose vast east-coast waters now have only three deepwater rigs, from a peak of 13, according to one executive’s estimates. The main barrier to attracting more investment is not geology, but politics and regulation. The country combines the worst of both worlds—nit-picking day-to-day regulation and long-term uncertainty.
The second lesson is for Reliance. Secretive, clannish and forceful, it used to be both famed and resented for its ability to work the government behind the scenes. Now, in an era of activism against business and popular demands for transparency, this heritage is a liability. Even when the firm has a plausible case, few listen. Reliance is sitting on a huge reservoir—of mistrust. As well as drilling more gas beneath the Bay of Bengal, Mr Ambani needs to dig deep and modernise his firm.
Source: The Economist
